Recording Closing Entries
in the Accounting Cycle

Closing Entries made in the ledger bring the Income Statement accounts to zero so that the new reporting period will start with zero balances. Since we are reporting sales and expenses for January, for example, February sales and expenses should start with a zero balance to properly report sales, expenses, and Net Income only for the month of February. Accountants can close accounts for any reporting period (e.g. monthly, quarterly, and yearly).






Income Statement accounts are called Nominal or Temporary accounts because Income Statement accounts are closed at the end of a reporting period to bring the balances to zero. Examples of Temporary Accounts are Sales and Expenses. Balance Sheet accounts are called Real or Permanent accounts because they continue to accumulate on the Balance Sheet from period to period for the life of the account. A Permanent Account is classified on the Balance Sheet as an Asset, a Liability, or Owner's Equity. Examples are Cash, Accounts Receivable, Loans Payable, and Owner's Equity.



The Trial Balance lists Income Statement accounts, or temporary accounts, highlighted below.





At the end of the reporting period, the credit accounts (i.e. Sales Accounts) are closed by making a debit entry for the balance, and the debit accounts (i.e. Expense Accounts) are closed by making a credit entry for the balance in the general ledger.

During this closing process, a new temporary account, called Income Summary, is created to transfer the income and expense account balances. The balance in the Income Summary Account equals the difference between sales and expenses, and is then transferred to Owner's Equity.

For example, Sunny Sunglasses Shop closed January Sales and Expense Accounts in the General Journal as follows:






Since Sales and Revenue Accounts have a credit balance, these accounts are closed by debiting the Sales and Revenue Accounts, and crediting the Income Summary Account. Closing entries are made to the Expense Accounts by crediting each expense Account, and debiting the Income Summary Account.

The difference between Sales and Expenses, or Net Income, was transferred to the Income Summary Account.



Sales $11,680 + Repair Revenue $20 - Expenses $11,452 = Net Income $248



The $248 equals Net Income and the balance in the Income Summary Account after the Sales and Expense Accounts are closed. In the final step, we transferred the balance in the Income Summary Account to Retained Earnings. Net Income directly increases Retained Earnings and Owner's Equity, or the value of the business as discussed in Accounting Formulas for Net Income. The $248 transferred to Retained Earnings appears on the January Balance Sheet.

After the above entries are posted to the General Ledger, the General Ledger Sales and Expense Accounts show a zero balance. For example, the Sales Account and the Wage Expense Account appear as follows in the General Ledger after the Closing Entries are posted from the General Journal to the General Ledger.






Because the Sales Account has a credit balance, the Closing Entry is made on the debit side to bring the account balance to zero. Similarly, because Expense Accounts have debit balances, the Closing Entry is made on the credit side to bring the Expense Account balances to zero.

GJ-2 simply means these entries were made on the second page of the General Journal and posted to the General Ledger above. Similarly, the accounts listed on the General Journal under the "Reference" column indicate the Journal Entries were posted to the respective General Ledger Accounts to close the accounts for January.




Recording Closing Entries is a Three Step Process: 1). Income Statement accounts with credit balances are debited and the Income Summary Account is credited for the total amount. 2). Income Statement accounts with debit balances are credited and the Income Summary Account is debited for the total amount. 3). The balance in the Income Summary Account, representing Net Income, is transferred to Retained Earnings by debiting Income Summary and crediting Retained Earnings.




After the Income Statement accounts are closed, the company prepares a Final Trial Balance.


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