Closing Journal Entries

Closing journal entries are used at the end of the accounting cycle to close the temporary
accounts for the accounting period, and transfer the balances to the retained earnings account.

Temporary and Permanent Accounts

A temporary account is an income statement account, dividend account or drawings account. It is
temporary because it lasts only for the accounting period. At the end of the accounting period,
the balance is transferred to the retained earnings account, and the account is closed with a zero
balance. For each temporary account there will be a closing journal entry.

In contrast, a permanent account is a balance sheet account. It is permanent because it is not

closed at the end of each accounting period. At the start of the new accounting period, the
closing balance from the previous accounting period is brought forward and becomes the new
opening balance on the account. Other than the retained earnings account, closing journal entries
do not affect permanent accounts.

Closing Journal Entries Process

The year end closing entries all follow a similar format. If a temporary account has a debit
balance it is credited to bring it to zero, and the retained earnings account is credited to balance
the closing entry. Likewise, if a temporary account has a credit balance, it is debited to bring it to
zero and the retained earnings account is credited. The closing entries are dated in the journal as
of the last day of the accounting period.

Typical closing journal entries for a generic temporary account are shown below:

Closing journal entries – Debit temporary account balance

Account Debit Credit
Temporary account 1,000
Retained earnings 1,000
Total 1,000 1,000
Closing journal entries – Credit temporary account balance
Account Debit Credit
Temporary account 1,000
Retained earnings 1,000
Total 1,000 1,000

Closing Journal Entries Example

Suppose a business had the following trial balance before any closing journal entries at the end
of an accounting period.

Trial balance before closing journal entries

Account Debit Credit
Revenue 9,000
Other income 1,000
Cost of sales 3,600
Payroll 2,500
Rent expense 1,500
Depreciation expense 800
Finance cost 200
Dividend 200
Balance sheet accounts 8000
Retained earnings 6,800
Total 16,800 16,800

The retained earnings account balance of 6,800 is the amount brought forward from the previous
accounting period, and for the sake of this example, the other balance sheet (permanent accounts)
are shown as one balance, as they are not part of the closing journal entries process.

The closing journal entries required to transfer the balance on each of these accounts to the
retained earnings account is as follows:

Closing journal entries – income statement accounts

Account Debit Credit
Revenue 9,000
Other income 1,000
Cost of sales 3,600
Payroll 2,500
Rent expense 1,500
Depreciation expense 800
Finance cost 200
Retained earnings 1,400
Total 10,000 10,000

Notice that the effect of this closing journal entry is to credit the retained earnings account with
the amount of 1,400 representing the net income (revenue – expenses) of the business for the
accounting period.
After the closing journal entries the balance on these temporary accounts will be zero ready for
the next accounting period, the balance on the permanent balance sheet accounts will remain
unchanged, and the balance on the retained earnings account will have increased by the net
income for the period of 1,400.

Dividend Accounts and Closing Journal Entries

Although it is not an income statement account, the dividend account is also a temporary account
and needs a closing journal entry to zero the balance for the next accounting period.

In the above example the balance on the dividend account was a debit of 200, to close the
dividend account the following closing entry is made:

Closing journal entries – Dividend account

Account Debit Credit
Dividend account 200
Retained earnings 200
Total 200 200

After the closing journal entry, the balance on the dividend account is zero, and the retained
earnings account has been reduced by 200.

Movement on the Retained Earnings Account

The movement on the retained earnings account as a result of the closing journal entries is
summarized in the table below:

Movement on the retained earnings account

Account Amount
Beginning balance 6,800
Net income 1,400
Dividend -200
Ending balance 8,000

The net effect on the retained earnings account is 1,400 – 200 = 1,200 which is the net income
less the dividend or the retained earnings for the accounting period.

The retained earnings account balance has now increased to 8,000, and forms part of the trial
balance after the closing journal entries have been made. This trial balance gives the opening
balances for the next accounting period, and contains only balance sheet accounts including the
new balance on the retained earnings account as shown below.
Trial balance after closing journal entries
Account Debit Credit
Balance sheet accounts 8000
Retained earnings 8,000
Total 8,000 8,000

Use of an Income Summary Account

While the net effect of closing journal entries is to transfer temporary account balances to the
retained earnings account, some businesses particularly those with manual accounting systems,
use an intermediate step in the closing journal entries process, and transfer the temporary income
statement type account balances (revenue and expenses) to an income summary account.

The purpose of the income summary is to show the net income (revenue less expenses) of the
business in more detail before it becomes part of the retained earnings account balance.

The process of using of the income summary account is shown in the diagram below.

The income summary account is in itself a temporary account and an additional closing journal
entry is made to zero the account at the end of the accounting period, and transfer the balance
(the net income for the period) to the retained earnings account as before.

Closing journal entries – Income summary account

Account Debit Credit
Income summary 1,400
Retained earnings 1,400
Total 1,400 1,400

Drawings Accounts and Closing Journal Entries

A sole proprietor or partnership often uses a separate drawings account to record withdrawals of
cash by the owners. Although the drawings account is not an income statement account, it is still
classified as a temporary account and needs a closing journal entry to zero the balance for the
next accounting period.

As the drawings account is a contra equity account and not an expense account, it is closed to the
capital account and not the income summary or retained earnings account.

Suppose for example, the balance on the drawings account was a debit of 1,300, to close the
account the following closing entry is made:

Closing journal entries – Drawings account

Account Debit Credit
Drawings account 1,300
Capital account 1,300
Total 1,300 1,300

After the closing journal entry, the balance on the drawings account is zero, and the capital
account has been reduced by 1,300.