Introduction
Closing the books is like clearing a scoreboard before the next game. At the end of an accounting period, closing entries reset temporary accounts, including revenue, expense, and dividend accounts, to zero while carrying forward permanent account balances. This keeps each period’s results separate, and updates retained earnings with the company’s net income or loss.
This article walks through each closing entry and explains how automation can reduce manual work during the financial close.
Quick answer: Close revenue accounts by debiting each account for its ending balance and crediting income summary for the total. Then close expenses to income summary, transfer net income or loss to retained earnings, and close dividends to retained earnings.
What are closing entries?
Closing entries are journal entries made at the end of an accounting period to reset temporary accounts and transfer the period’s results to equity. This updates retained earnings, the cumulative earnings kept in the business after accounting for losses and dividends.
Closing entries are completed after transactions and adjusting entries have been posted, the adjusted trial balance has been prepared, and the financial statements have been reviewed.
Unlike closing entries, adjusting entries record activity not yet fully reflected in the general ledger, such as accrued revenue, unpaid expenses, or depreciation.
Temporary accounts
Temporary accounts track activity during a specific accounting period and are reset to zero before the next period begins.
They include revenue accounts, such as service, sales, and interest revenue; expense accounts, such as salaries, rent, utilities, materials, and depreciation; and equity-related accounts, such as dividends or owner withdrawals. Income summary is also a temporary account used during the closing process.
Revenue and expense accounts appear on the income statement, while dividends are reported in the statement of retained earnings or shareholders’ equity.
For example, if a company earned $500,000 in one year and $50,000 in the next, failing to close the revenue account would show $550,000 instead of the current period’s $50,000. Closing temporary accounts keeps each period’s results separate.
Permanent accounts
Permanent accounts carry their balances into the next accounting period and generally appear on the balance sheet.
They include asset accounts, such as cash, accounts receivable (AR), inventory, property and equipment, and accumulated depreciation; liability accounts, such as accounts payable and loans payable; and equity accounts, such as retained earnings and owner’s capital.
Accounts receivable is a permanent asset account. The revenue from a credit sale is closed, but the unpaid balance remains in AR until it is collected, written off, or adjusted.
Account type | Examples | Period-end treatment |
Temporary accounts | Revenue, expenses, dividends, and income summary | Reset to zero |
Permanent accounts | Assets, liabilities, and equity | Carry forward |
What should you do before closing revenue accounts?
Closing revenue accounts is the first closing journal entry, but it comes after several period-end checks. Before posting closing entries, confirm that the accounting records are complete and accurate.
Record all transactions: Post invoices, payments, expenses, payroll, bank activity, and other routine transactions to the general ledger. Missing or late entries can place revenue or expenses in the wrong period.
Post adjusting entries: Record items not yet fully reflected in the accounts, such as accrued revenue and expenses, prepayments, deferred revenue, depreciation, bad debt expense, and foreign currency adjustments.
Complete account reconciliations: Compare general ledger balances with supporting records. For accounts receivable, compare the AR subledger with the total AR balance in the general ledger. Although AR is not closed, errors can affect revenue, cash, bad debt expense, and financial reporting.
Prepare the adjusted trial balance: Confirm that total debits equal total credits after all adjustments are posted. Use these final balances to prepare the financial statements and closing entries.
What are the steps in the closing entry process?
The traditional closing process moves revenue, expenses, net income or loss, and dividends through four journal entries.
Income summary is a temporary account that collects the period’s revenue and expense balances. Its final balance represents net income or net loss, which is transferred to retained earnings. Income summary does not appear on the financial statements and should have a zero balance when the process is complete.
The following example assumes the business is a corporation. Sole proprietorships and partnerships use different equity accounts, as explained later in the article.
Example adjusted account balances
Consider a repair company with these temporary account balances at the end of the period:
Account title | Debit balance | Credit balance |
Service revenue | $120,000 | |
Interest revenue | $2,000 | |
Salaries expense | $55,000 | |
Rent expense | $18,000 | |
Materials expense | $12,000 | |
Utilities expense | $7,000 | |
Depreciation expense | $5,000 | |
Dividends | $4,000 |
The company has $122,000 in revenue, $97,000 in expenses, $25,000 in net income, and $4,000 in dividends.
Step 1: Clear revenue to income summary
Revenue accounts normally have credit balances. To reset them to zero, debit each revenue account and credit income summary for the total.
Account title | Debit | Credit |
Service revenue | $120,000 | |
Interest revenue | $2,000 | |
Income summary | $122,000 |
After posting, both revenue accounts have zero balances and income summary has a $122,000 credit balance.
Include every revenue account with a balance, such as sales, consulting, subscription, rental, or interest revenue. Do not close permanent accounts such as unearned revenue, which remains a liability until the related goods or services are provided.
Step 2: Clear expenses to income summary
Expense accounts normally have debit balances. Close them by crediting each expense account and debiting income summary for the total.
Account title | Debit | Credit |
Income summary | $97,000 | |
Salaries expense | $55,000 | |
Rent expense | $18,000 | |
Materials expense | $12,000 | |
Utilities expense | $7,000 | |
Depreciation expense | $5,000 |
The expense accounts now have zero balances. Income summary has a remaining $25,000 credit balance, calculated as $122,000 in revenue less $97,000 in expenses.
This amount should match the net income shown on the income statement. If it does not, check for an omitted account, an incorrect amount, or a reversed debit and credit.
Step 3: Close income summary to retained earnings
Because the company has net income, debit income summary and credit retained earnings. If the company had a net loss, the entry would be reversed.
Step 4: Close dividends to retained earnings
Dividends are distributions to shareholders, not operating expenses, so they are closed directly to retained earnings.
Closing entry | Account title | Debit | Credit |
Transfer net income | Income summary | $25,000 | |
Retained earnings | $25,000 | ||
Close dividends | Retained earnings | $4,000 | |
Dividends | $4,000 |
Net income increases retained earnings by $25,000, while dividends reduce it by $4,000. The result is a net increase of $21,000 in retained earnings.
At this point, revenue, expense, dividend, and income summary accounts all have zero balances.
Does the closing process change by business structure?
Yes. The equity account used depends on the business structure.
Corporations close net income, net loss, and dividends to retained earnings. Sole proprietorships close income and withdrawals to the owner’s capital account. Partnerships close income and withdrawals to each partner’s capital account based on the partnership agreement.
Finance teams should follow the company’s chart of accounts and accounting policies.
What is the short-form closing method?
The short-form method closes temporary accounts directly to retained earnings without using income summary.
Account title | Debit | Credit |
Service revenue | $120,000 | |
Interest revenue | $2,000 | |
Salaries expense | $55,000 | |
Rent expense | $18,000 | |
Materials expense | $12,000 | |
Utilities expense | $7,000 | |
Depreciation expense | $5,000 | |
Dividends | $4,000 | |
Retained earnings | $21,000 |
The $21,000 credit to retained earnings equals $25,000 in net income less $4,000 in dividends.
This method produces the same result with fewer entries. The traditional method provides an extra review point because the income summary balance can be compared with the net income or loss on the income statement.
What is a post-closing trial balance?
After posting the closing entries, prepare a post-closing trial balance to verify the general ledger.
It should show that:
Total debits equal total credits
Temporary accounts no longer appear because their balances have been reduced to zero
Only permanent accounts remain open
The report includes balance sheet accounts such as cash, accounts receivable, inventory, property and equipment, accounts payable, loans payable, and retained earnings.
If a temporary account appears, a closing entry may be missing or incorrect. The post-closing trial balance confirms that the ledger is balanced, but it does not prove that every transaction was recorded correctly.
What are the best practices for closing entries?
Use a consistent checklist, complete all reconciliations before closing, and maintain clear supporting records for every entry.
Use a consistent closing checklist: Document each task, owner, deadline, supporting record, and approval status. A repeatable workflow helps prevent missed steps and makes period-to-period comparisons easier.
Check transaction timing: Confirm that revenue and expenses are recorded in the correct period, especially near the cut-off date. Timing errors can affect net income, retained earnings, taxes, and financial reporting.
Complete reconciliations first: Reconcile bank, credit card, accounts receivable, accounts payable, payroll, inventory, and intercompany accounts before posting closing entries. Eliminate intercompany activity where required for consolidated reporting.
Use standard journal entry templates: Templates should include account titles, supporting schedules, the accounting period, an entry description, and preparer and reviewer details. This improves consistency and reduces posting errors.
Maintain a clear audit trail: Keep supporting records for reconciliations, trial balances, financial statements, and closing entries. Each entry should show who prepared and approved it, when it was posted, and why it was required.
Lock completed periods: After the close is approved, restrict access to the period. Any later adjustment should include supporting evidence, a documented reason, and the appropriate approval.
What are the benefits of automating closing activities?
Closing speed varies by company size and complexity. APQC found that top-performing organizations complete the annual close in 10 days or less, compared with 18 days for median performers and 35 days for slower performers. Better preparation, ongoing reconciliations, and automation can help reduce delays.
Accounting software can automate calculations, journal postings, account updates, task assignments, and financial reporting.
Improve accuracy: Standard calculations, account rules, and journal templates help reduce data entry errors and inconsistent postings.
Speed up the close: Automating repetitive tasks allows balances and reports to be updated faster, giving finance teams more time to review unusual results.
Provide reports sooner: Updated trial balances and financial statements can be available shortly after entries are approved, giving finance leaders earlier access to the results.
Strengthen controls: Task management, access controls, review sign-offs, audit trails, and period locks support a more consistent closing process.
Automation still requires oversight. Accountants must confirm that transactions are complete, accounts are classified correctly, and the results are reasonable.
How can accounts receivable automation support the close?
Accounts receivable is a permanent account, so it remains open after closing entries are posted. However, inaccurate AR data can affect revenue, cash, bad debt expense, and balance sheet balances.
Accounts receivable automation can help finance teams:
Apply cash faster: Match incoming payments to invoices and update customer accounts and ERP records.
Reduce reconciliation issues: Identify unapplied cash, missing remittance details, and differences between the AR subledger and general ledger.
Improve receivables visibility: Track overdue invoices, disputes, customer credits, and outstanding balances.
Keep a clear payment history: Preserve payment and collection activity for reconciliation and review.
With fewer unapplied payments and account differences to investigate, accountants can complete AR reconciliations before preparing the closing entries.
Conclusion
Closing entries reset revenue, expense, and dividend accounts so each accounting period begins with a clean slate. The traditional process closes revenue and expenses through income summary, transfers net income or net loss to retained earnings, and then closes dividends.
Completing reconciliations before posting closing entries can reduce errors and prevent delays. Automation can also remove some of the repetitive work involved in finalizing the period. Quadient Accounts Receivable Automation helps keep receivables and payment information current, making it easier to resolve AR issues before the period is finalized.
Explore Quadient Accounts Receivable Automation to simplify receivables management and support a more efficient financial close.
