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. All drawing accounts are closed to the respective capital accounts at the end of the accounting period. Income summary effectively collects NI for the period and distributes the amount to be retained into retained earnings. Balances from temporary accounts are shifted to the income summary account first to leave an audit trail for accountants to follow. Income summary is a holding account used to aggregate all income accounts except for dividend expenses.

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It can also create errors and financial mistakes in both the current and upcoming financial reports, of the next accounting period. The next and final step in the accounting cycle is to prepare one last post-closing trial balance. Close the income summary account by debiting income summary and crediting retained earnings. Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period.

Temporary accounts

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• The income summary account is a temporary account solely for posting entries during the closing process.
• For our purposes, assume that we are closing the books at theend of each month unless otherwise noted.
• To further clarify this concept, balances are closed to assureall revenues and expenses are recorded in the proper period andthen start over the following period.
• Accounts are considered “temporary” when they only accumulate transactions over one single accounting period.

A closing entry is a journal entry that is made at the end of an accounting period to transfer balances from a temporary account to a permanent account. Closing entries play a crucial role in maintaining accurate financial records and ensuring that each accounting period’s performance is distinct. They also facilitate the creation of financial statements that provide stakeholders with a clear understanding of a company’s financial position and performance over time.

Step 4: Close withdrawals to the capital account

Thethird entry closes the Income Summary account to Retained Earnings.The fourth entry closes the Dividends account to Retained Earnings.The information needed to prepare closing entries comes from theadjusted trial balance. Closing entries are performed after adjusting entries in the accounting cycle. Adjusting entries ensures that revenues and expenses are appropriately recognized in the correct accounting period. Once adjusting entries have been made, closing entries are used to reset temporary accounts. Recording closing entries is essential for maintaining accurate financial records, ensuring that each accounting period is distinct, and facilitating the preparation of financial statements.

So for posting the closing entries in the general ledger, the balances from revenue and expense account will be moved to the income summary account. Income summary account is also a temporary account that is just used at the end of the accounting period to pass the closing entries journal. The balance in dividends, revenues and expenseswould all be zero leaving only the permanent accounts for a postclosing trial balance. The trial balance shows the ending balancesof all asset, liability and equity accounts remaining. The mainchange from an adjusted trial balance is revenues, expenses, anddividends are all zero and their balances have been rolled intoretained earnings. We do not need to show accounts with zerobalances on the trial balances.

• They zero-out the balances of temporary accounts during the current period to come up with fresh slates for the transactions in the next period.
• The next day, January 1, 2019, you get ready for work, butbefore you go to the office, you decide to review your financialsfor 2019.
• Temporary accounts are used to record accounting activity during a specific period.
• As mentioned, one way to make closing entries is by directly closing the temporary balances to the equity or retained earnings account.
• Understanding the accounting cycle and preparing trial balancesis a practice valued internationally.
• The term can also mean whatever they receive in their paycheck after taxes have been withheld.

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You might not feel like an expert in closing entries just yet but you can always refer back to refresh your memory. Imagine we are doing a month-end or year-end close, we’re going to follow these steps. The account is then cleared out and transferred to retained earnings, which we will explain. Closing entries in accounting are something you are certainly going to run across if you take a position in internal accounting. While they tend to be similar and repetitive, it is worth having a good understanding of what entries are being made and why they are being made.

Step 4: Closing the drawing/dividends account

This process ensures that your temporary accounts are properly closed out sequentially, and the relevant balances are transferred to the income summary and ultimately to the retained earnings account. At the end of an accounting period when the books of accounts are at finalization stage, some special journal entries are required to be passed. In accounting terms, these journal entries are termed as closing entries. The main purpose of these closing entries is to bring the temporary journal account balances to zero for the next accounting period, which keeps the accounts reconciled.

Step 2 – Close Expenses to the Income Summary

Something noteworthy here is that the above closing entry can be passed even without using the income summary account. I.e., moving the balances directly from revenue and expense account to the retained earnings account. But using the income summary account was used to give a clear view of the company’s performance when there was only manual accounting. Usually, where the accounting is automated or done using software, this intermediate income summary account is not used, and the balances are directly transferred to the retained earnings account. The temporary accounts need to be zero at the end of an accounting period. closing entries take place at the end of an accounting cycle as a set of journal entries.