What are closing entries?

Definition

Closing entries are the period-end postings that move every income and expense balance into equity and leave those P&L accounts at zero. They turn this period's profit or loss into retained earnings, or owner's equity, so the next period can start with a clean Income Statement.

In books language, this is the last set of postings in the period. Temporary accounts close, and permanent accounts on the Balance Sheet stay open and carry forward.

Where it shows up

Balance Sheet: Related to retained earnings or owner's equity receiving the net.

P&L: Related to income and expense accounts going to zero.

Cash flow: Related to nothing extra.

See also: Retained Earnings · Year-End Close · Post-Closing Trial Balance

You will not see closing entries as a caption on the Income Statement. They are the postings that take revenue and expense accounts to zero after that statement has been prepared.

On the Balance Sheet, the net of those closed accounts lands in retained earnings or owner's equity. The equity line grows when the period made a profit, and it shrinks when the period ran a loss.

The Statement of Cash Flows does not move because of closing entries. Cash has not changed, and the close is only a books movement between temporary accounts and equity.

How it works

Temporary accounts are the P&L accounts that measure one period: revenue, expenses, gains, and losses. Permanent accounts are the Balance Sheet accounts that carry forward: assets, liabilities, and equity.

A common sequence uses an income summary account as a holding place. Each revenue account is debited for its balance, with income summary credited, and each expense account is credited for its balance, with income summary debited.

If income summary then has a credit balance, that amount is net income, and the close debits income summary and credits retained earnings for the net. If income summary has a debit balance, the business ran a loss, and the sides swap.

Some ledgers skip income summary and close revenue and expenses straight into retained earnings. The result is the same: P&L accounts sit at zero, and equity holds the period's net.

Dividends or owner draws, if they sit in a temporary account, close to retained earnings as well. That posting reduces equity for amounts taken out, separate from the profit close.

After the closing entries post, the next period can record a new invoice or a new vendor bill in empty P&L accounts. Those accounts no longer carry last year's totals, so this year's Income Statement starts at zero.

Closing entries are usually dated the last day of the year, after the statements are ready. Monthly books often skip a full close and keep P&L accounts running until year-end, then close once.

Example

A florist finishes the year with $8,000 of net income sitting in income summary after revenue and expenses have already been closed into that account. The last closing entry moves that net into retained earnings:

Debit: Income summary $8,000

Credit: Retained earnings $8,000

Income summary returns to zero. Retained earnings on the Balance Sheet increase by $8,000, which is the florist's profit kept in the business.

Common mix-ups

Closing entries are not adjusting journal entries. Adjusting entries record accruals and deferrals so the statements are complete, and closing entries come after the statements are ready and zero the P&L.

Closing entries are not reversing journal entries. A reverse undoes one prior adjustment at the start of the next period, and closing entries empty temporary accounts into equity at the end of this period.

Closing entries do not move cash. They rearrange balances already in the books, so a profit close can raise equity while the checking account stays exactly where it was.

Related terms

• Retained Earnings: Cumulative profits kept in the business rather than paid out.
• Net Income: What is left from revenue after every expense, including interest and taxes, is subtracted.
• Year-End Close: The heavier close at fiscal year end, including closing entries and audit preparation.
• Post-Closing Trial Balance: The trial balance produced after closing entries, showing only balance-sheet accounts.
• Journal Entry: A dated record of debits and credits posted to the ledger.
• General Ledger: The master record of every account and every posted transaction.
• Accounting Period: The span of time a set of financial statements covers.
• Opening Balance: The balance loaded into an account when the books are first set up or moved to a new system.