Closing Entries

Closing Entries are pass in order to close temporary accounts. Revenue increase owner’s equity and expenses and withdrawals (drawings) by owner decrease owner’s equity, all accounts relating to expenses, revenues and drawing are called temporary accounts. Assets (real accounts) and Liabilities and owner equity (personal accounts) are permanent accounts At the end of financial period, temporary accounts (revenue and expenses) are closing by opening a new temporary account called Income summary account.

When revenue and expenses accounts have been closed than we need to close last nominal account i.e. income summary with owner Equity account. drawings are also closed with Owner’s Equity account. The balances of permanent accounts continue to exist beyond the current accounting period. The process of transferring the balances of the temporary accounts into owner’s equity permanent account is called closing the accounts. The Journal entries made for the purpose of closing the temporary accounts are called closing entries. It is common practice to close the accounts only once a year at the end of accounting period.

Closing Entries for Revenue Accounts

Revenue Accounts have credit balances. Closing the revenue accounts are, therefore, mean transferring its credit balance to the Income Summary account. This transfer is accomplished by a journal entry debiting the revenue accounts in an amount equal to its credit balance, with an offsetting credit to the Income Summary account. The debit portion of this entry returns the balances of the revenue accounts to zero; the credit portion transfers to the former balances of the revenue accounts into the Income Summary account:

Closing for Expense Accounts

Expense Accounts have debit balances. Closing an expense account means transferring its debit balance to the Income Summary account. The Journal entry to close an expense account, therefore, consists of a credit to the expense account in an amount equal to its debit balance, with an offsetting debit to the Income Summary:

Closing Income Summary Account

After closing revenue and expenses with Income summary account, next step is to close income summary account, because it is also nominal account and must close at the end of each account period. If income summary account has credit balance means it is profit and if income summary account reflects debit balance suggested lose by business operation. Income summary account will closed against permanent account of owner equity.

 For Profit

For Loss

Closing the Owner’s Drawing Account

Withdrawals of cash or other assets by owner are not considered as an expense of the business and, therefore, are not a factor in determining the income for the period ended. Since Drawings Account is not closed by the Income Summary account but directly to Owner equity account. For closing drawing, the closing entry as:

Summary of the Closing Entries

Let us now summarize the process of closing the accounts:

1. Close the various Revenue accounts by transferring their balances into the Income Summary account.
2. Close the various Expense accounts by transferring its balances in to the Income Summary account.
3. Close the Income Summary account by transferring its balance into the Owner equity account.
4. Close the owner’s drawing account into the Owner equity account. (The balance of the Owner equity account in the ledger will now be the same as the amount of owner’s equity appearing in the Balance Sheet).

>>> Read Accounting Worksheet.

Example 1:

The following Adjusted Trial Balance was extracted from the books of Anees & Sons on 31^st December, 2015. From this you are required to pass closing entries.

Solution: 

Post-Closing Trial Balance

After the revenue and expense accounts have been closed, it is desirable to prepare post closing trial balance. This trial balance has same total as appears in Balance Sheet:

Example # 2:

Prepare post closing trial balance for example # 1 after closing:

>> Read Post Closing Trial Balance.

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