Closing entries accounting are made at the end of an accounting period to transfer the balances of temporary accounts (such as revenues, expenses, and dividends) to permanent accounts (like retained earnings). This process resets the temporary accounts to zero, preparing them for the next accounting period, and ensures that the net income or loss is accurately reflected in the equity section of the balance sheet.
Key Concepts
- Temporary Accounts: Accounts that accumulate balances only for the current accounting period (e.g., revenues, expenses, dividends).
- Permanent Accounts: Accounts that carry balances over multiple periods (e.g., assets, liabilities, equity).
- Income Summary: A temporary account used during the closing process to summarize net income or loss.
Steps for Closing Entries
- Close Revenue Accounts
- Close Expense Accounts
- Close Income Summary
- Close Dividends (if applicable)
Step-by-Step Closing Entries
1. Close Revenue Accounts
Transfer the balance of all revenue accounts to the Income Summary account.
Example: Revenue accounts with the following balances:
- Service Revenue: ₹500,000
- Sales Revenue: ₹300,000
Journal Entry:
| Date | Account Title | Debit (INR) | Credit (INR) | Description |
|---|---|---|---|---|
| 31-12-2023 | Service Revenue | 500,000 | Close Service Revenue to Income Summary | |
| 31-12-2023 | Sales Revenue | 300,000 | Close Sales Revenue to Income Summary | |
| 31-12-2023 | To Income Summary | 800,000 |
2. Close Expense Accounts
Transfer the balance of all expense accounts to the Income Summary account.
Example: Expense accounts with the following balances:
- Rent Expense: ₹100,000
- Salary Expense: ₹150,000
- Utilities Expense: ₹50,000
Journal Entry:
| Date | Account Title | Debit (INR) | Credit (INR) | Description |
|---|---|---|---|---|
| 31-12-2023 | Income Summary | 300,000 | Close Expenses to Income Summary | |
| 31-12-2023 | To Rent Expense | 100,000 | ||
| 31-12-2023 | To Salary Expense | 150,000 | ||
| 31-12-2023 | To Utilities Expense | 50,000 |
3. Close Income Summary
Transfer the balance of the Income Summary account to Retained Earnings. This step finalizes the net income or loss for the period.
Example: Assuming net income (revenues – expenses) is ₹500,000.
Journal Entry:
| Date | Account Title | Debit (INR) | Credit (INR) | Description |
|---|---|---|---|---|
| 31-12-2023 | Income Summary | 500,000 | Close Income Summary to Retained Earnings | |
| 31-12-2023 | To Retained Earnings | 500,000 |
4. Close Dividends (if applicable)
Transfer the balance of the Dividends account to Retained Earnings.
Example: Dividends paid during the year are ₹50,000.
Journal Entry:
| Date | Account Title | Debit (INR) | Credit (INR) | Description |
|---|---|---|---|---|
| 31-12-2023 | Retained Earnings | 50,000 | Close Dividends to Retained Earnings | |
| 31-12-2023 | To Dividends | 50,000 |
Combined Closing Entries
Combining all the steps, the closing entries would look like this:
| Date | Account Title | Debit (INR) | Credit (INR) | Description |
|---|---|---|---|---|
| 31-12-2023 | Service Revenue | 500,000 | Close Service Revenue to Income Summary | |
| 31-12-2023 | Sales Revenue | 300,000 | Close Sales Revenue to Income Summary | |
| 31-12-2023 | To Income Summary | 800,000 | ||
| 31-12-2023 | Income Summary | 300,000 | Close Expenses to Income Summary | |
| 31-12-2023 | To Rent Expense | 100,000 | ||
| 31-12-2023 | To Salary Expense | 150,000 | ||
| 31-12-2023 | To Utilities Expense | 50,000 | ||
| 31-12-2023 | Income Summary | 500,000 | Close Income Summary to Retained Earnings | |
| 31-12-2023 | To Retained Earnings | 500,000 | ||
| 31-12-2023 | Retained Earnings | 50,000 | Close Dividends to Retained Earnings | |
| 31-12-2023 | To Dividends | 50,000 |
Conclusion
Closing entries are crucial for accurately transitioning from one accounting period to the next. They ensure that temporary accounts are reset to zero, and the net income or loss is correctly reflected in retained earnings. This process maintains the integrity of financial statements and prepares the accounts for the upcoming period.