Closing Entries in Accounting: Everything You Need to Know +How to Post Them

The next step is to repeat the same process for your business’s expenses. All expenses can be closed out by crediting the expense stock in cash flow statement accounts and debiting the income summary. The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts.

Retained earnings are defined as a portion of a business’s profits that isn’t paid out to shareholders but is rather reserved to meet ongoing expenses of operation. Shaun Conrad is a Certified Public Accountant and CPA exam expert with how to register vehicles purchased in private sales california dmv a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise.

How to Record a Closing Entry

The closing entry entails debiting income summary and crediting retained earnings when a company’s revenues are greater than its expenses. The income summary account must be credited and retained earnings reduced through a debit in the event of a loss for the period. The permanent accounts in which balances are transferred depend upon the nature of business of the entity. For example, in the case of a company permanent accounts are retained earnings account, and in case of a firm or a sole proprietorship, owner’s capital account absorbs the balances of temporary accounts. Closing entries are performed after adjusting entries in the accounting cycle. Adjusting entries ensures that revenues and expenses are appropriately recognized in the correct accounting period.

Permanent accounts track activities that extend beyond the current accounting period. They’re housed on the balance sheet, a section of financial statements that gives investors an indication of a company’s value including its assets and liabilities. All of Paul’s revenue or income accounts are debited and credited to the income summary account.

How to close an income summary account?

1. There may be a scenario where a business’s revenues are greater than its expenses.
2. These entries transfer balances from temporary accounts—such as revenues, expenses, and dividends—into permanent accounts like retained earnings.
3. All of Paul’s revenue or income accounts are debited and credited to the income summary account.
4. Permanent accounts, also known as real accounts, do not require closing entries.
5. Remember that all revenue, sales, income, and gain accounts are closed in this entry.

A business will use closing entries in order to reset the balance of temporary accounts to zero. If expenses were greater than revenue, we would have net loss. A net loss would decrease retained earnings so we would do the opposite in this journal entry by debiting Retained Earnings and crediting Income Summary. ‘Retained earnings‘ account is credited to record the closing entry for income summary. Closing entries are put into action on the last day of an accounting period. There are various journals for example cash journal, sales journal, purchase journal etc., which allow users to record transactions and find out what caused changes in the existing balances.

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For example, the revenues account records the amount of revenues earned during an accounting period—not during the life of the company. We don’t want the 2015 revenue account to show 2014 revenue numbers. 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. Total revenue of a firm at the end of an accounting period is transferred to the income summary account to ensure that the revenue account begins with zero balance in the following accounting period. 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.

Close all dividend or withdrawal accounts

For corporations, Income Summary is closed entirely to “Retained Earnings”. 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. The month-end close is when a business collects financial accounting information.

Now Paul must close the income summary account to retained earnings in the next step of the 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 balances have been rolled into retained earnings. We do not need to show accounts with zero balances on the trial balances.