Remember from your past studies that dividends are not expenses, such as salaries paid to your employees or staff. Instead, declaring and paying dividends is a method utilized by corporations to return part of the profits generated by the company to the owners of the company—in this case, its shareholders. Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period. The Income Summary account has a credit balance of $10,240 (the revenue sum). As an another example, you should shift any balance in the dividends paid account to the retained earnings account, which reduces the balance in the retained earnings account. In accounting, bookkeepers and accountants often refer to the process of closing entries as closing the books.

Temporary accounts are income statement accounts that are used to track accounting activity during an accounting period. For example, the revenues account records the amount of revenues earned during an accounting period—not during the life of the company. After the income statement accounts are closed, the company prepares a final trial balance. Total revenue of a firm at the end of an accounting period is transferred to the income summary account to ensure that the revenue account begins with zero balance in the following accounting period.

Accounting Simplified

The revenue and expense accounts should start at zero each period, because we are measuring how much revenue is earned and expenses incurred during the period. However, the cash balances, as well as the other balance sheet accounts, are carried over from the end of a current period to the beginning of the next period. Below are some of the examples of closing entries that can be used to transfer revenue and expense account balances into income summary and from there to the retained earnings. A temporary account records balances for a single accounting period, whereas a permanent account stores balances over multiple periods. For instance, the year 2020 revenue and expense accounts would show the balances pertaining to just that year and not for 2019 or 2018. Examples of temporary accounts are the revenue, expense, and dividends paid accounts.

• If your expenses for December had exceeded your revenue, you would have a net loss.
• GJ-2 simply means these entries were made on the second page of the general journal and posted to the general ledger above.
• Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow.
• That way, your next accounting period does not have a balance in your revenue or expense account from the previous period.

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, https://turbo-tax.org/tax-professionals-in-detroit-michigan/ which keeps the accounts reconciled. Your closing journal entries serve as a way to zero out temporary accounts such as revenue and expenses, ensuring that you begin each new accounting period properly.

15 Closing Entries

The retained earnings account is reduced by the amount paid out in dividends through a debit, and the dividends expense is credited. Permanent (real) accounts are accounts that transfer balances to the next period and include balance sheet accounts, such as assets, liabilities, and stockholders’ equity. These accounts will not be set back to zero at the beginning of the next period; they will keep their balances. Here Bob needs to debit retained earnings account and credit dividends account.

Closing entries are journal entries made at the end of the accounting cycle to move temporary (nominal) account balances into permanent accounts. Closing entries zero out temporary accounts, preparing them to be used for the next accounting period. The closing process in accounting prepares accounting books for a new fiscal period by resetting income statement account balances to zero. This is done through a four-step process often known by the acronym REID (Revenue, Expenses, Income Summary, Dividends).

Close dividends

Because this is a positive number, you will debit your income summary account and credit your retained earnings account. In partnerships, a compound entry transfers each partner’s share of net income or loss to their own capital account. In corporations, income summary is closed to the retained earnings account. 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.

We will debit the revenue accounts and credit the Income Summary account. The credit to income summary should equal the total revenue from the income statement. You might be asking yourself, “is the Income Summary account even necessary? ” Could we just close out revenues and expenses directly into retained earnings and not have this extra temporary account?

How to Prepare Your Closing Entries

The income summary account is then closed to the retained earnings account. Again, if the company decides not to use an income summary account, then it will substitute the retained earnings account for the income summary account and finish this part of the closing process. If the company decides not to use an income summary account, it would substitute the retained earnings account for the income summary account, and finish this part of the closing process. Finally, you are ready to close the income summary account and transfer the funds to the retained earnings account. This process resets both the income and expense accounts to zero, preparing them for the next accounting period.