Accountants, bookkeepers or individual business owners prepare closing entries at the end of an accounting period to zero temporary accounts and transfer their balances to permanent accounts. Temporary accounts include revenue, expense and capital withdrawal accounts, such as distributions and dividends. A special account, called the income summary, is often used to enter all the revenue and expense accounts to calculate the company's net income for the period. The closing entries prepare the company books for recording the next period's transactions.
Review all expense accounts to ensure all entries are accurate and all expenses generated for the period are included. You must accrue for expenses generated during the period but were not received or entered into the period. For example, if you had raw materials expenses for products created and sold during the period, but have not yet received the invoice, you must add those expenses to include their amounts for the period.
Reconcile all accounts to ensure all entries, adjustments or mistakes are corrected. This allows you to correct entries made to the wrong accounts and place them in the correct accounts. It also helps to find out-of-balance accounts or one-legged entries -- accounting entries that are incomplete, as each entry in accounting has two legs -- a debit and credit transaction.
Make any adjustments for bad debts, write-offs or credit invoices that apply to the period in the appropriate accounts.
Review and reconcile revenue accounts to ensure that all activity for the period has been accurately posted. Make adjustments or correcting entries as necessary
Close revenue accounts by debiting the revenue accounts with amounts equal to the credit balance in these accounts. For example, if the balance in the sales account is ($500,000), the debit entry to this account is a $500,000. The closing entry is a debit $500,000 to sales and a credit ($500,000) to the income summary account. Write an explanation for this entry, such as, "Close sales to the income summary account for the period ending --." Add the date of the period end in MM/DD/YY format. Since revenue, gain and contra expense accounts maintain a credit balance, you bring them to zero with an opposite or debit entry.
Make closing entries to each expense account by posting an amount equal to the balance in each of these accounts. For example, if wage expense is $100,000, telephone expense is $42,000, and cost of goods sold is $240,000, all accounts with all debit balances -- post a credit of ($100,000) to wage expense, a credit of ($42,000) to telephone expense and a ($240,000) credit to cost of goods sold. Add these amounts together and post one combined debit of $382,000 to the income summary account to balance the entry and add an explanation as listed in Step 5. All expense accounts typically maintain a debit balance, requiring a credit entry to clear them out and transfer their balance accordingly.
Transfer the net income or loss from the income summary account to the company's equity accounts. For a corporation, this is the retained equity account. For a partnership, it's the partners' equity accounts. For a limited liability company, it's the members' equity accounts. This entry closes the income summary account by posting a credit or a debit to the income summary account and the opposite entry to the individual or multiple equity accounts.
Adjust the temporary equity accounts to zero. These accounts are normally debit balances. Post a credit equal to these balances in each temporary equity account and a debit to the appropriate permanent equity account. Written and dated explanations of each of these entries keep the transactions clear for later examination.
Each business entity has its own period and year-end accounting procedures. Review these to ensure you comply with the policies and procedures when completing the accounting close.
As the closing entries are the final steps completed during the period close, you must ensure that all the data is accurate and correct before bringing the temporary accounts to zero.
When making any kind of journal entry, always include a dated note to explain what the entry was for to avoid confusion when reviewing the transactions month or years later.
Check to be sure all transaction amounts have been properly posted by checking all temporary account balances after the closing entries are completed. All temporary accounts should have zero balances.
Do not zero an account balance without having reviewed the individual entries for accuracy first.
Keep accurate back-ups of all activity as required by law for your business.
- AndreyPopov/iStock/Getty Images