What are closing entries in accounting? Closing entries are journal entries that reduce the balances of all revenue and expense accounts to zero.
Since income statement accounts are temporary accounts, their balances don’t transfer from one accounting period to another. Instead, they always start each period at a zero balance by debiting revenue and crediting expenses to the income summary account. Think of it as a fresh start!
Once temporary accounts (revenues and expenses) are closed, the income summary account is then closed to owner’s equity or retained earnings. You may generate a post-closing trial balance to test the equality of debits and credits before the start of the next accounting period.
Closing Temporary Accounts
A temporary account is an account that doesn’t carry over to the next accounting period, which means that we have to close it before starting a new accounting period. Remember that all income statement accounts are temporary accounts, so all closing journal entries will focus on revenue and expense accounts.
Let’s see the pro forma entries for closing temporary accounts.
Debiting Revenues to Income Summary
The normal balance of revenue is credit. When we credit revenue, we increase its balance. During the closing stage, we need to reduce it to zero balance. Hence, we debit revenues and credit a holding account called income summary.
| Debit | Credit | |
|---|---|---|
| Revenues | xxx | |
| Income summary | xxx |
Debiting Expense to Income Summary
Just like revenue, we need to close all expenses. The normal balance of expenses is debit. Debiting expenses means that we increase its balance. During the closing stage, we credit expense accounts to reduce them to zero balance. With that, we also debit the income summary account to balance out the journal entry.
| Debit | Credit | |
|---|---|---|
| Income summary | xxx | |
| Expenses | xxx |
Closing Income Summary
After putting all temporary accounts in the income summary, we need to ultimately close the income summary account to the capital account. Note that the balance of the income summary account should be equal to the current period’s net income. Let’s examine the T-account below.
| Income Summary | |
|---|---|
| $0.00 | |
| Dr. Expense | Cr. Revenues |
| Ending balance (Net loss) | Ending balance (Net income) |
If the debits in the T-account exceed the credits, then the T-account has a debit balance representing a net loss for the period. If the credits exceed the debits, the T-account has a credit balance representing net income for the period.
Regardless of net income or loss, the income summary account must be closed to retained earnings. The closing journal entries for income summary are the following:
- If it results in net income (income summary has a credit balance)
| Debit | Credit | |
|---|---|---|
| Income summary | xxx | |
| Owner’s equity / Retained earnings | xxx |
- If it results in net loss (income summary has a debit balance)
| Debit | Credit | |
|---|---|---|
| Owner’s equity / Retained earnings | xxx | |
| Income summary | xxx |
Creating the Post-closing Trial Balance
At the end of the closing process, you may create a post-closing trial balance to test the equality of debits and credits. A post-closing trial balance is also a good accounting report if you want an overview of all balance sheet accounts after closing.
A post-closing trial balance only contains the permanent accounts (assets, liabilities, and equity). To make a post-closing trial balance, all you need to do is gather all non-zero accounts after the closing process and then assemble them in a trial balance format similar to the format below:
| Post-closing Trial BalanceAs of December 31, 20xx | ||
|---|---|---|
| Debit | Credit | |
| Assets | $xxx | |
| Liabilities | $xxx | |
| Equity | $xxx | |
| Balance | $xxx | $xxx |
If the trial balance doesn’t balance, there must be an arithmetical problem. Review the figures, and recompute them if necessary.
Closing Journal Entries: Comprehensive Example
To illustrate the closing process and closing journal entries, let’s use the trial balance of Petrichor Consulting as of December 29, 2023. The cells highlighted in light yellow are the accounts that we need to close. These are income statement accounts.
| Account | Debit | Credit |
|---|---|---|
| Cash | $379,000 | |
| Accounts receivable | $187,400 | |
| Allowance for doubtful accounts | $5,000 | |
| Supplies | $24,000 | |
| Prepaid insurance | $9,600 | |
| Equipment | $90,000 | |
| Accumulated depreciation | $27,000 | |
| Notes payable | $36,000 | |
| Accounts payable | $55,240 | |
| Interest payable | $720 | |
| Unearned revenues | $15,520 | |
| Salaries payable | $40,000 | |
| Owner's capital | $382,000 | |
| Consulting revenue | $322,520 | |
| Salaries expense | $150,000 | |
| Supplies expense | $18,480 | |
| Rent expense | $10,000 | |
| Insurance expense | $800 | |
| Interest expense | $720 | |
| Depreciation expense | $9,000 | |
| Bad debts expense | $5,000 | |
| Balance | $884,000 | $884,000 |
First, we close the revenue accounts by making the closing entry below:
| Debit | Credit | |
|---|---|---|
| Consulting revenue | $322,520 | |
| Income summary | $322,520 |
Once this entry is posted, the income summary account will have a credit balance of $322,520.
Second, we close the expense accounts by making the closing entry below:
| Debit | Credit | |
|---|---|---|
| Income summary | $194,000 | |
| Salaries expense | $150,000 | |
| Supplies expense | $18,480 | |
| Rent expense | $10,000 | |
| Insurance expense | $800 | |
| Interest expense | $720 | |
| Depreciation expense | $9,000 | |
| Bad debts expense | $5,000 |
After posting, the net balance of the income summary account is $128,520. The T-account below shows the effect of the journal entries above:
| Income Summary | |
|---|---|
| $0 | |
| $194,000 (Expenses) | $322,520 (Revenues) |
| $128,520 (Net income) | |
Ultimately, we close the income summary account to the retained earnings account.
| Debit | Credit | |
|---|---|---|
| Income Summary | $128,520 | |
| Owner’s capital | $128,520 |
The balance of the income summary account is now zero. The post-closing trial balance of Petrichor Consulting is shown below:
| Account | Debit | Credit |
|---|---|---|
| Cash | $379,000 | |
| Accounts receivable | $187,400 | |
| Allowance for doubtful accounts | $5,000 | |
| Supplies | $24,000 | |
| Prepaid insurance | $9,600 | |
| Equipment | $90,000 | |
| Accumulated depreciation | $27,000 | |
| Notes payable | $36,000 | |
| Accounts payable | $55,240 | |
| Interest payable | $720 | |
| Unearned revenues | $15,520 | |
| Salaries payable | $40,000 | |
| Owner's capital | $510,520 | |
| Balance | $690,000 | $690,000 |
Notice that there are no longer income statement accounts present. The updated balance of the owner’s capital is now $510,520 after adding the net income of $128,520.
Frequently Asked Questions (FAQs)
The three major closing journal entries are (1) closing revenues to income summary; (2) closing expenses to income summary; and (3) closing income summary to equity.
They are performed several days before the end of the accounting period.
Bottom Line
Closing journal entries are part of the full accounting cycle and is the second to last step. For manual accounting, closing entries are important. Otherwise, most accounting software makes the closing process easy. With just a few clicks, you can close the accounting books and start with the new accounting period.
