Closing the Accounts
At the end of the period, temporary or nominal accounts are closed; these include expense, revenue, and owner withdrawing accounts. This process zeros out the account balances so that the balance of the transactions in each account reflects only the transactions of a particular period. This is normally done only at the end of the year.
To facilitate closing, a clearing account called Income Summary is used. The Income Summary account is used only momentarily; revenue and expensed are closed into it and then that balance is immediately closed out to Owner’s Equity (or Retained Earnings). The four steps in closing the accounts are:
- Close revenue accounts by debiting each for its credit balance and crediting Income Summary.
- Close expense accounts by crediting each for its debit balance and debiting Income Summary.
- Income Summary is closed into the Capital account by debiting (for a net income) or crediting (for a net loss) the balance.
- Close the Withdrawals account by crediting it by its balance and debiting the Capital account.
In the example of closing journal entries below, assume that revenue, expense, and owner equity accounts have the following balances.
|Rent Expense||1,400||Sales Revenue||6,000|
|Salary Expense||1,200||Owner’s Equity|
|Office Supplies Expense||400||Capital Account||9,000|
The entries below depict a net income for the period. Read below how the entries differ for a net loss.
|General Journal||Page: 1|
|31(1)||Sales RevenueIncome SummaryTo close revenue account||6000|
|31(2)||Income SummaryRent ExpenseSalary ExpenseOffice Supplies ExpenseUtilities ExpenseTo close expense accounts||3320|
|31(3)||Income SummaryOwner, CapitalTo close net income to Capital||2680||2680|
|31(4)||Owner, CapitalOwner, WithdrawalsTo close drawing account to Capital||1000||1000|
Here is how the transactions above effect the Income Summary and Capital accounts. The number in parenthesis indicates which of the transactions results in the account’s entry:
|Income Summary(2) 3320(3) 2680(1) 6000||Owner’s Equity(4) 1000Bal 9000(3) 2680|
When the revenue and expense accounts are closed to Income Summary and a credit balance exists, a net income is the result. The opposite is true for a net loss; the Income Summary account has a debit balance. In the case of a net loss, the third entry above would contain a debit to Owner’s Capital and a credit to Income Summary.