What is Closing Entry?
Closing entries are used to classify and summarize all revenue and expense accounts. Each expense and revenue account is completely cleared, with a zero balance, at the end of the accounting cycle. These accounts are temporary holding accounts whose balances should be transferred to an account that is permanent in nature. This would be the capital account or retained earnings. The accumulation of new amounts of revenues and expenses begins at the start of each new accounting period.
These accounts are closed or transferred to a summary account called revenue and expense summary. The revenue and expense summary account is then closed to the capital (retained earnings) account. Ideally, closing should take place after an organization’s busy period. At this time, inventories should be low and liquidity should be high. Drawing (dividends) accounts are also closed at the end of the accounting cycle. The effect of closing entries is to bring to zero all accounts that affect the income statement. Accounts that are closed will not show any balances in the balance sheet. After the closing entries, the new year will start fresh in that no income statement account balances will exist.
Steps in Closing Entries
As in other parts of the recording process of the accounting cycle, the closing of accounts involves both the recording of entries in the journal and then the posting of the amounts and explanations in the ledger. Revenue accounts normally have a credit balance and expense accounts normally have a debit balance. When closing accounts, an amount will be debited (revenue) or credited (expense) to the account to leave a zero balance. A like amount will be entered into the revenue and expense summary account.
The entries to close the revenue and expense summary account will depend on whether the revenues were greater than expenses or vice versa. This relationship is summarized in table below.