Closing Entries

Closing journal entries are made at year-end to prepare temporary accounts for the next accounting period.

Temporary or nominal accounts, (also called income statement accounts), are measured periodically.

The amounts in one accounting period should be closed or brought to zero so that they won't be mixed with those of the next period.

Temporary accounts consist of all revenue and expense accounts, and also withdrawal accounts of owner/s in the case of sole proprietorships and partnerships.

Take note that closing entries are prepared only for temporary accounts. Permanent accounts are never closed.

Four Steps in Preparing Closing Entries

  1. Close all income accounts to Income Summary
  2. Close all expense accounts to Income Summary
  3. Close Income Summary to the appropriate capital account
  4. Close withdrawals to the capital account/s (this step is for sole proprietorship and partnership only)

Closing Entries: Example

Prepare the closing entries using the following information:

Gray Electronic Repair Services
Adjusted Trial Balance
December 31, 2014
         
Account Title   Debit   Credit
Cash   $    7,480.00    
Accounts Receivable   3,700.00    
Service Supplies   600.00    
Furniture and Fixtures   3,000.00    
Service Equipment   16,000.00    
Accumulated Depreciation       $      720.00
Accounts Payable       9,000.00
Utilities Payable       1,800.00
Loans Payable       12,000.00
Mr. Gray, Capital       13,200.00
Mr. Gray, Drawing   7,000.00    
Service Revenue       9,850.00
Rent Expense   1,500.00    
Salaries Expense   3,500.00    
Taxes and Licenses   370.00    
Utilities Expense   1,800.00    
Service Supplies Expense   900.00    
Depreciation Expense   720.00    
Totals   $  46,570.00   $  46,570.00

Step 1: Close all income accounts to Income Summary

Date
2014
Particulars Debit Credit
Dec 31 Service Revenue 9,850.00  
    Income Summary   9,850.00

In the given data, there is only 1 income account, i.e. Service Revenue. It has a credit balance of $9,850. To close that, we debit Service Revenue for the full amount and credit Income Summary for the same.

The Income Summary account is temporary. It is used to close income and expenses. As you will see later, Income Summary is eventually closed to capital.

Step 2: Close all expense accounts to Income Summary

  31 Income Summary 8,790.00  
    Rent Expense   1,500.00
    Salaries Expense   3,500.00
    Taxes and Licenses   370.00
    Utilities Expense   1,800.00
    Service Supplies Expense   900.00
    Depreciation Expense   720.00

To close expenses, we credit the expense accounts and debit Income Summary.

Now for the next 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. It would then have a credit balance of $1,060.

Notice that the balance of the Income Summary account is actually the net income for the period. Remember that net income is equal to all income minus all expenses.

Step 3: Close Income Summary to the appropriate capital account

The Income Summary balance is ultimately closed to the capital account.

  31 Income Summary 1,060.00  
    Mr. Gray, Capital   1,060.00

Step 4: Close withdrawals to the capital account

Note: This step is applicable only to sole proprietorships and partnerships.

In a sole proprietorship, a drawing account is maintained to record all withdrawals made by the owner. In a partnership, a drawing account is maintained for each partner. Drawing accounts are closed to capital at the end of the accounting period.

Our example is a sole proprietorship business. Mr. Gray's withdrawals are recorded in Mr. Gray, Drawing. To close the drawing account to the capital account, we credit the drawing account and debit the capital account. Notice that drawings decrease capital.

  31 Mr. Gray, Capital 7,000.00  
    Mr. Gray, Drawing   7,000.00

Conclusion

The purpose of closing entries is to prepare the temporary accounts for the next accounting period. In other words, the income and expense accounts are "restarted".

After preparing the closing entries above, Service Revenue will now be zero. The expense accounts and withdrawal accounts will now also be zero. The balances of these accounts have been absorbed by the capital account – Mr. Gray, Capital, which now has a balance of $7,260 ($13,200 beginning balance + $1,060 in step #3 - $7,000 in step #4).

Online resource for all things accounting. more
Search this Site
Featured in the Blog
Feedback
Questions, comments and suggestions?
Contact us here.
Copyright © 2016 Accountingverse.com - Your Online Resource For All Things Accounting
Terms of Use | Home | About | Contact