Closing Entries

Closing entries are the tool to close the temporary accounts and are passed to transfer the balances of the temporary accounts into the permanent accounts. These closing entries are made on the basis of accounts in the adjusted trial balance.

Closing entries are passed for all items of income and expenses so that their account balance could be made zero as these are temporary accounts. In short, we can say all income statement account items are temporary accounts and need to be closed by passing the closing entries.  Closing entries are also called Closing Journal Entries.

How to pass closing entries

  1. The process of passing closing entries is not difficult as it seems. Follow the steps below to close the temporary accounts:
  2. As income accounts such as sales and gain on sale are found on the credit side of the trial balance. In order to make them zero, we have to debit it and shift the balance to income summary account by debiting it.
  3. As expenses accounts such as Electricity expenses and Depreciation expenses are found on the debit side of the trial balance. In order to make them zero, we have to credit it and shift the balances to income summary account by crediting it.
  4. Now, we need to close the income summary account as well by debiting income summary account and crediting retained earning account, if the company is making profit. However, If the company is incurring losses, then entry will be reverse by debiting retained earning account and crediting income summary account.

Example

XYZ Plc has sales revenue of $50,000. The expenses include Electricity $12,000, water $4,000 etc. The closing entries will be passed like below:

   

 

Debit

Credit

Sales Revenue

 

 

50,000

 

 

Income Summary

 

 

50,000

   

 

 

 

Income Summary

 

 

16,000

 

 

Water Expenses

 

 

12,000

 

Electricity Expenses

 

 

4,000

 

Now, we can see the difference between sales revenue and total expenses is 36,000, which is found in income summary account on the credit side. We need to close the income summary account as well because it is also a temporary account. We transfer this balance of income summary account into retained earning account by passing the following entry:

     

Debit

Credit

Income Summary

 

 

36,000

 

 

Retained Earning

 

 

36,000

There are two options available for an accountant. Either he or she can transfer all items of income statement into retained earnings or to temporary income and summary account. Later, the income summary account is nullified with entry to the retained earning account. It is the choice of the accountant with which process he or she is comfortable. Now-a-days, modern accounting software do this task automatically, so there is no need to close the accounts manually. So, in an automated accounting or ERP systems, the burden over the accountant has reduced due to these automatic work.

Example

XYZ has following data available for the income statement as follows:
Sales revenue            $1,000,000
Electricity expense        $1,000
Salary expense            $2,000
Rent expense            $3,000
Interest expense        $1,000
Depreciation expense        $1,000
Cost of sales is 60 % of the sales revenue.

Solution

First, we need to calculate cost of sales by multi-plying 60 % to sale figure. So,
Cost of sales = 60 % x 1,000,000 = 600,000
In order to close all these, accountant can pass on the following entry:
Income summary account                        607,000 (Debit)
Cost of sales                                            600,000 (Credit)
Electricity expense                                    1,000 (Credit)
Salary expense                                         2,000 (Credit)
Rent expense                                           3,000 (Credit)
Interest expense                                       1,000 (Credit)


And in order to close the revenue account, it should be debited against retained earning account as follows.


Sales revenue                          1,000,000 (Debit)
Income summary account                                    1,000,000 (Credit)


It should be kept in mind that dividend are not closed via income summary accounts. The reason behind this logic is that dividend is not an income statement or profit & loss account. So, it is adjusted directly with retained earning account.
 

Question

Tohya is involved in the digital camera production and has been r unning its business since last 11 months. Following are the adjusted balances of Tohya on December 31, 2015.

Debit balances

Credit Balances

Cash

70,000

Creditors

40,000

Inventory

40,000

Unearned rent income

30,000

Other assets

120,000

Share capital

140,000

Sales return

30,000

Sales revenue

400,000

Discount allowed

10,000

Purchase return

32,000

Purchases

300,000

Discount received

8,000

Carriage in

20,000

Commission fees

10,000

Payroll expenses

50,000

   

Insurance expenses

20,000

   
 

660,000

 

660,000

 

Inventory as on December 31, 2015 was physically counted and valued at 60,000.

Required:

Prepare closing entries in the books of accounts.

Tohya

Closing Entries

Date

Particulars

Debit

Credit

 

Expense & Revenue Summary

Inventory

Purchase

Carriage in

Sales return

Sales discount

Payroll expenses

Insurance expense

(to close all debit balances of income statement.)

470,000

 

40,000

300,000

20,000

30,000

10,000

50,000

20,000

 

Sales

Closing inventory

Purchase return

Purchase discount

Commission income

Expense & Revenue Summary

(to close out all credit balances of income statement.)

400,000

60,000

32,000

8,000

10,000

 

 

 

 

 

510,000

 

Expense & Re venue Summary

Capital

(Net income shifted to capital account.)

40,000

 

40,000

Michael Traders is the well-known business name in the buying and selling of vegetable oils in Western part of Europe. Over the years, it has evolved as a leading trader in the industry. This is all due to the untidy efforts of its senior management who always worked hard for the betterment of the company.

The following is the trial balance of Michael Traders on 30 June, 2015.

Accounts

Debit

Credit

Cash

20,000

 

Bank

30,000

 

Furniture & fixture

34,000

 

Machinery

50,000

 

Office equipment

10,000

 

Cost of goods sold

150,000

 

Sales return

30,000

 

Payroll expense

36,000

 

Prepaid adverting

32,000

 

Inventory

46,000

 

Goodwill

24,000

 

Office supplies

8,000

 

Accounts receivable

120,000

 

Accounts payable

 

20,000

Loan from bank

 

120,000

Unearned rent income

 

10,000

Payroll payable

 

2,000

Capital

 

200,000

Sales revenue

 

208,000

Advance from customers

 

30,000

 

Payroll expense for the year $ 30,000.

Interest payable on outstanding bank loan at 10 % for 03 months.

Office supplies still unused $ 1,000.

Prepaid advertising $ 4,000.

Required

Closing Entries.

Solution

Michael Traders

Closing Entries

No.

Particulars

Debit

Credit

 

Expense & revenue summary

Cost of goods Sold

Sales return

Payroll expense

Advertising expense

Office supplies expense

Interest expense

(Closing all debit balances of Profit & Loss account.)

221,000

 

150,000

3,000

30,000

28,000

7,000

3,000

 

Sales

Expense & revenue summary

(Closing credit sales of profit & loss account.)

208,000

 

208,000

 

Capital

Expense & Revenue Summary

(Net loss from the business carried to capital account).

13,000

 

13,000

Contents
Financial Ratios Accounting Cycle Income Summary Accounts Adjusted Trial Balance Adjusting Entries Closing Entries Compound Journal Entry Journal Entries Ledger Accounts and Posting to Ledger Accounts Post Closing Trial Balance Preparation of Unadjusted Trial Balance Reversing Entries Accounting Principles Financial Accounting Basics Financial Statements Reporting Bad Debts Current Assets Long-term Assets Voucher System Partnership Depreciation Work Sheet - 10 Column Work Sheet Difference Between Reserve and Fund Accounting for Leases Capital reduction and reconstruction Absorption of Company Amalgamation Accounting for Installment Sales Basis of Recording Profit and Loss Branch Accounting Construction Contracts Revenue Recognition Accounting for Groups Financial Analysis Events After the Balance Sheet Date Deferred Tax Cost Accounting Activity Based Costing (ABC) Throughput Accounting Relevant Cost Break Even Analysis Standard Costing Inventory Management Payroll Accounting Royalty Accounting Statistics Master Budget Salary Income Microsoft Excel Tutorial Other Topics Share or Stock Valuation Model Financial Management Topics Kinds of Endorsement Letter of Credit, Kinds and Its Advantages/ Utilities Modern Functions of a Commercial Banks Difference Between Secured And Unsecured Loan Excel conditional formatting red if negative green if positive How to Remove Extra Spaces in Excel Result Card or Result Sheet Creation Using Excel Basic Accounting MCQS Multiple Choice Questions