Closing Entries

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:

1. Revenue, Income and Gain Accounts
2. Expense and Loss Accounts
3. Dividend, Drawings or Withdrawals Accounts
4. 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:

1. 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.
2. Each expense account is credited and the income summary is debited for the sum of the balances of expense accounts.
3. 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.
4. The last closing entry transfers the dividend or withdrawal account balance to the retained earnings account.

Post-Closing Trial Balance

A post-closing trial balance is a list of balances of ledger accounts prepared after closing entries have been passed and posted to the ledger accounts. Since the closing entries transfer the balances of temporary accounts (i.e. expense, revenue, gain, dividend and withdrawal accounts) to the retained earnings account, the new balances of temporary accounts are zero and therefore they are not listed on a post-closing trial balance. However, all the other accounts having non-negative balances are listed including the retained earnings account.

The preparation of post-closing trial balance is the last step of the accounting cycle and its purpose is to be sure that sum of debits equal the sum of credits before the start of new accounting period. It provides the openings balances for the ledger accounts of the new accounting period.

The following post-closing trial balance was prepared after posting the closing entries of Company A to its general ledger and calculating new account balances:

Company A
Adjusted Trial Balance
January 31, 2010
Particulars	Debit	Credit
Cash	20,430
Accounts Receivable	5,900
Office Supplies	4,320
Prepaid Rent	24,000
Equipment	80,000
Accumulated Depreciation		1,100
Accounts Payable		5,200
Utilities Payable		3,964
Unearned Revenue		1,000
Interest Payable		150
Notes Payable		20,000
Common Stock		100,000
Retained Earnings		3,236
Total	134,650	134,650

This is the end of the accounting cycle. In the next accounting period, the accounting cycle will be repeated again starting from the preparation of journal entries i.e. the first step of accounting cycle.