The balances of these accounts are eventually used to construct the income statement at the end of the fiscal year. At the end of the year, all the temporary accounts must be closed or reset, so the beginning of the following year will have a clean balance to start with. In other words, revenue, expense, and withdrawal accounts always have a zero balance at the start of the year because they are always closed at the end of the previous year.

When the income statement is published at the end of the year, the balances of these accounts are transferred to the income summary, which is also a temporary account. All temporary accounts with zero balances were left out of this trial balance. Unlike previous trial balances, the retained earnings figure is included, which was obtained through the closing process. Since dividend and withdrawal accounts are not income statement accounts, they do not typically use the income summary account.

Practice Questions: Types of Accounts

Now, if you’re new to accounting, you probably have a ton of questions.

It is the end of the year,
December 31, 2018, and you are reviewing your financials for the
entire year. You see that you earned $120,000 this year in revenue
and had expenses for rent, electricity, cable, internet, ace the investment banking interview financial statements question gas, and
food that totaled $70,000. The year-end closing is the process of closing the books for the year. This involved reviewing, reconciling, and making sure that all of the details in the ledger add up.

It is the end of the year, December 31, 2018, and you are reviewing your financials for the entire year. You see that you earned $120,000 this year in revenue and had expenses for rent, electricity, cable, internet, gas, and food that totaled $70,000. That’s why most business owners avoid the struggle by investing in cloud accounting software instead. Well, dividends are not part of the income statement because they are not considered an operating expense. That’s exactly what we will be answering in this guide –  along with the basics of properly creating closing entries for your small business accounting.

Module 4: Completing the Accounting Cycle

Remember that all revenue, sales, income, and gain accounts are closed in this entry. Because you paid dividends, you will need to reduce your retained earnings account, which is what this entry accomplishes. For sole proprietorships and partnerships, you’ll close your drawing account to your capital account, because you will need to reduce your capital account by the draws taken for the month.

Closing Entry Shortcuts and Software Handling

If the subsidiaries also use their own subledgers, then their subledgers must be closed out before the results of the subsidiaries can be transferred to the books of the parent company. Since the income summary account is only a transitional account, it is also acceptable to close directly to the retained earnings account and bypass the income summary account entirely. The net result of these activities is to move the net profit or net loss for the period into the retained earnings account, which appears in the stockholders’ equity section of the balance sheet. The remaining balance in Retained Earnings is
$4,565 (Figure
5.6). This is the same figure found on the statement of
retained earnings. The fourth entry requires Dividends to close to the Retained
Earnings account.

Everything to Run Your Business

All income statement balances are eventually shifted to retained earnings, which is a permanent account on the balance sheet. Once you have completed and posted all closing entries, the final step is to print a post-closing trial balance, and review it to ensure that all entries were made correctly. Understanding the accounting cycle and preparing trial balances is a practice valued internationally. The Philippines Center for Entrepreneurship and the government of the Philippines hold regular seminars going over this cycle with small business owners.

Both closing entries are acceptable and both result in the same outcome. All temporary accounts eventually get closed to retained earnings and are presented on the balance sheet. Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step.

Permanent and Temporary Accounts

These accounts are closed directly to retained earnings by recording a credit to the dividend account and a debit to retained earnings. 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. Notice that revenues, expenses, dividends, and income summary
all have zero balances. The post-closing T-accounts will be transferred to the
post-closing trial balance, which is step 9 in the accounting
cycle. Closing entries are journal entries made at the end of an accounting period, that transfer temporary account balances into a permanent account.

Second, the closing process updates the retained earnings account to its correct end of period balance. Recall that the balance in the retained earnings comes from the statement of change in equity and not the adjusted trial balance. The transfer to retained earnings is the mechanism that updates the actual retained earnings account balance in the general ledger.

Only income
statement accounts help us summarize income, so only income
statement accounts should go into income summary. Understanding the accounting cycle and preparing trial balances
is a practice valued internationally. The Philippines Center for
Entrepreneurship and the government of the Philippines hold regular
seminars going over this cycle with small business owners.

The last closing entry reduces the amount retained by the amount paid out to investors. Temporary accounts are used to record accounting activity during a specific period. All revenue and expense accounts must end with a zero balance because they are reported in defined periods and are not carried over into the future. For example, $100 in revenue this year does not count as $100 of revenue for next year, even if the company retained the funds for use in the next 12 months.

Close all revenue and gain accounts

Temporary accounts include all revenue and expense accounts, and also withdrawal accounts of owner/s in the case of sole proprietorships and partnerships (dividends for corporations). Close the income summary account by debiting income summary and crediting retained earnings. Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period.