The process of using of the income summary account is shown in the diagram below. The month-end close is when a business collects financial accounting information. After Closing Entries in the accounting cycle, a Post-Closing Trial Balance would be created. Just like a normal Trial Balance, it will contain and display all accounts that have non-zero balances and see if the debits and credits will balance. Notice how only the balance in retained earnings
has changed and it now matches what was reported as ending retained
earnings in the statement of retained earnings and the balance
sheet. This adjusted trial balance reflects an accurate and fair view of your bakery’s financial position.
As mentioned above, Temporary Accounts are closed, and their balances are transferred into a Permanent Account. During the process of closing accounts, there are multiple steps and information that you must remember. If not followed precisely, it would cause a misreport of a very important Account. A process where all temporary accounts opened in the fiscal year are transferred and closed to a permanent arrangement. Doing so will give zero balance to the brief history to use for the next fiscal year. On the statement of retained earnings, we reported the
ending balance of retained earnings to be $15,190.
Step 2 of 3
And unless you’re extremely knowledgeable in how the accounting cycle works, it’s likely you’ll make a few accounting errors along the way. 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. Now that we know the basics of closing entries, in theory, let’s go over the step-by-step process of the entire closing procedure through a practical business example.
The expenses would be listed in the expense section, so you would need to find the total costs. Depending on the company, there could be many different expenses. Accounting Expense is a contra account that displays the balance of the assets and liabilities spent to generate Revenue in the business. The abbreviation REID makes it simple to recall which accounts need to be closed and how they are completed. Revenue, Expense, Income Summary, and Dividend are referred to as REID. Permanent Accounts are the opposite of Temporary Accounts as they are not closed at the end of the fiscal year, and their balances are carried over to the next fiscal year.
Temporary vs Permanent Accounts
Remember the income statement is like a moving picture of a business, reporting revenues and expenses for a period of time (usually a year). We see from the adjusted trial balance that our revenue accounts have a credit balance. 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. Once adjusting entries have been made, closing entries are used to reset temporary accounts and transfer their balances to permanent accounts.
You can do this by debiting the income summary account and crediting your capital account in the amount of $250. This reflects your net income for the month, and increases your capital account by $250. Other accounting software, such as Oracle’s PeopleSoft™, post closing entries to a special accounting period that keeps them separate from all of the other entries. So, even though the process today is slightly (or completely) different than it was in the days of manual paper systems, the basic process is still important to understand. After preparing the closing entries above, Service Revenue will now be zero. The expense accounts and withdrawal account will now also be zero.
8: Closing Entries
The income summary account is then closed to the retained earnings account. The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Take note that closing entries are prepared only for temporary accounts. 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). Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period.
‘Total expenses‘ account is credited to record the closing entry for expense accounts. In this case, if you paid out a dividend, the balance would be moved to retained earnings from the dividends account. Once this has been completed, a post-closing trial balance will be reviewed to ensure accuracy. The closing journal entries example comprises of opening and closing balances. Opening entries include revenue, expense, Depreciation etc., while closing entries include closing balance of revenue, liability, Depreciation etc. These entries are made to update retained earnings to reflect the results of operations and to eliminate the balances in the revenue and expense accounts, enabling them to be used again in a subsequent period.
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. The next step is to repeat the same process for your business’s expenses. All expenses can be closed out by crediting the expense accounts and debiting the income summary. All revenue accounts are first transferred to the income summary.
- It is a holding account for revenues and expenses before they are transferred to the retained earnings account.
- The goal is to make the
posted balance of the retained earnings account match what we
reported on the statement of retained earnings and start the next
period with a zero balance for all temporary accounts. - Any funds that are not held onto incur an expense that reduces NI.
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- C. If the income exceeds the cost in the income summary account, the result is a net profit, for which income summary account shows a credit balance.
- The opening balance is usually that balance which is brought forward at the beginning of an accounting year from the end of a previous accounting year.
Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own.