Closing entries
Closing entries (closing journal entries) are accounting entries prepared at the end of a given accounting period. Entries are made in the manual accounting system to transfer balances from temporary accounts (from the income statement) to permanent accounts (on from the balance sheets). In this way, temporary accounts are closed, which is usually called closing the books[1].
Temporary accounts
Temporary accounts (income statement accounts or nominal accounts) are ledger accounts. They are used to create transaction entries during a single billing period. At the end of this period, temporary accounts are closed or reset using closure entries. It is important not to mix up the amounts from several periods. The zero balance is mostly the starting point for this account in the next billing period. Income statement accounts include all of expense and income accounts. The recording of the amount in the income account observe the accounting activity on these types of accounts. All nominal accounts are finally closed for retained earnings (a company) or owner's equity (an individual entrepreneurship). In the next step, the data is presented in the balance sheet. Closing a temporary account is possible in two ways[2]:
- direct closing of retained earnings in the account,
- closing in an intermediate account (income summary account).
Permanent accounts
Permanent accounts (real accounts) are ledger accounts unclosed at the end of the accounting period. Real account balances are also available outside of the current billing period. These accounts are included in the balance sheet (accounts of assets, liabilities and capital accounts). The non-zero balance is usually the starting point for this account in the next billing period[3].
Closing entries phases
Closing entries can be shown in four steps [4]:
- Transferring all of revenue accounts to income summary.
- Transferring all of expense accounts to income summary.
- Closing the income summary account.
- Closing the dividend account for retained earnings.
Examples of Closing entries
- In a service business, the closing entry to close out the revenue and expense accounts involves transferring the net income or net loss from the income summary account to the owner's capital account. This entry is typically recorded as a debit to the owner's capital account for the amount of net income and a credit to the income summary account for the same amount.
- For companies that use the periodic inventory system, a closing entry is made to transfer the balance of the cost of goods sold account to the inventory account. This entry is typically recorded as a debit to the inventory account for the amount of the cost of goods sold and a credit to the cost of goods sold account for the same amount.
- If a business has issued bonds during the period and recorded the interest expense associated with the bonds, a closing entry is made to transfer the balance of the interest expense account to the interest payable account. This entry is typically recorded as a debit to the interest payable account for the amount of interest expense and a credit to the interest expense account for the same amount.
Advantages of Closing entries
Closing entries have a number of advantages which make them an essential part of the accounting process. These include:
- Providing a clean slate for the next accounting period by transferring the balances of temporary accounts to permanent accounts. This ensures that the income statement and balance sheet are accurate and up to date.
- Allowing the financial statements to be prepared which in turn provide an accurate overview of the company’s financial performance and position.
- Helping to maintain the double-entry accounting system by ensuring that the equation of assets = liabilities + owners’ equity is always true.
- Eliminating the need for adjusting entries and providing a more efficient and accurate way to close the books each period.
Limitations of Closing entries
Closing entries have certain limitations which must be kept in mind when preparing them. These include:
- Timing: Closing entries must be done at the end of the accounting period to ensure the accuracy of the financial statements. If they are done too early, the financial statements will not reflect the true financial position of the business.
- Accuracy: The closing entries must be accurate. If the entries are incorrect, it can lead to errors in the financial statements, which could have serious consequences for the business.
- Consistency: Closing entries must be done in the same way each time, to ensure consistency in the financial statements. Any discrepancies between the closing entries and the general ledger can lead to errors in the financial statements.
- Integration: Closing entries must be integrated with the other accounts in the general ledger, as well as the other financial statements. Any discrepancies between the closing entries and the other accounts and statements can lead to errors in the financial statements.
- Documentation: Closing entries must be properly documented. This includes documenting the amounts and the accounts that are affected by the closing entries, as well as the date they were done. This ensures that the closing entries are traceable, which is essential for audit purposes.
Below are a few additional approaches that can also be helpful to ensure accurate closing entries:
- Using a closing checklist - Developing a closing checklist can help to ensure that all necessary steps have been taken and all accounts have been properly closed. This can be a helpful tool to keep track of all closing entries that need to be completed.
- Reconciling accounts - Reconciling accounts before closing entries are made can help ensure that all accounts are properly closed and that the correct balances are transferred to the correct accounts.
- Reviewing the closing entries - After closing entries have been made, it is important to review them to make sure that all entries are accurate and that all accounts have been closed properly.
In summary, Closing entries are important accounting steps that help to ensure that financial records are kept accurate and up to date. Other approaches that can be helpful when making closing entries include using a closing checklist, reconciling accounts, and reviewing the closing entries.
Footnotes
- ↑ Maher M.W., Hermanson R., Edwards J.D. (2011), Accounting Principles: A Business Perspective, CreateSpace Independent Publishing Platform
- ↑ Williams J.R., Haka S.F., Bettner M.S., Carcello J.V. (2015), Financial & Managerial Accounting: The basic for bussiness decision, McGraw-Hill Education
- ↑ Scott C.J. (2014), College Accounting: A Career Approach, Cengage Learning
- ↑ Cunningham B.M., Nikolai L.A., Bazley J., Kavanagh M., Slaughter G., Simmons S. (2011), Accounting: Information for Business Decisions, Cengage Learning
| Closing entries — recommended articles |
| Opening entries — Closing the accounts — Income summary account — Post closing trial balance — Book of original entry — Reversing entry — Nominal ledger — Statutory books — T account |
References
- Dauderis H., Annand D. (2014), Introduction to Financial Accounting, Valley Educational Services Ltd
- Finance Department York University (2014), Journal Entries At York University
- Lawror E. (2009), Double Entry Accounting Workbook
- Slater J. (2016), College Accounting: A Practical Approach, Pearson Custom Publishing
- The Institute of Cost Accountants of India (2016), Financial accounting: study notes, Directorate of Studies
- The Institute of Cost Accountants of India (2014), Fundamentals of accounting: study notes, Directorate of Studies
Author: Patryk Schmidt
