Lesson 73 - Beginner accounting course

73. The Closing Process in Accounting

The closing process is a crucial step in the accounting cycle that ensures a company’s temporary accounts (revenues, expenses, and dividends) are reset to zero at the end of a reporting period. This allows the business to prepare for the next accounting period with a clean slate.

1. What Is the Closing Process?

The closing process involves transferring balances from temporary accounts (income statement accounts) to permanent accounts (balance sheet accounts). This ensures that revenue and expense accounts start fresh each period.

Key Objectives:

• Close revenue, expense, and dividend accounts.

• Transfer net income (or loss) to retained earnings.

• Ensure the next accounting period starts with zero balances in temporary accounts.

2. Accounts Involved in the Closing Process 

3. The Four Steps of the Closing Process

Step 1: Close Revenue Accounts

Revenue accounts are closed by transferring their balances to the Income Summary account.

Example:

A company has total revenue of $50,000.

This resets revenue to zero and moves the balance to Income Summary.

Step 2: Close Expense Accounts

Expense accounts are closed by transferring their balances to Income Summary.

Example:

A company has the following expenses:

• Salaries Expense: $10,000

• Rent Expense: $5,000

• Utilities Expense: $2,000

• Total Expenses: $17,000

This resets all expense accounts to zero.

Step 3: Close Income Summary to Retained Earnings

The net income or net loss from the Income Summary is transferred to Retained Earnings.

Example:

• Revenues: $50,000

• Expenses: $17,000

• Net Income = $33,000 ($50,000 - $17,000)

If there were a net loss, the entry would be reversed, with a debit to Retained Earnings.

Step 4: Close Dividends (or Withdrawals) to Retained Earnings

If the company paid dividends, that balance is transferred to Retained Earnings.

Example:

A company declared $5,000 in dividends.

This resets the Dividends account to zero. 

4. Post-Closing Trial Balance

After closing entries are made, a post-closing trial balance is prepared to ensure that:

• All temporary accounts have zero balances.

• Only permanent accounts (assets, liabilities, and equity) remain.

5. Why Is the Closing Process Important?

• Prepares for the next period: Temporary accounts reset to zero.

• Ensures accuracy: Financial statements reflect only relevant period data.

• Maintains proper records: Retained Earnings account correctly shows cumulative profit.

By following the closing process, businesses ensure financial statements are accurate and comply with accounting principles.