5 1 Describe and Prepare Closing Entries for a Business Principles of Accounting, Volume 1: Financial Accounting

If this is the case, then this temporary dividends account needs to be closed at the end of the period to the capital account, Retained Earnings. When dividends are declared by corporations, they are usually recorded by debiting Dividends Payable and crediting Retained Earnings. Note that by doing this, it is already deducted from Retained Earnings (a capital account), hence will not require a closing entry. To close the drawing account to the capital account, we credit the drawing account and debit the capital account. Temporary accounts include all revenue and expense accounts, and also withdrawal accounts of owner/s in the case of sole proprietorships and partnerships (dividends for corporations).

What Are Closing Entries?

The balance in dividends, revenues and expenses would all be zero leaving only the permanent accounts for a post closing trial balance. The trial balance shows the ending balances of all asset, liability and equity accounts remaining. The main change from an adjusted trial balance is revenues, expenses, and dividends are all zero and their nonprofit accounting explanation balances have been rolled into retained earnings. We do not need to show accounts with zero balances on the trial balances. This is no different from what will happen to a company at the end of an accounting period. A company will see its revenue and expense accounts set back to zero, but its assets and liabilities will maintain a balance.

Temporary vs Permanent Accounts

To make them zero we want to decrease the balance or do the opposite. We will debit the revenue accounts and credit the Income Summary account. The credit to income summary should equal the total revenue from the income statement.

Closing Journal Entries

We need to do the closing entries to make them match and zero out the temporary accounts. Now that the journal entries are prepared and posted, you are almost ready to start next year. Remember, modern computerized accounting systems go through this process in preparing financial statements, but the system does not actually create or post journal entries. From this trial balance, as we learned in the prior section, you make your financial statements. After the financial statements are finalized and you are 100 percent sure that all the adjustments are posted and everything is in balance, you create and post the closing entries.

What is a Closing Entry?

Now for this step, we need to get the balance of the Income Summary account. In step 1, we credited it for $9,850 and debited it in step 2 for $8,790. As you will see later, Income Summary is eventually closed https://www.online-accounting.net/ to capital. To close that, we debit Service Revenue for the full amount and credit Income Summary for the same. Prepare the closing entries for Frasker Corp. using the adjusted trial balance provided.

If you own a sole proprietorship, you have to close temporary accounts to the owner’s equity instead of retained earnings. The retained earnings account balance has now increased to 8,000, and forms part of the trial balance after the closing journal entries have been made. This trial balance gives the opening balances for the next accounting period, and contains only balance sheet accounts including the new balance on the retained earnings account as shown below. It is permanent because it is not closed at the end of each accounting period. At the start of the new accounting period, the closing balance from the previous accounting period is brought forward and becomes the new opening balance on the account. Other than the retained earnings account, closing journal entries do not affect permanent accounts.

Closing journal entries are made at the end of an accounting period to prepare the accounting records for the next period. They zero-out the balances of temporary accounts during the current period to come up with fresh slates for the transactions in the next period. At the end of an accounting period when the books of accounts https://www.online-accounting.net/how-to-find-the-present-value-of-your-annuity/ are at finalization stage, some special journal entries are required to be passed. In accounting terms, these journal entries are termed as closing entries. The main purpose of these closing entries is to bring the temporary journal account balances to zero for the next accounting period, which keeps the accounts reconciled.

1. For sole proprietorships and partnerships, you’ll close your drawing account to your capital account, because you will need to reduce your capital account by the draws taken for the month.
2. Therefore, these accounts still have a balance in the new year, because they are not closed, and the balances are carried forward from December 31 to January 1 to start the new annual accounting period.
3. In just a few clicks, the entire financial year closing is streamlined for you.
4. Instead,  as a form of distribution of a firm’s accumulated earnings, dividends are treated as a distribution of equity of the business.

Therefore, these accounts still have a balance in the new year, because they are not closed, and the balances are carried forward from December 31 to January 1 to start the new annual accounting period. Our discussion here begins with journalizing and posting the closing entries (Figure 5.2). These posted entries will then translate into a post-closing trial balance, which is a trial balance that is prepared after all of the closing entries have been recorded. Take note that closing entries are prepared only for temporary accounts. The purpose of closing entries is to merge your accounts so you can determine your retained earnings.

Retained earnings represent the amount your business owns after paying expenses and dividends for a specific time period. Clear the balance of the expense accounts by debiting income summary and crediting the corresponding expenses. Permanent accounts are accounts that show the long-standing financial position of a company.

The Retained Earnings account balance is currently a credit of $4,665. Let’s explore each entry in more detail using Printing Plus’s information from Analyzing and Recording Transactions and The Adjustment Process as our example. The Printing Plus adjusted trial balance for January 31, 2019, is presented in Figure 5.4.