Closing entries, also known as closing the books, are journal entries made at the end of an accounting period to transfer the balances of temporary accounts to permanent accounts. Temporary accounts, also known as nominal or revenue accounts, include income, expenses, and dividends. Permanent accounts, also known as real or balance sheet accounts, include assets, liabilities, and equity.
The purpose of closing entries is to reset the balances of temporary accounts to zero so that they are ready to receive new transactions in the next accounting period. This helps to ensure the accuracy and completeness of financial statements, as it ensures that only the permanent accounts are carried forward to the next period.
Here is an example of closing entries:
At the end of the year, the balance in the income account is $50,000 and the balance in the expenses account is $30,000. To close these accounts, the following entries are made:
Debit Credit
Income account $50,000
Retained Earnings account $50,000
Debit Credit
Expenses account $30,000
Retained Earnings account $30,000
The net effect of these entries is to transfer the $20,000 difference between income and expenses ($50,000 – $30,000) to the retained earnings account, which is a permanent equity account. The balances in the income and expenses accounts are then reset to zero, ready to receive new transactions in the next period.
It’s important to note that closing entries are only made at the end of an accounting period, such as a month, quarter, or year. They are not made for individual transactions or on a daily basis.