In this article, we will learn in-depth about closing entries including their definition, features, objective, necessity, preperation method, example, and many more.
What are Closing Entries?
The journal entries made at the end of an accounting period for the purpose of transferring the balances of temporary accounts to a permanent owner’s equity account are known as closing entries.
Closing entries are entries made to close and clear the revenue and expense accounts and to transfer the amount of the net income or loss to a capital account or accounts or, to the retained earning accounts.Pyle and Larson
Closing entries are the entries provided closing the income-expenditure accounts and transferring it to the owner’s capital or the retained earnings statement during the preparation of financial statements at the end of the accounting year.
What is the Main Objective of Closing Entries?
The main objective of closing entries is to close the nominal accounts (income and expenditure account) at the end of the accounting period and transferring the net profit or loss of the organization as well as the withdrawal of the owner to the owner’s capital account or retained income statement.
What are the Features of Closing Entries?
The important features of the closing entries are as follows:
1. A required step in the accounting cycle is journalizing and posting closing entries.
2. Closing entries record the transfer of net income or net loss and the owner’s drawings from the owner’s capital to the owner’s capital in the ledger.
3. The closing entries are reflected in the owner’s equity statement.
4. Closing entries are only used to close nominal accounts; they are not used to close permanent accounts.
5. Closing entries leave each temporary account with a zero balance. The temporary accounts are now ready to collect data in the next accounting period, separate from previous periods’ data.
Why do Companies Prepare Closing Entries?
The business organization’s income-expenditure account is linked to the accounting period. The usefulness of these accounts ends in the relevant accounting period.
All of these accounts appear on the income statement, and their impact is temporary.
In other words, their usefulness expires during the accounting period. Their balances will not be transferable in the following year. During the current accounting period, these accounts are closed.
Companies use closing entries to transfer nominal account (Income and expenditure) balances to the permanent owner’s equity account, Owner’s Capital, at the end of the accounting period.
When are the Closing Entries Prepared?
Companies usually prepare the closing entries only at the end of the annual accounting period after the preparation of financial statements.
How to Prepare Closing Entries?
Companies could close each income statement account directly to the owner’s capital when preparing closing entries. However, doing so would result in an excessive amount of detail in the Owner’s Capital account.
Instead, companies close the revenue and expense accounts and transfer the resulting net income or net loss to the owner’s capital through a temporary account called Income Summary.
The general journal is where businesses record their closing entries. The closing entries are then posted to the ledger accounts.
In most cases, companies prepare closing entries directly from the ledger’s adjusted balances. They could make separate closing entries for each nominal account, but the following four entries will save time:
Closing Entries for Revenue Account:
Each Revenue A/c————Debit
Income Summary A/c——-Credit
Closing Entries for Expenses Account:
Income Summary A/c—–Debit
Closing Entries for Income Summary Account
Income Summary A/c—–Debit
Owner’s Capital A/c——–Credit
Owner’s Capital A/c——–Debit
Income Summary A/c—–Credit
Closing Entries for Owner’s Drawings Account
Owner’s Capital A/c——–Debit
Owner’s Drawings A/c—-Credit
Which Things to keep in Mind When Preparing Closing Entries?
There are a few things to keep in mind when preparing closing entries.
- Instead of zeroing the revenue and expense balances, avoid accidentally doubling them.
- Do not close the Owner’s Drawings account via the Income Summary account. Owner’s Drawings are neither an expense nor a factor in calculating net income.
Example of Closing Entries:
The following example will help you better understand closing entries.
|Date||Account Titles & Explanations||Ref.||Debit||Credit|
|Dec 31||Income Summary||$3000|
|(To close revenue account)|
|Dec 31||Income Summary||$2000|
|Salaries and wages Expenses||$900|
|Supplies Expense||$ 300|
|(To close expense accounts)|
|Dec 31||Income Summary||$1000|
|(To close net income to capital)|
|Dec 31||Owner’s Capital||$400|
|(To close drawings to capital)|
What is the Difference between Adjusting Entries and Closing Entries?
The following are the 5 important differences between the adjusting entries and the closing entries:
|Sl No.||Subject||Adjusting Entries||Closing Entries|
|1.||Definition||Adjusting entries refers to the recordings of unadjusted transactions such as arrears and income, expenses paid in advance, and income received in advance at the time of preparation of the final account at the end of an accounting period.||Closing entries are the entries required to close the nominal accounts i.e. expenses and income.|
|2.||Time||Adjusting entries come before closing entries.||Closing entries are provided following the adjusting entries.|
|3.||Content||This section contains entries for topics other than trial balance.||These entries are provided for both inclusive and exclusive trial balance subjects.|
|4.||Result||This entry determines the actual expenditure and income which helps in calculating the profit and loss of the accounting period.||As a result of this entry, the accounts related to income and expenditure in the ledger were closed.|
|5.||Business Closure||This entry is not required at the time of business closure.||This entry is required at the time of business closure.|
According to the preceding discussion, although there is a distinction between adjusting and closing entries, both aid in the preparation of an organization’s final accounts.
You can also read: