Closing entries in accounting are something you are certainly going to run across if you take a position in internal accounting. While they tend to be similar and repetitive, it is worth having a good understanding of what entries are being made and why they are being made.
Let’s discuss closing entries before we get into a step-by-step example for beginners.
What Are Closing Entries in Accounting?
Closing entries are journal entries that are made at the end of an accounting period to transfer the balances of temporary accounts to permanent accounts. Temporary accounts include:
- Revenues
- Expenses
- Dividends
These are accounts that are reset to zero at the end of each accounting period. Permanent accounts do not get closed. These include
Balances of permanent accounts are carried forward to the subsequent accounting period.
How Often to Close Accounts in Accounting?
Accounts can be closed on a monthly, quarterly, semi-annual or annual basis. It is really determined by a company’s need for financial reporting. Most companies close on a monthly or annual basis but that isn’t to say it is uncommon to see a quarterly or semi-annual close.
What is the Income Summary Account in Closing Entries?
One account you’ll want to be aware of when performing closing entries is the income summary account. The income summary account is a temporary account that you put all revenue and expense accounts into at the end of the accounting period.
The account is then cleared out and transferred to retained earnings, which we will explain.
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How to Do Closing Entries in Accounting – What to Remember
When you make closing accounting entries, you can follow the same steps. We are going to go over these at a high level and then jump into each step individually.
First, you are going to start by identifying the temporary accounts that need to be closed. As we mentioned, these include revenue, expense, and dividend accounts.
Next, determine the ending balance of each temporary account. You can find this by taking a look at the trial balance or income statement in your accounting system.
Then you are going to create a journal entry to transfer the balance of each temporary account to the appropriate permanent account. For example, the balance of a revenue account will go to the income summary. More on this in a second.
Lastly, you’ll repeat the process for each temporary account that you have to close. Alright, with a high-level understanding let’s dive into the 4-step close process.
4-Step Closing Process in Accounting (Step-by-Step Example)
Imagine we are doing a month-end or year-end close, we’re going to follow these steps.
Step 1 – Close Revenue to the Income Summary
As we mentioned, the income summary is a temporary account in itself. You will start by clearing out the income accounts from the income statement (revenue) and crediting the income summary.
Closing Entry for Revenue
| Date | Account | Debit | Credit |
| December 31 | Revenue | $500,000 | |
| Income Summary | $500,000 |
Remember that revenue accounts normally have a credit balance so here we are debiting them to zero them out.
Step 2 – Close Expenses to the Income Summary
Similar to closing income, we close expenses. You can find the expenses on the income statement but the goal is to credit these accounts and zero them out.
| Date | Account | Debit | Credit |
| December 31 | Income Summary | $200,000 | |
| Expenses | $200,000 |
Remember that expense accounts have a normal debit balance so a credit will zero out their balance and then you can debit the income summary to move it.
Step 3 – Close Income Summary to Retained Earnings
Now that we have closed income and expenses, we need to move the balances from the income summary to retained earnings.
If you have completed a T account for the income summary account then you’d realize we have a profit of $300,000. ($500,000-$200,000 =$300,000)
Let’s debit the income summary since there is a credit balance of $300,000 in the income summary and credit retained earnings
| Date | Account | Debit | Credit |
| December 31 | Income Summary | $300,000 | |
| Retained earnings | $300,000 |
Step 4 – Close Dividends to Retained Earnings
The last entry is to close out dividends. If your company doesn’t have dividends then you won’t need to do this step. If it does, you’ll need to debit retained earnings and credit dividends like in the example here.
| Date | Account | Debit | Credit |
| December 31 | Dividends | $20,000 | |
| Retained earnings | $20,000 |
It’s important to carefully follow each step of the closing process in order to properly close the books at the end of an accounting period.
Closing the books not only helps to ensure the accuracy and completeness of the financial statements but also provides a clean set of books for the next accounting period.
Once all of the temporary accounts have been closed, review the journal entries to ensure that they are accurate and complete.
Lastly, prepare a post-closing trial balance to verify that the balances of the permanent accounts are correct and that the temporary accounts have been reset to zero. Your books should now be ready for the next accounting cycle.
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Do you Need to Close Your Books in Quickbooks?
If it all seems a bit complex or maybe you are a small business owner who takes on their own accounting, you may wonder if you really need to know closing entries in practice. The beautiful thing is that some accounting programs like QuickBooks, make these entries for you.
Since QuickBooks automates the year-end close, you don’t have to get caught up with all of these manual entries unless something was to go wrong. Even then you can get a bit of help or an accountant to sort you out.
Let’s Recap Accounting Closing Entries:
Closing entries in accounting are something that all businesses have to do. Here are the highlights we covered:
- Closing entries zero out temporary accounts and get them ready for the next accounting cycle.
- The goal of closing entries is to reset those temporary accounts.
- Follow the 4-step close process to close your books.
Closing Entries in Accounting: Final Thoughts
You might not feel like an expert in closing entries just yet but you can always refer back to refresh your memory.
As long as you do the closing entries in order and zero out those temporary accountants, you’ll be all set for the next accounting period. Don’t let closing entries scare you, they are much more straightforward than many people make them out to be!
