This means you are preparing all steps in the accounting cycle by hand. In this chapter, we complete the final steps (steps 8 and 9) of the accounting cycle, the closing process. This is an optional step in the accounting cycle that you will learn about in future courses. Steps 1 through 4 were covered in Analyzing and Recording Transactions and Steps 5 through 7 were covered in The Adjustment Process. Now for this step, we need to get the balance of the Income Summary account. In step 1, we credited it for $9,850 and debited it in step 2 for $8,790.
- The purpose of the income summary is to show the net income (revenue less expenses) of the business in more detail before it becomes part of the retained earnings account balance.
- In the event of a loss for the period, the income summary account needs to be credited and retained earnings reduced through a debit.
- These accounts were reset to zero at the end of the previous year to start afresh.
- Afterwards, withdrawal or dividend accounts are also closed to the capital account.
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.
Closing Entry for Dividends Account
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). The eighth step in the accounting cycle is preparing closing entries, which includes journalizing and posting the entries to the ledger. 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.
When an accountant closes an account, the account balance returns to zero. Starting with zero balances in the temporary accounts each year makes it easier to track revenues, expenses, and withdrawals and to compare them from one year to the next. There are four closing entries, which transfer all temporary account balances to the owner’s capital account. This is no different from what will happen to a company at the end of an accounting period. A company will see its revenue and expense accounts set back to zero, but its assets and liabilities will maintain a balance.
Temporary accounts include revenue, expenses, and dividends, and these accounts must be closed at the end of the accounting year. To update the balance in the owner’s capital account, accountants close revenue, expense, and drawing accounts at the end of each fiscal year or, occasionally, at the end of each accounting period. For this reason, these types of accounts are called temporary or nominal accounts.
To close that, we debit Service Revenue for the full amount and credit Income Summary for the same. All modern accounting software automatically generates closing entries, so these entries are no longer required of the accountant; it is usually which of the following accounts will be debited in the closing entry at the end of the year? not even apparent that these entries are being made. Accounts payable form the largest portion of the current liability section on the company’s financial statements. The income statement summarizes your income, as does income summary.
What are Closing Entries?
As an another example, you should shift any balance in the dividends paid account to the retained earnings account, which reduces the balance in the retained earnings account. In order to produce more timely information some businesses issue financial statements for periods shorter than a full fiscal or calendar year. Such periods are referred to as interim periods and the accounts produced as interim financial statements.
The closing entries are the last journal entries that get posted to the ledger. Only balance sheet accounts are included in the post-closing trial balance and are prepared at the end of the accounting cycle. When revenues exceed the expenses, the income summary account will be positive and will have a credit balance. The balance of the income summary account should tally with the net income as derived from the income statement. However, you might wonder, “Where are the revenue, expense, and dividend accounts?