At the end of an accounting period, it is necessary to "close" the temporary accounts which means to make their balances zero. The temporary accounts are closed by transferring their balances to permanent accounts. This is done by passing closing entries. Closing entries are based on the account balances in the adjusted trial balance.
Temporary accounts include:
- Revenue, Income and Gain Accounts
- Expense and Loss Accounts
- Dividend, Drawings or Withdrawals Accounts
- Income Summary Account
The following example shows the closing entries based on the adjusted trial balance of Company A.
Closing Entries
Note | Date | Account | Debit | Credit |
1 | Jan 31 | Service Revenue | 85,600 | |
Income Summary | 85,600 | |||
2 | Jan 31 | Income Summary | 77,364 | |
Wages Expense | 38,200 | |||
Supplies Expense | 18,480 | |||
Rent Expense | 12,000 | |||
Miscellaneous Expense | 3,470 | |||
Electricity Expense | 2,470 | |||
Telephone Expense | 1,494 | |||
Depreciation Expense | 1,100 | |||
Interest Expense | 150 | |||
3 | Jan 31 | Income Summary | 8,236 | |
Retained Earnings | 8,236 | |||
4 | Jan 31 | Retained Earnings | 5,000 | |
Dividend | 5,000 |
Notes:
- Service revenue account is debited and income summary account is credited to transfer the balance of service revenue account to income summary account. If a business has other income accounts, for example gain on sale account, then the debit side of the first closing entry will also include the gain on sale account and the income summary account will be credited for the sum of all income accounts.
- Each expense account is credited and the income summary is debited for the sum of the balances of expense accounts.
- Income summary account is debited and retained earnings account is credited for the an amount equal to the excess of service revenue over total expenses i.e. the net balance in income summary account after posting the first two closing entries. In this case 85,600 − 77,364 = 8,236.
- The last closing entry transfers the dividend or withdrawal account balance to the retained earnings account.