The next day, January 1, 2019, you get ready for work, but before you go to the office, you decide to review your financials for 2019. What are your total expenses for rent, electricity, cable and internet, gas, and food for the current year? You have also not incurred any expenses yet for rent, electricity, cable, internet, gas or food. This means that the current balance of these accounts is zero, because they were closed on December 31, 2018, to complete the annual accounting period. Temporary account balances can either be shifted directly to the retained earnings account or to an intermediate account known as the income summary account beforehand. As part of the closing entry process, the net income (NI) is moved into retained earnings 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 accounting period. 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.
After closing both income and revenue accounts, the income summary account is also closed. All generated revenue of a period is transferred to retained earnings so that it is stored there for business use whenever needed. At the end of an accounting period when the books of accounts 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. We see from
the adjusted trial balance that our revenue accounts have a credit
balance.
Closing Entry for Income Summary
The statement of retained earnings shows the period-ending
retained earnings after the closing entries have been posted. When
you compare the retained earnings ledger (T-account) to the
statement of retained earnings, the figures must match. It is
important to understand retained earnings is not closed out, it is only updated. Retained
Earnings is the only account that appears in the closing entries
that does not close. You should recall from your previous material
that retained earnings are the earnings retained by the company
over time—not cash flow but earnings. Now that we have closed the
temporary accounts, let’s review what the post-closing ledger
(T-accounts) looks like for Printing Plus.
- As you will learn in
Corporation Accounting, there are three components to the
declaration and payment of dividends. - All accounts can be classified as either permanent (real) or
temporary (nominal) (Figure
5.3). - Do you want to learn more about debit, credit entries, and how to record your journal entries properly?
- You will notice that we do not cover step 10, reversing entries.
Printing Plus has $100 of dividends with a debit balance on the adjusted trial balance. The closing entry will credit Dividends and debit Retained Earnings. The income summary account is an intermediary between revenues and expenses, and the Retained Earnings account. It stores all of the closing information for revenues and expenses, resulting in a “summary” of income or loss for the period.
Types of Accounts
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. It is the end of the year,
December 31, 2018, and you are reviewing your financials for the
entire year.
Automating accounting management to increase projection velocity
Instead, declaring and paying dividends is a method utilized by
corporations to return part of the profits generated by the company
to the owners of the company—in this case, its shareholders. Dividend account is credited to record the closing entry for dividends. Any remaining balances will now be transferred and a post-closing trial balance will be reviewed. The fourth entry requires Dividends to close to the Retained Earnings account. Remember from your past studies that dividends are not expenses, such as salaries paid to your employees or staff.
They are special entries posted at the end of an accounting period. Using the above steps, let’s go through an example of what the closing entry process may look like. Adjusting entries are used to modify accounts so that they’re in compliance with the accrual concept of recording income and expenses. From the Deskera “Financial Year Closing” tab, you can easily choose the duration of your accounting closing period and the type of permanent account you’ll be closing your books to. We at Deskera offer the best accounting software for small businesses today. Our program is specifically developed for you to easily set up your closing process and initiate book closing within seconds – no prior technical knowledge necessary.
Understanding Closing Entries
Manually creating your closing entries can be a tiresome and time-consuming process. 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.
This means that the
current balance of these accounts is zero, because they were closed
on December 31, 2018, to complete the annual accounting period. 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). Only income statement accounts help us summarize income, so only income statement accounts should go into income summary. Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period. The Income Summary account has a credit balance of $10,240 (the revenue sum).
You should recall from your previous material that retained earnings are the earnings retained by the company over time—not cash flow but earnings. Now that we have closed the temporary accounts, let’s review what how to fill out & file form w the post-closing ledger (T-accounts) looks like for Printing Plus. The first entry closes revenue accounts to the Income Summary account. The second entry closes expense accounts to the Income Summary account.
Close all dividend or withdrawal accounts
Answer the following questions on closing entries and rate your confidence to check your answer. Most organizations appear to be doing well on the surface while underlying accounting management issues silently sabotage. Lengthy accounting cycles and inaccurate projections can result in revenue leaks costing companies millions.
Retained earnings represent the amount your business owns after paying expenses and dividends for a specific time period. 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. Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow.
These accounts will not be set back to zero at the beginning of the
next period; they will keep their balances. The $1,000 net profit balance generated through the accounting period then shifts. This is from the income summary to the retained earnings account. Failing to make a closing entry, or avoiding the closing process altogether, can cause a misreporting of the current period’s retained earnings. It can also create errors and financial mistakes in both the current and upcoming financial reports, of the next accounting period. As mentioned, one way to make closing entries is by directly closing the temporary balances to the equity or retained earnings account.
The balance in Income Summary is the same figure as what
is reported on Printing Plus’s Income Statement. You might be asking yourself, “is the Income Summary account
even necessary? ” Could we just close out revenues and expenses
directly into retained earnings and not have this extra temporary
account? We could do this, but by having the Income Summary
account, you get a balance for net income a second time. This gives
you the balance to compare to the income statement, and allows you
to double check that all income statement accounts are closed and
have correct amounts.
Recent Comments