Closing the accounts is an essential part of accounting cycle. Closing the accounts means, close the temporary accounts by Journalizing and posting for the future transaction of next accounting period.
At the end of accounting period, the accounting transactions or entries are closed to make the entries prepared for the next accounting period. At the end of period, each period’s net income needs to quantify separately from all other periods. To do so, the closing process zeroes out all the balances of revenues and expenses account.
The company closes all temporary accounts at the end of the accounting period. During the process of closing the accounts, the company differentiates temporary accounts from permanent accounts due to some differences. For example all temporary accounts are made for the current given period only and all permanent accounts are linked to one or more future accounting periods. Moreover, temporary accounts consist of all income statement accounts and the owner’s drawing account. Whereas permanent accounts include all balance sheet accounts, along with the owner’s capital account.
Permanent accounts do not need to close in every accounting period. Thus the balances of permanent accounts are transferable into the next accounting period.
Preparing Closing Entries
For measuring net income or net loss the balances of the temporary account should be zero balance. So at the end of accounting period the temporary accounts need to be closed for computing net income or net loss. Because fixed account do not represent net income.
To complete the closing process the company transfers all temporary account balances to the permanent accounts of Owner’s equity, Owner’s Capital at the end of the accounting period.
Journal and posting entries need to be closed at the end of accounting period. Closing the entries is a preparation of recording the accounting transactions for next accounting period. Closing the journal and posting lead to zero balance in the revenues and expense account. Companies close these revenues and expense accounts to income summery for computing net income or net loss of each individual accounting period.
Generally, those entries are closed which are needed to measure net income. There are some steps for preparing closing entries:
- First, include closing entries in the general journal.
- The last adjusting entry and closing entry should record the closing entries from journal.
- Specify the entry.
- Finally, these closing entries will be posted into the ledger.
These are very primary steps for preparing closing entries. The closing entries are actually being illustrated or intended by following procedure:
- Debit each revenue account for the amounts of its credit balance.
- Credit income summary for the total amount of revenue and transfer this balances of revenue to the credit side of income summary.
- Oppositely credit each expense account for the amount of its debit balance and debit income summary for the total amount of expense.
- After closing expense and revenues, close the net income. For closing the net income debit the income summary with its balance and credit capital. In case, net loss there will be reverse step.
- Closing the withdrawals. Credit the drawings accounts for its debit balance and debit the capital account.