Closing Entries – Process, Types and Examples

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Closing entries are basically closing journal entries which are based on the balances of adjusted trial balance and made at the end of accounting period. Books of account are closed at the end of accounting year. This means that balances in nominal accounts are transferred to Income and Expense Summary Account. All expenses and losses are debited and all incomes and revenues are credited to this income and expense summary account. In other words, closing entries mean transferring data from ledger accounts to Profit and Loss and Balance Sheet Account.

In accounting practices, the balances of expenses and revenues are brought to zero for next accounting year. Therefore, these temporary accounts are closed by transferring the closing balances of these account to the Income and Expense Summary Account.

What are the temporary accounts?

Temporary accounts include

  1. Revenues, incomes and gains
  2. Expenses and losses
  3. Dividend and drawings, and
  4. Income and expense summary account (net result)

What is an income and expense summary account?

Income and expense summary account is basically a temporary account which is opened at the end of the financial year / accounting year. In this account, all the debit and credit balances of temporary accounts (incomes, expenses etc) are transferred and thus those accounts are closed in this way. Whereas, the net balance of income and expense summary account whether net income or loss, is finally transferred to Capital Account. When the closing balance of income and expense summary account is transferred to Capital Account, the balance of this account becomes zero and it is automatically closed.

This very important point to note that in case where income statement is prepared in an account form such as ‘profit and loss account’, there is no need to create or prepare income and expense summary account.

Types of Journal Entries

While closing the temporary accounts, following closing journal entries are made at the end of accounting period

To close all income accounts 

Date Description Post Ref. Debit Credit
31 Dec
Income & expense summary
 
 
31 Dec
 
Expenses accounts
 
 
 
All expense accounts are closed
     

To close all expense accounts

Date Description Post Ref. Debit Credit
31 Dec
Incomes accounts
 
 
31 Dec
 
Income & expense summary
 
 
 
All Income accounts are closed
     

Transfer of income to Capital account

Date Description Post Ref. Debit Credit
31 Dec
Income and expense summary account
 
 
31 Dec
 
Capital account
 
 
 
All Income accounts are closed
     

Transfer of net loss to capital account

Date Description Post Ref. Debit Credit
31 Dec
Capital account
 
 
31 Dec
 
Income and expense summary
 
 
 
Net loss is transferred to Capital account
     

Transfer of net loss to capital account

Date Description Post Ref. Debit Credit
31 Dec
Capital account
 
 
31 Dec
 
Income and expense summary
 
 
 
Net loss is transferred to Capital account
     

Transfer of drawings to capital account 

Date Description Post Ref. Debit Credit
31 Dec
Capital account
 
 
31 Dec
 
Drawings
 
 
 
Drawings are transferred to Capital account
     

Examples

In order to understand the closing entries process, consider the following example based on adjusted triall balance.

After adjusted trial balance, the stage of preparing financial statements begins. For the purpose of understanding closing entries, we have assumed that income statement has prepared accordingly which has produced a net loss amounting to $ 500. However, the following closing entries shall have been passed.

Date Description Post Ref. Debit Credit
31 Dec
Income & expense summary
 
4,700
 
31 Dec
 
Supplies Exp
Advertisement Exp
Salaries Exp
Depreciation
Bad Debt Exp
 
 
2,400
1,200
900
150
50
 
All the debit balances of nominal accounts have been closed
     

 

Date Description Post Ref. Debit Credit
31 Dec
Revenue
Commission
 
3,900
300
 
31 Dec
 
Income and expense summary
 
 
4,200
 
All the debit balances of nominal accounts have been closed
 

 

Date Description Post Ref. Debit Credit
31 Dec
Capital account
 
500
 
31 Dec
 
Income and expense summary
 
 
500
 
Net loss is transferred to Capital account
     

After closing the accounts, we will move on to the last step of accounting cycle and will prepare post closing trial balance.