When it comes to accounting a closing entry is one of the crucial steps to finalizing an accounting period. This type of entry is made at the end of an accounting period and its purpose is to zero out all temporary accounts so that they are ready to be used in the next accounting period. Without closing entries, a company’s financial statements would be inaccurate and incomplete.
In this article, we will be discussing what is a closing entry, how to record it, and what are its benefits. So if you are interested in learning about this important accounting process, keep reading!
Definition of Closing Entry
A closing entry is a type of accounting journal entry that is made at the end of an accounting period. The purpose of this entry is to zero out all temporary accounts so that they are ready to be used in the next accounting period. In simple words, closing entries are made to close the books for an accounting period.
There are three types of accounts that are closed at the end of an accounting period
- Revenue accounts: Revenue accounts are the accounts that track a company’s income. These accounts are usually closed at the end of an accounting period by debiting them and crediting the Income Summary account.
- Expense accounts: Expense accounts are the opposite of revenue accounts, they track a company’s expenses. Similar to revenue accounts, these accounts are closed at the end of an accounting period by debiting them and crediting the Income Summary account.
- Dividends account: The dividends account is used to track a company’s dividend payments. It means that when a company pays out dividends to its shareholders, the dividend payments are recorded in this account. These accounts are also closed by debiting them and crediting the Income Summary account.
How to record a closing entry
Here is how you can record a closing entry in your books
- First, all revenue accounts are moved to the income summary. This is accomplished by debiting all revenue accounts and crediting the income summary in a journal entry.
- Next, the procedure is repeated for expenses. All expenses are credited to expense accounts and debited from the income summary to close everything out.
- Next, the income summary account is closed and added to retained earnings.
- And lastly, if a dividend is paid, the balance is moved from the dividends account to retained earnings.
Benefits of closing entries
There are many benefits of closing entries, some of them are listed below
- Helps in preparing accurate financial statements: Since all temporary accounts are closed at the end of an accounting period, it helps in preparing accurate financial statements. If these entries were not made, the financial statements would be incomplete and inaccurate.
- Gives an idea of the company’s profitability: Since all revenue and expense accounts are closed at the end of an accounting period, it gives us an idea of the company’s profitability. If a company is making more revenue than expenses, it means that the company is profitable.
- Helps in decision-making: Closing entries help managers and owners in decision-making by providing them with an accurate picture of the company’s financial state.
- Helps in preparing budgets: A budget is a plan that outlines how a company plans to spend its money. By preparing a budget, a company can track its actual spending against what it planned to spend. This helps in better decision-making.
Closing entries are an important part of accounting as it helps in preparing accurate financial statements. These entries help in understanding a company’s profitability, making decisions, and in preparing budgets. So if you are an accountant or someone interested in learning about accounting, it is important to understand the concept of closing entries.