BUS103: Introduction to Financial Accounting

Transferring information from temporary accounts to permanent accounts is referred to as closing the books.

Learning Objective

• Identify the steps in the closing process

Key Points

• Closing may be performed monthly or annually.
• There are four basic steps to closing the books.
• Closing the revenue accounts - transferring the balances in the revenue accounts to a clearing account called Income Summary.
• Closing the expense accounts - transferring the balances in the expense accounts to a clearing account called Income Summary.
• Closing the Income Summary account - transferring the balance of the Income Summary account to the Retained Earnings account (also known as the capital account).
• Closing the Dividends account - transferring the balance of the Dividends account to the Retained Earnings Account.
  

Terms

• revenue
  Income that a company receives from its normal business activities, usually from the sale of goods and services to customers.
• account
  A registry of pecuniary transactions; a written or printed statement of business dealings or debts and credits, and also of other things subjected to a reckoning or review
• temporary account
  an account that is closed at the end of the period to be made a permanent account
  

Examples

• Closing entries for our yoga studio example would be:

Closing the Accounting Cycle

The process of closing the temporary accounts is often referred to as closing the books . Accountants may perform the closing process monthly or annually. Only revenue, expense, and dividend accounts are closed - not asset, liability, Capital Stock, or Retained Earnings accounts. If the accounts are not closed correctly the beginning balances for the next month may be incorrect.

The Steps to Close the Accounts

There are four basic steps in the closing process:

• Closing the revenue accounts - transferring the balances in the revenue accounts to a clearing account called Income Summary.
• Closing the expense accounts - transferring the balances in the expense accounts to a clearing account called Income Summary.
• Closing the Income Summary account - transferring the balance of the Income Summary account to the Retained Earnings account (also known as the capital account).
• Closing the Dividends account - transferring the balance of the Dividends account to the Retained Earnings Account
  

The Income Summary account is a clearing account only used at the end of an accounting period to summarize revenues and expenses for the period. After transferring all revenue and expense account balances to Income Summary, the balance in the Income Summary account represents the net income or net loss for the period. Closing or transferring the balance in the Income Summary account to the Retained Earnings account results in a zero balance in the Income Summary. The Dividends account is also closed at the end of the accounting period. It contains the dividends declared by the board of directors to the stockholders. The dividends account is closed directly to the Retained Earnings account. It is not closed to the Income Summary because dividends have no effect on income or loss for the period.

Closing entries for our yoga studio example would be:

Example 1 July closing journal entries.

Example 2 August closing journal entries.