How to Create Opening and Closing Entries in Accounting

The balance in the Income Summary account equals the net income or loss for the period. However, you might wonder, “Where are the revenue, expense, and dividend accounts?” Trial balances often filter out accounts with zero balances. If we expand the view, we’ll find the usual suspects—the temporary accounts. These accounts were reset to zero at the end of the previous year to start afresh.

These accounts will not be set back to zero at the beginning of the next period; they will keep their balances. 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?

1. All revenue and expense accounts must end with a zero balance because they are reported in defined periods and are not carried over into the future.
2. If your business uses automatic software to manage your financial needs, it will not use an income summary account to shift these temporary account balances.
3. Adjusting entries are used to modify accounts so that they’re in compliance with the accrual concept of recording income and expenses.
4. Other than the retained earnings account, closing journal entries do not affect permanent accounts.
5. No matter which way you choose to close, the same final balance is in retained earnings.
6. Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period.

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. 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.

If your business is a corporation, you will not have a drawing account, but if you paid stockholders, you will have a dividends account. If you paid dividends for the month, you will need to close that account https://intuit-payroll.org/ as well. 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.

Closing Entry for Expense Account

Income and expenses are closed to a temporary clearing account, usually Income Summary. Afterwards, withdrawal or dividend accounts are also closed to the capital account. However, some corporations use a temporary clearing account for dividends declared (let’s use “Dividends”). They’d record declarations by debiting Dividends Payable and crediting Dividends. 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.

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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.

In summary, permanent accounts hold balances that persist from one period to another. In contrast, temporary accounts capture transactions and activities for a specific period and require resetting to zero with closing entries. 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. A closing entry is a journal entry that is made at the end of an accounting period to transfer balances from a temporary account to a permanent account.

Should closing entries be performed before or after adjusting entries?

Therefore, it will not appear on any trial balances, including the adjusted trial balance, and will not appear on any of the financial statements. Closing entries are those journal entries made in a manual accounting system at the end of an accounting period to shift the balances in temporary accounts to permanent accounts. Temporary accounts are used to compile transactions that impact the profit or loss of a business during a year, while permanent accounts maintain an ongoing balance over time.

Let’s investigate an example of how closing journal entries impact a trial balance. Imagine you own a bakery business, and you’re starting a new financial year on March 1st. 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. Now that the journal entries are prepared and posted, you are almost ready to start next year.

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. The eighth step in the accounting cycle is preparing closing entries, which includes journalizing and posting the entries to the ledger. Companies are required to close their books at the end of each fiscal year so that they can prepare their annual financial statements and tax returns. Let’s move on to learn about how to record closing those temporary accounts. Whether you’re processing closing entries manually, or letting your accounting software do the work, closing entries are perhaps the most important part of the accounting cycle.

Opening entries, also known as initial entries, are made at the beginning of an accounting period. All opening entries should be recorded in the general ledger journal of the business and will represent the opening balance of accounts for the new period. 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). As mentioned, one way to make closing entries is by directly closing the temporary balances to the equity or retained earnings account. These permanent accounts form the foundation of your business’s balance sheet.

The credit to income summary should equal
the total revenue from the income statement. 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.

Step 3: Closing the income summary account

We see from the adjusted trial balance that our revenue account has a credit balance. To make the balance zero, debit the revenue account and credit the Income Summary account. In this example we will close Paul’s Guitar Shop, Inc.’s temporary accounts using the income summary account method from his financial statements in the previous example. Both closing entries are acceptable and both result in the same outcome. All temporary accounts eventually get closed to retained earnings and are presented 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.

The general journal is used to record various types of accounting entries, including closing entries at the end of an accounting period. Now, all the temporary accounts stand tall with their respective figures, showcasing the revenue your bakery has generated, the expenses it has incurred, and the dividends declared throughout the past year. The trial balance is like a snapshot of your business’s financial health at a specific moment. In this case, since it’s an opening trial balance, we’re just getting started with the accounting cycle (Step 1). The next and final step in the accounting cycle is to prepare one last post-closing trial balance. Instead the balances in these accounts are moved at month-end to either the capital account or 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. Closing entries prepare a company for the next accounting period by clearing any outstanding difference between fixed and flexible budget balances in certain accounts that should not transfer over to the next period. Closing, or clearing the balances, means returning the account to a zero balance. Having a zero balance in these accounts is important so a company can compare performance across periods, particularly with income.