A Guide to Closing Entries: How to Prepare Them

how to do a closing entry

We have completed the first two columns and now we have the final column which represents the closing (or archive) process. All accounts can be classified as either permanent (real) or temporary (nominal) (Figure 5.3). Closing entry to account for draws taken for the month, for sole proprietors and partnerships. Closing entries help in the reconciliation of accounts which facilitates in types of government budget controlling the overall financials of a firm. You can close your books, manage your accounting cycle, issue invoices, pay back vendor bills, and so much more, from any device with an internet connection, just by downloading the Deskera mobile app. Instead,  as a form of distribution of a firm’s accumulated earnings, dividends are treated as a distribution of equity of the business.

Closing entries Closing procedure

how to do a closing entry

Now, the income summary account has a zero balance, whereas net income for the year ended appears as an increase (or credit) of $14,750. 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. After most of the cycle is completed and financial statements are generated, there’s one last step in the process known as closing your books. The process of using of the income summary account is shown in the diagram below. Printing Plus has a $4,665 credit balance in its Income Summary account before closing, so it will debit Income Summary and credit Retained Earnings. In this chapter, we complete the final steps (steps 8 and 9) of the accounting cycle, the closing process.

Movement on the Retained Earnings Account

After the posting of this closing entry, the income summary now has a credit balance of $14,750 ($70,400 credit posted minus the $55,650 debit posted). After the closing journal entry, the balance on the drawings account is zero, and the capital account has been reduced by 1,300. What is the current book value of your electronics, car, and furniture? Are the value of your assets and liabilities now zero because of the start of a new year? Your car, electronics, and furniture did not suddenly lose all their value, and unfortunately, you still have outstanding debt.

Step 2: Closing the expense accounts

As you will learn in Corporation Accounting, there are three components to the declaration and payment of dividends. The first part is the date of declaration, which creates the obligation or liability to pay the dividend. The second part is the date of record that determines who receives the dividends, and the third part is the date of payment, which is the date that payments are made.

Practice Question: Preparing a Closing Entry

The second entry requires expense accounts close to the Income Summary account. To get a zero balance in an expense account, the entry will show a credit to expenses and a debit to Income Summary. Printing Plus has $100 of supplies expense, $75 of depreciation expense–equipment, $5,100 of salaries expense, and $300 of utility expense, each with a debit balance on the adjusted trial balance.

  1. When dividends are declared by corporations, they are usually recorded by debiting Dividends Payable and crediting Retained Earnings.
  2. This is an optional step in the accounting cycle that you will learn about in future courses.
  3. Closing entry to account for draws taken for the month, for sole proprietors and partnerships.
  4. Failing to make a closing entry, or avoiding the closing process altogether, can cause a misreporting of the current period’s retained earnings.
  5. All of these entries have emptied the revenue, expense, and income summary accounts, and shifted the net profit for the period to the retained earnings account.
  6. All temporary accounts must be reset to zero at the end of the accounting period.

If your expenses for December had exceeded your revenue, you would have a net loss. When closing expenses, you should list them individually as they appear in the trial balance. Notice that the balance of the Income Summary account is actually the net income for the period. Remember that net income is equal to all income minus all expenses.

The third entry closes the Income Summary account to Retained Earnings. The fourth entry closes the Dividends account to Retained Earnings. The information needed to prepare closing entries comes from the adjusted trial balance. Companies use closing entries to reset the balances of temporary accounts − accounts that show balances over a single accounting period − to zero. By doing so, the company moves these balances into permanent accounts on the balance sheet.

These accounts are temporary because they keep their balances during the current accounting period and are set back to zero when the period ends. Revenue and expense accounts are closed to Income Summary, and Income Summary and Dividends are closed to the permanent account, Retained Earnings. When making closing entries, the revenue, expense, and dividend account balances are moved to the retained earnings permanent account.

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