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How to Create Opening and Closing Entries in Accounting

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.

  1. Clear the balance of the revenue account by debiting revenue and crediting income summary.
  2. Examples of accounts not affected by closing entries include asset, liability, and equity accounts.
  3. The use of closing entries resets the temporary accounts to begin accumulating new transactions in the next period.
  4. Prepaid taxes will be reversed within one year but can result in prepaid assets and liabilities.

The post-closing T-accounts will be transferred to the post-closing trial balance, which is step 9 in the accounting cycle. To further clarify this concept, balances are closed to assure all revenues and expenses are recorded in the proper period and then start over the following period. The revenue and expense accounts should start at zero each period, because we are measuring how much revenue is earned and expenses incurred during the period. However, the cash balances, as well as the other balance sheet accounts, are carried over from the end of a current period to the beginning of the next period.

Financial Accounting

Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow. The total of the income summary account after the all temporary accounts have been close should be equal to the net income for the period. Now that the journal entries are prepared and posted, you are almost ready to start next year. Remember, modern computerized accounting systems go through this process in preparing financial statements, but the system does not actually create or post journal entries. 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. Income summary effectively collects NI for the period and distributes the amount to be retained into retained earnings.

Step #4: Close Dividends

Notice that the Income Summary account is now zero and is ready for use in the next period. The Retained Earnings account balance is currently a credit of $4,665. 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.

Step 3: Close and Credit

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. This process resets both the income and expense accounts to zero, preparing them for the next accounting period. After the land depreciation, the balance on the drawings account is zero, and the capital account has been reduced by 1,300. 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.

Answer the following questions on closing entries
and rate your confidence to check your answer. We
have completed the first two columns and now we have the final
column which represents the closing (or archive) process. It’s vital in business to keep a detailed record of your accounts. All accounts can be classified as either permanent (real) or temporary (nominal) (Figure 5.3). Answer the following questions on closing entries and rate your confidence to check your answer.

As well as being consistently up-to-date on the financial health of your business. The third entry requires Income Summary to close to the Retained Earnings account. To get a zero balance in the Income Summary account, there are guidelines to consider. The income statement reflects your net income for the month of December.

Your car, electronics, and furniture did not suddenly lose all their value, and unfortunately, you still have outstanding debt. Therefore, these accounts still have a balance in the new year, because they are not closed, and the balances are carried forward from December 31 to January 1 to start the new annual accounting period. Our discussion here begins with journalizing and posting the closing entries (Figure 5.2). 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. Businesses can easily open and close accounts every period by using accounting software to track all financial transactions throughout a given period.

Practice Questions: Types of Accounts

Although it is not an income statement account, the dividend account is also a temporary account and needs a closing journal entry to zero the balance for the next accounting period. Closing journal entries are used at the end of the accounting cycle to close the temporary accounts for the accounting period, and transfer the balances to the retained earnings account. If a company’s revenues are greater than its expenses, the closing entry entails debiting income summary and crediting retained earnings. In the event of a loss for the period, the income summary account needs to be credited and retained earnings reduced through a debit. The second entry requires expense accounts close to the Income Summary account.

The permanent accounts in which balances are transferred depend upon the nature of business of the entity. For example, in the case of a company permanent accounts are retained earnings account, and in case of a firm or a sole proprietorship, owner’s capital account absorbs the balances of temporary accounts. Now that all the temporary accounts are closed, the income summary account should have a balance equal to the net income https://intuit-payroll.org/ shown on Paul’s income statement. Now Paul must close the income summary account to retained earnings in the next step of the closing entries. Closing your accounting books consists of making closing entries to transfer temporary account balances into the business’ 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).

To get a zero balance in an expense account, the entry will show a credit to expenses and a debit to Income Summary. Printing Plus has $100 of supplies expense, $75 of depreciation expense–equipment, $5,100 of salaries expense, and $300 of utility expense, each with a debit balance on the adjusted trial balance. The closing entry will credit Supplies Expense, Depreciation Expense–Equipment, Salaries Expense, and Utility Expense, and debit Income Summary.

Prepare the closing entries for Frasker Corp. using the adjusted trial balance provided. 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. HighRadius Autonomous Accounting Application consists of End-to-end Financial Close Automation, AI-powered Anomaly Detection and Account Reconciliation, and Connected Workspaces.

If you paid dividends for the month, you will need to close that account as well. This transaction increases your capital account and zeros out the income summary account. Revenue is one of the four accounts that needs to be closed to the income summary account. This is the adjusted trial balance that will be used to make your closing entries. One of the most important steps in the accounting cycle is creating and posting your closing entries. As you will see later, Income Summary is eventually closed to capital.

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