The purpose of closing entries is to prepare the temporary accounts for the next accounting period. In other words, the income and expense accounts are “restarted”. When doing closing entries, try to remember why you are doing them and connect them to the financial statements.

Secondary-Activity Expenses

• The income summary account is an account that receives all the temporary accounts of a business upon closing them at the end of every accounting period.
• A publicly traded company must submit income statements to the U.S.
• In other words, the income summary account is simply a placeholder for account balances at the end of the accounting period while closing entries are being made.
• When you compare the retained earnings ledger (T-account) to the statement of retained earnings, the figures must match.
• However, each temporary account can be reset thanks to closing entries and begin the next accounting period with a zero balance.
• In many cases, the computer never even shows the income summary or has a record.

It is important to understand retained earnings is not closed out, it is only updated. Retained Earnings is the only account that appears in the closing entries that does not close. You should recall from your previous material that retained earnings are the earnings retained by the company over time—not cash flow but earnings. Now that we have closed the temporary accounts, let’s review what the post-closing ledger (T-accounts) looks like for Printing Plus.

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While some businesses would be very happy if the balance in Notes Payable reset to zero each year, I am fairly certain they would not be happy if their cash disappeared. Assets, liabilities and most equity accounts are permanent accounts. The first is to close all of the temporary accounts in order to start income summary account with zero balances for the next year. The second is to update the balance in Retained Earnings to agree to the Statement of Retained Earnings. Looking at the revenue account balance, all the revenue-generating sources, whether operating or non-operating business functions are included in the process.

Closing Entry: What It Is and How to Record One

• Note that by doing this, it is already deducted from Retained Earnings (a capital account), hence will not require a closing entry.
• These transfers effectively reset the temporary revenue and expense accounts to zero balances, preparing them for the upcoming accounting period.
• What is the current book value of your electronics, car, and furniture?
• The income summary account is an intermediary between revenues and expenses, and the Retained Earnings account.
• Let’s look at the trial balance we used in the Creating Financial Statements post.
• The primary purpose of an income statement is to convey details of profitability and business activities of the company to the stakeholders.

After the closing journal entry, the balance on the drawings account is zero, and the capital account has been reduced by 1,300. The purpose of the income summary is to show the net income (revenue less expenses) of the business in more detail before it becomes part of the retained earnings account balance. After the closing journal entry, the balance on the dividend account is zero, and the retained earnings account has been reduced by 200.

• The Revenue section shows that Microsoft’s gross margin, also known as gross (annual) profit, for the fiscal year ending June 30, 2023, was $146.05 billion.
• Net income is then used to calculate earnings per share (EPS) using the average shares outstanding, which are also listed on the income statement.
• This final income summary balance is then transferred to the retained earnings (for corporations) or capital accounts (for partnerships) at the end of the period after the income statement is prepared.
• In a partnership, for example, you’d transfer $75,000 in net profits into the partners’ capital accounts.
• The company received $25,800 from the sale of sports goods and $5,000 from training services for a total of $30,800 in revenue.
• Suppose a business had the following trial balance before any closing journal entries at the end of an accounting period.

Closing Journal Entries Process

The balances of these accounts are eventually used to construct the income statement at the end of the fiscal year. Permanent (real) accounts are accounts that transfer balances to the next period and include balance sheet accounts, such as assets, liabilities, and stockholders’ equity. These accounts will not be set back to zero at the beginning of the next period; they will keep their balances. In a sole proprietorship, a drawing account is maintained to record all withdrawals made by the owner. In a partnership, a drawing account is maintained for each partner.

The illustration above comprehensively shows the different levels of profitability of XYZ Corporation. It includes marketing costs, rent, inventory costs, equipment, payroll, step costs, insurance, and funds intended for research and development. However, it uses multiple equations to determine the net profit of the company. However, if the company also wanted to keep year-to-date information from month to month, a separate set of records could be kept as the company progresses through the remaining months in the year.

• Next, the balance resulting from the closing entries will be moved to Retained Earnings (if a corporation) or the owner’s capital account (if a sole proprietorship).
• In a partnership, a drawing account is maintained for each partner.
• These permanent accounts show a company’s long-standing financials.
• These include the net income realized from one-time nonbusiness activities, such as a company selling its old transportation van, unused land, or a subsidiary company.
• Thus, shifting revenue out of the income statement means debiting the revenue account for the total amount of revenue recorded in the period, and crediting the income summary account.

Step 2: Close Expense accounts

With 7.45 billion outstanding shares for Microsoft, its EPS came to $9.72 per share ($72.361 billion ÷ 7.446 billion). These are all expenses that go toward a loss-making sale of long-term assets, one-time or any other unusual costs, or expenses toward lawsuits. These are all expenses linked to noncore business activities, like interest paid on loan money. A business’s cost to continue operating and turning a profit is known as an expense.

What is your current financial priority?