Closing the Books: Learn the Basics and How to Close the Books

25 Mar Closing the Books: Learn the Basics and How to Close the Books

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. Remember that revenue accounts normally have a credit balance so here we are debiting them to zero them out. You can find this by taking a look at the trial balance or income statement in your accounting system. ‘Retained earnings‘ account is credited to record the closing entry for income summary. In order to produce more timely information some businesses issue financial statements for periods shorter than a full fiscal or calendar year. Such periods are referred to as interim periods and the accounts produced as interim financial statements.

The expense accounts and withdrawal account will now also be zero. Once the finance team has confidence that their work reflects fair and proper accounting, they prepare a year-end financial statement. At a minimum, this includes a balance sheet, an income statement, an equity statement, and a cash flow statement. The year-end statements will be used by company executives, lenders, business partners, and investors to determine whether the business is financially sound and in compliance with regulations. It is also used for purposes of tax calculation and audit support. The purpose of the closing process for each period is to avoid incorrectly recording income or expenses in previous periods.

Step #2: Close Expense Accounts

• Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.
• There may be new regulations or recommended practices that should be followed.
• The closing entry entails debiting income summary and crediting retained earnings when a company’s revenues are greater than its expenses.
• 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.

Well, dividends are not part of the income statement because they are not considered an operating expense. In other words, they represent the long-standing finances of your business. That’s exactly what we will be answering in this guide –  along with the basics of properly creating closing entries for your small business accounting.

Usually, where the accounting is automated or done using software, this intermediate income summary account is not used, and the balances are directly transferred to the retained earnings account. The temporary accounts need to be zero at the end of an accounting period. Closing entries, also called closing journal entries, are entries made at the end of an accounting period to zero out all temporary accounts and transfer their balances to permanent accounts. In other words, the temporary accounts are closed or reset at the end of the year.

Temporary vs. Permanent Accounts

In this example we will close Paul’s Guitar Shop, Inc.’s temporary accounts using the income summary account method from his financial statements in the previous example. Both closing entries are acceptable and both result in the same outcome. All temporary accounts eventually get closed to retained earnings and are presented on the balance sheet. Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step. There is no need to close temporary accounts to another temporary account (income summary account) in order to then close that again. Temporary accounts are income statement accounts that are used to track accounting activity during an what is a closing entry accounting period.

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This resets the income accounts to zero and prepares them for the next year. This document establishes a clean starting point for the next accounting period, ensuring all accounts are balanced. It provides financial managers with a reliable framework for future planning and performance analysis, enhancing the integrity of financial reporting and supporting long-term stability. Revenue, expense, and dividends or withdrawals accounts are closed at the end of an accounting period. Closing entries are necessary to reset the balances of temporary accounts to zero and to update the Retained Earnings account.

For corporations, Income Summary is closed entirely to “Retained Earnings”. Compare all recorded transactions with the corresponding receipts, invoices, bank statements, credit card statements, etc. Make appropriate adjustment entries for any discrepancies discovered. Once the year-end close  is completed, final adjustments to the upcoming year’s financial plan are made. The data gathered for the year-end statements should help company decision-makers identify areas for improvement as well as opportunities for growth. The company’s short-term and long-term goals can be adjusted to put the company on the best course for success.

In short, we can clear all temporary accounts to retained earnings with a single closing entry. By debiting the revenue account and crediting the dividend and expense accounts, the balance of $3,450,000 is credited to retained earnings. All temporary accounts must be reset to zero at the end of the accounting period. To do this, their balances are emptied into the income summary account. The income summary account then transfers the net balance of all the temporary accounts to retained earnings, which is a permanent account on the balance sheet. The closing entry entails debiting income summary and crediting retained earnings when a company’s revenues are greater than its expenses.