It effortlessly sifts through large amounts of data and generates closing entries automatically. This ensures that your financial operations infrastructure can scale with your business’s growth. We
have completed the first two columns and now we have the final
column which represents donating to charity the closing (or archive) process. The Income Summary balance is ultimately closed to the capital account. This entry zeros out dividends and reduces retained earnings by total dividends paid. With the use of modern accounting software, this process often takes place automatically.

The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Temporary account balances can either be shifted directly to the retained earnings account or to an intermediate account known as the income summary account beforehand. This process resets both the income and expense accounts to zero, preparing them for the next accounting period. These accounts have continuous balances that carry forward from one accounting period to another. Examples of accounts not affected by closing entries include asset, liability, and equity accounts. However, you might wonder, “Where are the revenue, expense, and dividend accounts?” Trial balances often filter out accounts with zero balances.

Retained earnings are those earnings not distributed to shareholders as dividends, but retained for further investment, often in advertising, sales, production, and equipment. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.

1. It’s essential for businesses to perform this process efficiently to ensure that their financial statements reflect true performance and inform decision-making.
2. Any funds that are not held onto incur an expense that reduces NI.
3. The income summary is used to transfer the balances of temporary accounts to retained earnings, which is a permanent account on the balance sheet.
4. Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period.
5. This process ensures that your temporary accounts are properly closed out sequentially, and the relevant balances are transferred to the income summary and ultimately to the retained earnings account.

Instead, the basic closing step is to access an option in the software to close the reporting period. Doing so automatically populates the retained earnings account for you, and prevents any further transactions from being recorded in the system for the period that has been closed. 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 income summary account is a temporary account solely for posting entries during the closing process.

Purpose of Closing Entries

The purpose of closing entries is to prepare the temporary accounts for the next accounting period. Closing journal entries are made at the end of an accounting period to prepare the accounting records for the next period. They zero-out the balances of temporary accounts during the current period to come up with fresh slates for the transactions in the next period. 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. Whether you’re posting entries manually or using accounting software, all revenue and expenses for each accounting period are stored in temporary accounts such as revenue and expenses.

Transitioning to New Accounting Period

Without closing revenue accounts, you wouldn’t be able to compare how much your business earns each period because the amount would build up. And without closing expense https://simple-accounting.org/ accounts, you couldn’t compare your business expenses from period to period. Temporary accounts are used to record accounting activity during a specific period.

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. The trial balance is like a snapshot of your business’s financial health at a specific moment.

As you will see later, Income Summary is eventually closed to capital. Because you paid dividends, you will need to reduce your retained earnings account, which is what this entry accomplishes. 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 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.

How do you close revenue accounts to retained earnings?

The entries take place “behind the scenes,” often with no income summary account showing in the chart of accounts or other transaction records. Closing revenue accounts is a critical task in the accounting cycle, marking the end of an accounting period and setting the stage for accurate financial reporting. It’s essential for businesses to perform this process efficiently to ensure that their financial statements reflect true performance and inform decision-making.

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. To close that, we debit Service Revenue for the full amount and credit Income Summary for the same. We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars.

We will debit the revenue accounts and credit the
Income Summary account. The credit to income summary should equal
the total revenue from the income statement. Transitioning from preparation to execution, the closure of revenue accounts is a systematic process that involves recording the necessary journal entries and updating the general ledger. This phase is where the preparatory work comes to fruition, ensuring that the financial records accurately represent the company’s revenue activities for the period. The first step in preparing for revenue account closure is to identify all revenue accounts that need to be closed for the period. This typically includes all income accounts, such as sales revenue, service revenue, and any other income streams the business has.

The balance in dividends, revenues and expenses
would all be zero leaving only the permanent accounts for a post
closing trial balance. The trial balance shows the ending balances
of all asset, liability and equity accounts remaining. The main
change from an adjusted trial balance is revenues, expenses, and
dividends are all zero and their balances have been rolled into
retained earnings. We do not need to show accounts with zero
balances on the trial balances. Once the relevant accounts have been identified, the next step is to review their balances and underlying transactions.

What are Temporary and Permanent Accounts?

The balances from these temporary accounts have been transferred to the permanent account, retained earnings. Moreover, technology facilitates real-time data processing, which allows for a more dynamic and responsive approach to closing revenue accounts. With immediate access to financial data, accountants can quickly identify and address discrepancies, ensuring that the financial records are always up-to-date. This real-time capability is particularly beneficial in today’s fast-paced business environment, where timely financial information is crucial for decision-making. After preparing the closing entries above, Service Revenue will now be zero.

The trial balance shows the ending balances of all asset, liability and equity accounts remaining. The main change from an adjusted trial balance is revenues, expenses, and dividends are all zero and their balances have been rolled into retained earnings. We do not need to show accounts with zero balances on the trial balances. In the short way, we can clear all temporary accounts to retained earnings with a single closing entry. By debiting the revenue account and crediting the dividend and expense accounts, the balance of $3,450,000 is credited to retained earnings.

The process of recording closing entries involves transferring the balances of all revenue accounts to a temporary account, typically referred to as the Income Summary account. This is done by debiting each revenue account for the amount of its credit balance, thereby bringing the balance to zero. Concurrently, the Income Summary account is credited for the total revenue.