After recording financial transactions all month, the accounting staff needs to perform the closing process in order to finalize the financial records for the month and prepare the accounts for the following month. Every business uses temporary accounts, or revenue and expense accounts, which allows the company to record the total activities in those accounts for the month. The purpose of the closing process is to close out the balances in those accounts, allowing them to start with a balance of zero the next month. The closing process of the accounting cycle consists of four steps.
The first step in the closing process involves closing out all revenue accounts. The accountant reviews each revenue account and identifies each account with a balance. Companies record all transactions using debits and credits. Revenue accounts maintain normal credit balances. The accountant closes out the revenues by debiting each account for the ending balance. The accountant credits an account called Income Summary for the total debits recorded for the revenue accounts.
The second step in the closing process involves closing out all expense accounts. The accountant reviews each expense account and the accounts with a balance more than zero. Expense accounts maintain normal debit balances. The accountant closes out the expenses by crediting each account for the ending balance. The accountant debits an account called Income Summary for the total credits recorded for the expense accounts.
The Income Summary account exists only during the closing process for the purpose of zeroing the revenue and expense accounts. After closing those accounts, the accountant needs to close the Income Summary account. The accountant determines the balance in this account by reviewing the first two closing entries. The net income reported on the income statement equals revenues minus expenses and should equal the balance in the Income Summary account. If the Income Summary account has a debit balance, the accountant should credit this account for the balance and debit Retained Earnings. If the Income Summary account has a credit balance, the accountant should debit this account for the balance and credit Retained Earnings.
The final entry in the closing process considers the dividends declared during the period. Dividends represent a return of equity and start at zero each period. Dividends have a normal debit balance. The accountant closes the Dividend account by crediting the Dividend account and crediting Retained Earnings for the balance.