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Closing Entry

Journal entries to close off the year

What is a Closing Entry?

A closing entry is a journal entry that is made at the end of the accounting period to transfer balances from a temporary account to a permanent account.

Companies use closing entries to reset the balances of temporary accounts − accounts that show balances over a single accounting period − to zero. By doing so, the company moves these balances into permanent accounts on the balance sheet. These permanent accounts show a company’s long-standing financials.

 

Closing Entry Theme

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Temporary Accounts

Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period. The balances of these accounts are eventually used to construct the income statement at the end of the fiscal year.

The income statement is a financial statement that is used to portray a company’s financial performance and activities over a single fiscal year. It is for this reason that the date line in the annual income statement is written as “Year ended.”

Below is an example of Amazon’s 2017 annual income statement. You can see that for the date, it is written as ‘Years ended December 31, YYYY’.

 

Closing Entry - Temporary Accounts Income Statement
Source: Amazon.com

 

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As mentioned, temporary accounts in the general ledger consist of income statement accounts such as sales or expense accounts. After the income statement has been published at the end of the year, the balances of these accounts are transferred to the income summary, which is also a temporary account.

The income summary is used to transfer the balances of temporary accounts to retained earnings, which is a permanent account on the balance sheet.

 

Income Summary

The income summary is a temporary account used to make closing entries.

All temporary accounts must be reset to zero at the end of the accounting period. To do this, their balances are emptied into the income summary account. The income summary account then transfers the net balance of all the temporary accounts to retained earnings, which is a permanent account on the balance sheet.

 

Permanent Accounts

Permanent accounts are accounts that show the long-standing financial position of a company. Balance sheet accounts are permanent accounts. These accounts carry forward their balances throughout multiple accounting periods.

To understand this better, we can look at an account such as inventory. Below is an excerpt from Amazon’s 2017 annual balance sheet.

 

Closing Entry - Permanent Accounts Balance Sheet
Source: amazon.com

 

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The balance sheet captures a snapshot of a company at a given point in time. By looking at this balance sheet we can observe the following:

  1. On December 31, 2016, Amazon reported $11,461 million of inventory. This amount was carried forward into the beginning of 2017.
  2. On December 31, 2017, Amazon posted $16,047 million of inventory.
  3. Amazon increased its inventories by $4,586 million in 2017 to come to the balance it reported on December 31, 2017.

By looking at it this way, we can see how Inventory is a permanent account that carries forward balances through multiple accounting periods.

 

Example of a Closing Entry

Below are examples of closing entries that ‘zero’ the temporary accounts in the income statement and transfer the balances to the permanent retained earnings account. This is done using the income summary account.

 

1. Close Revenue Accounts

Clear the balance of the revenue account by debiting revenue and crediting income summary.

 

Closing Entry - Close Revenue

 

2. Close Expense Accounts

Clear the balance of the expense accounts by debiting income summary and crediting the corresponding expenses.

 

Closing Entry - Close Expenses

 

3. Close Income Summary

Close the income summary account by debiting income summary and crediting retained earnings.

 

Closing Entry - Close Income Summary

 

4. Close Dividends

Close the dividends account by crediting retained earnings and crediting dividends.

 

Closing Entry - Close Dividends

 

Additional Resources

Thanks for reading CFI’s closing entry guide. Corporate Finance Institute has other resources that will help you expand your knowledge and advance your career! Check out the links below:

  • Accounting Fundamentals
  • Introduction to Corporate Finance
  • Accounting Equation
  • Linking the Financial Statements

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