Closing entry

Closing entry is made at the end of accounting period. It is the last entry made in the journal before data is moved from temporary accounts to permanent accounts on the balance sheet. The closing entry allows to zero all the temporary accounts.

The procedure of ending accounting period is as follows:

• transfer all the revenues accounts to income summary,
• debit revenue accounts,
• transfer all the expenses accounts to expense summary,
• credit expense accounts,
• close income summary (closing entry),
  • if incomes are greater than expenses: debit income summary, credit retained earnings (profit),
  • otherwise: credit income summary and debit retained earnings (loss)
• close dividents account - debit retained earnings by the amount of dividends and credit dividends account.

Settlement of the period

According to the quantitative order form, the supplier says to pay for the item immediately after receiving the parcels. However, in practice, it allows you to pay the due amount for items delivered within a certain time. If the outstanding amount is paid within a certain period of time, usually no additional fees are charged. After the expiration of the fixed deadline, interest is accrued.

In this way, the provider actually grants loan to the customer without interest on time to settle the invoice. In the time between delivery and the final repayment date, the customer can sell items and collect income instead of paying off the overdraft. Therefore, delaying the account settlement by the customer up to the last minute allowed by the supplier of the billing period is economically justified.

The result of the delay is the growing order volume, which reduces annual costs. This saving results from the permissible delay in the settlement of payments without interest. However, as a result of increasing the size of orders you have to order less often.

Increasing arrears

Companies that pay after the deadline and the tolerance of employees to late payment are the factors behind the rise of arrears in Russia. Both of them are supported by wages commonly covered.

In rural areas with lower employment rates, concentrated labor markets and more common backlogs in the past, there is usually a higher backlog of workers. In contrast to wage reductions, wage arrears have an ambiguous impact on employee behavior. However, depending on the scope of practice on the local market, this effect is different.

Examples of Closing entry

• Income Summary: At the end of the accounting period, the net income or net loss is calculated by transferring all the income and expense account balances to the income summary account. A closing entry is made to transfer the net income or net loss to the owner's capital account.

For example, at the end of the year, the net income of ABC company is $20,000. The closing entry to transfer the net income to the owner's capital account will be as follows:

Debit: Owner's Capital Account $20,000 Credit: Income Summary Account $20,000

• Depreciation Expense: Depreciation is recorded throughout the year by debiting the depreciation expense account and crediting the accumulated depreciation account. At the end of the period, a closing entry is made to transfer the balance of the depreciation expense account to the accumulated depreciation account.

For example, at the end of the year, the balance in the depreciation expense account is $12,000. The closing entry to transfer the balance to the accumulated depreciation account will be as follows:

Debit: Accumulated Depreciation Account $12,000 Credit: Depreciation Expense Account $12,000

Advantages of Closing entry

Closing entry is an important part of the accounting period that helps in transferring the data from temporary accounts to permanent accounts. Following are the advantages of closing entry:

• It helps to transfer the data from temporary accounts such as income and expenses to permanent accounts such as assets and liabilities.
• It allows to zero all the temporary accounts and helps in starting the new accounting period.
• It helps in preparing the financial statements like balance sheet and income statement accurately.
• It helps in the preparation of the trial balance.
• It helps in understanding the financial performance of the business.

Limitations of Closing entry

Closing entries have certain limitations that need to be taken into consideration when preparing them. These include:

• Incorrect allocations - Closing entries may result in incorrect allocations if the underlying transactions are incorrect or incomplete.
• Unused assets - Closing entries may not take into account unused assets, such as inventory or accounts receivable, which can lead to an inaccurate balance sheet.
• Timing differences - Closing entries may not reflect the true timing of transactions, which can cause differences in the reported financial results.
• Error correction - Closing entries may not be able to correct errors that have occurred during the period.
• Overlooked items - Closing entries may overlook minor items that may not have a significant impact on the overall financial statement.

Other approaches related to Closing entry

The closing entry is just one approach to closing the temporary accounts. Other approaches include:

• Post closing trial balance: This approach involves taking a trial balance after all the closing entries have been made. This allows the accountants to verify that all the accounts have been closed, and that the debits and credits in each account are in balance.
• Reverse closing entries: This approach involves reversing the closing entries made in the previous accounting period. This allows the accountants to start the new accounting period with all the accounts at zero, and eliminates the need for additional journal entries.
• Adjusting entries: This approach involves making adjusting entries at the end of the accounting period to ensure that all the data is accurate and up to date. This includes making adjustments for depreciation, amortization, inventory, and other items.

In summary, closing entries are just one approach to closing the temporary accounts. Other approaches, such as post closing trial balance, reverse closing entries, and adjusting entries, can also be used to ensure that all the accounts are zeroed out and all the data is accurate.

Closing entry — recommended articles

Income summary — Deposits in transit — Accounts uncollectible — Reversing entry — Nominal account — Deferred expense — Prepaid income — Books of original entry — Purchase returns and allowances

References

• Dechow, P. M. (1994). Accounting earnings and cash flows as measures of firm performance: The role of accounting accruals. Journal of accounting and economics, 18(1), 3-42.
• Earle J. S., Peter K.S. (2002). How Late to Pay? Understanding Wage Arrears in Russia. Journal of Labor Economics, Upjohn Institute Working Paper No. 02-77.
• Famma E.F., French K.R. (2000). Disappearing dividends: changing firm characteristics or lower propensity to pay?. Journal of Financial Economics, 3-43.
• Goyal S.K. (1985). Economic Order Quantity under Conditions of Permissible Delay in Payments. Journal of the Operational Research Society, Vol. 36, p. 335-338.
• Sutton S.G. (2006). Enterprise systems and the re-shaping of accounting systems: A call for research. International Journal of Accounting Information Systems, 1-6.

Footnotes

Author: Anna Zuwała