Close-the-Books Process Flow

Also closed at the end of the accounting period is the Dividends account containing the dividends declared by the board of directors to the stockholders. We close the Dividends account directly to the Retained Earnings account and not to Income Summary because dividends have no effect on income the closing process is sometimes referred to as closing the books or loss for the period. The next and final step in the accounting cycle is to prepare one last post-closing trial balance. Accrual accounting is one of the reasons closing the books is so important. To make a long story short, accrual accounting records transactions before cash changes hands.

• These reports can be generated automatically in your accounting software.
• Most small companies close their books monthly, though some only do so at year’s end.
• This includes understanding the full accounting information
  cycle, and what is used to create the financial statements that will be
  provided to required and interested stakeholders.
• In Chapter 2, you learned that revenue, expense, and dividends accounts are nominal (temporary) accounts that are merely subclassifications of a real (permanent) account, Retained Earnings.
• For smaller businesses, it might make sense to bypass the income summary account and instead close temporary entries directly to the retained earnings account.
• In some cases, accounting software might automatically handle the transfer of balances to an income summary account, once the user closes the accounting period.

Because revenue accounts have credit balances, you must debit them for an amount equal to their balance to bring them to a zero balance. When you debit Service Revenue and Interest Revenue, credit Income Summary (Account No. 600). Enter the account numbers in the Posting Reference column when the journal entry has been posted to the ledger. At the end of the year in the old paper-based accounting system, the journal would be put in a safe and a new journal started (often businesses had so many transactions they had multiple huge journals). Obviously, with our computer data storage systems, we just keep adding journal entries to our digital files.

Why we close the books

As a result of the previous entry, you would credit the Income Summary account for USD 13,800. Closing the books is important to maintain accurate financial records, comply with regulations, assess performance, facilitate decision-making, and provide reliable financial information to stakeholders. There is a lot that goes into running a small business, and being a small business owner r… Retained earnings are those earnings not distributed to shareholders as dividends, but retained for further investment, often in advertising, sales, production, and equipment.

“The books” are a business’s revenue, expense, and income summary reports. Business owners can close their books by zeroing out their income and expense accounts and then plugging net profit (or loss) into the balance sheet. A term often used for closing entries is «reconciling» the company’s accounts.

Financial Accounting

In turn, the income or loss is then swept to Retained Earnings along with the dividends. Recall that beginning retained earnings, plus income, less dividends, equals ending retained earnings; likewise, the closing process updates the beginning retained earnings to move forward to the end-of-period balance. From this trial balance, as we learned in the prior section, you make your financial statements. After the financial statements are finalized and you are 100 percent sure that all the adjustments are posted and everything is in balance, you create and post the closing entries. The closing entries are the last journal entries that get posted to the ledger.

Accountants perform closing entries to return the revenue, expense, and drawing temporary account balances to zero in preparation for the new accounting period. The debit of USD 6,510 to the Income Summary account agrees with the Income Statement debit column subtotal in the work sheet. This comparison with the work sheet serves as a check that all revenue and expense items have been listed and closed. If the debit in the preceding entry was made for a different amount than the column subtotal, the company would have an error in the closing entry for expenses. This process results in all revenues and expenses being “corralled” in Income Summary (the net of which represents the income or loss for the period).

What Is the Purpose of the Closing Process?

• Closing the Dividends account—transferring the balance of the Dividends account to the Retained Earnings account. • Closing the Income Summary account—transferring the balance of the Income Summary account to the Retained Earnings account. Sign up for a free, no-obligation trial to start exploring our timesaving, valuable resources. Accounting automation streamlines data collection, reconciliation, adjustments and report generation, significantly reducing book closing time from weeks to days. When you are growing a business, there are bound to be times when you need to invest money…

Keeping your books balanced entails keeping a detailed record of all debits and all credits to each account. These records are then used to generate reports that can tell a business owner the financial status of their enterprise. This process helps owners stay on track with business goals and prepare for filing their income tax returns. In partnerships, a compound entry transfers each partner’s share of net income or loss to their own capital account. In corporations, income summary is closed to the retained earnings account. The balance sheet’s assets, liabilities, and owner’s equity accounts, however, are not closed.