A Comprehensive Guide to Closing Entries

In preparing a company’s financial statements, isa sa mga importanteng elemento ay ang closing journals or closing entries. Jurnal na ito ay ginagawa sa end ng accounting period to close nominal accounts at maghanda ng balance sheet.

The closing journal is a specialized entry for the retained earnings statement, ensuring that the balances reported in the retained earnings statement and the balance sheet align with the final profit balances in the company’s ledger.

To simplify the preparation of closing journals, using HashMicro accounting software can help companies optimize their financial reporting. HashMicro’s accounting software can automatically and accurately generate closing entries.

To learn more about closing journals and the use of accounting software, check out the following article.

What are Closing Entries?

The closing entries are an accounting process performed at the end of a reporting period (usually year-end or month-end) to close all temporary accounts and transfer the balances of those accounts to the profit and loss account or balance sheet.

The purpose of the closing journal is to prepare the general ledger for the next reporting period by starting the beginning balances of the income, expense, and dividend accounts from zero.

It also helps separate transactions that occurred in the current reporting period from the next reporting period.

The closing journal entry process involves several steps, including closing revenue accounts, closing expense accounts, closing other temporary revenue and expense accounts, and closing dividend accounts.

With the aid of accounting software, the closing journal process can be done more quickly and accurately, which eliminates the possibility of manual errors.

Purposes and Functions of Closing Journal Entries

Closing journal entries play a crucial role in wrapping up a company’s financial activities for a specific period. They ensure that financial records are accurate, organized, and ready for the next cycle. Let’s explore the purposes and functions of these entries in detail.

Purposes of Closing Entries

• Adjust Temporary Account Balances: The primary purpose is to close all temporary accounts, such as revenues, expenses, and dividends, resetting their balances to zero. This ensures that the capital balance accurately reflects the company’s actual condition at the end of the period.
• Prepare for a New Period: Closing temporary balances provides a clean slate for bookkeeping in the next period. The adjusted capital balance will align with the ending balance of the previous period’s financial statements.

Functions of Closing Journal Entries

• Separate Revenue and Expense Accounts: The main function of closing journal entries is to separate revenue and expense accounts, preventing balances from mixing with the next accounting period. This step allows the company to start preparing financial records for the new period.
• Facilitate Audit Processes: Closing journal entries clearly separate transactions between periods, helping company auditors efficiently verify transactions from multiple accounting periods.
• Present Accurate Financial Statements: Closing journal entries ensure that end-of-period financial statements include only the company’s assets, liabilities, and equity. This provides a more accurate and realistic financial overview.

Temporary and Permanent Accounts

Temporary accounts, such as revenues, expenses, and withdrawal accounts, are used to track financial activities within a specific period and do not carry over to the next year.

For instance, ₱50,000 in revenue this year will not be recorded as ₱50,000 in revenue for the next year, even if the company retains the funds for future use.

In contrast, permanent accounts include assets, liabilities, and most equity accounts. These balances carry forward into the next accounting period and provide a long-term view of the company’s financial health.

They are recorded on the balance sheet, which helps investors assess the company’s value.

Income Summary Account

Temporary account balances can be transferred either directly to the retained earnings account or through an intermediary account called the income summary account.

The income summary account is a temporary holding account used to consolidate income accounts, excluding dividend expenses. It is not included in financial statements because it exists solely for the closing process and has a zero balance once the process is complete.

The income summary serves to gather the net income for the period and allocate it to retained earnings. Temporary account balances are first moved to the income summary to provide an audit trail for accountants to revie

Examples of Closing Entries

Closing entries are essential for resetting temporary accounts and preparing accurate records for the next period. Below are examples of how each step is performed.

Example 1: Close Revenue Accounts

The revenue account, such as Service Revenue, is closed by transferring its balance to the Income Summary account. This resets the revenue account to zero for the new accounting period.

Example 2: Close Expense Accounts

Expense accounts, including Cost of Goods Sold, Depreciation Expense, and others, are closed by transferring their balances to the Income Summary account. This ensures that expense accounts are also reset to zero for the new period.

Example 3: Close Income Summary

The balance of the Income Summary account, representing the net income (or loss), is transferred to the Retained Earnings account. This step reflects the company’s profit or loss in the equity section of the balance sheet.

Example 4: Close Dividends

The Dividends account is closed by transferring its balance to the Retained Earnings account. This decreases retained earnings and reflects the dividends paid out to shareholders during the period.

How to Prepare Closing Entries

The closing process involves a structured sequence of a journal entry as follows:

Step 1: Close all income accounts to Income Summary

In this case, the sole income account is Service Revenue, which has a credit balance of ₱492,500. To close it, debit Service Revenue for the full amount and credit Income Summary for the same.

The Income Summary account is a temporary account used solely to close income and expenses. It will eventually be closed to the capital account.

Step 2: Close all expense accounts to Income Summary

To close expense accounts, credit each expense and debit the Income Summary account.

Step 3: Close Income Summary to the appropriate capital account

The Income Summary account now reflects the net income. From Step 1, it was credited with ₱492,500. From Step 2, it was debited for ₱439,500. The remaining credit balance of ₱53,000 represents the net income.

For partnerships, net income would be distributed based on an agreed ratio (e.g., Partner A receives 60%, Partner B gets 40%). For corporations, the Income Summary balance is closed to the Retained Earnings account.

If the Income Summary had a debit balance instead, indicating a net loss, the entry would be reversed—debit the capital account and credit Income Summary.

Step 4: Close withdrawals to the capital account

In a sole proprietorship, withdrawals (recorded in a drawing account) reduce the capital balance. For partnerships, each partner’s withdrawals are tracked in their respective drawing accounts.

For corporations, dividends declared are often recorded by debiting Dividends Payable and crediting Retained Earnings. If a temporary dividends account is used, it must be closed to Retained Earnings at the end of the period.

Simplify Writing Closing Entries with HashMicro Accounting Software

HashMicro Accounting Software ang isa sa mga pinakamahusay na accounting software, trusted by over 2,000 companies. With complete features and modules, HashMicro simplifies various accounting processes, including creating closing journal entries.

Here are some of its key features:

• Automated Financial Reports: HashMicro enables companies to generate accurate financial reports automatically, saving time and effort.
• Cash Flow Management: This module allows real-time monitoring of cash inflows and outflows for better decision-making.
• Tax Management: This feature helps companies calculate, report, and pay taxes in compliance with applicable regulations.
• Automated Bank Reconciliation: Bank transaction matching can be done automatically, minimizing manual errors.
• Automated Journal Entries: Closing and adjusting journal entries can be created quickly and easily, reducing the risk of errors.
• Integration with Other Modules: HashMicro integrates seamlessly with other modules like CRM and inventory management, providing a complete solution for business needs.

With HashMicro, accounting processes become more efficient, transparent, and accurate. This software is designed to help businesses of all sizes, from small enterprises to large corporations, manage their finances more effectively.

Conclusion

Closing entries play a vital role in preparing accurate financial statements by resetting temporary accounts for the next period. Sa proseso, ang balances ng revenue, expense, at dividend accounts ay nililipat sa retained earnings para maayos ang records.

For an easier and faster closing process, HashMicro’s accounting software is here to help. It automates closing journal entries, binabawasan ang manual errors, at nagse-save ng time with just a few clicks.

Moreover, HashMicro integrates seamlessly with CRM and inventory modules, offering a complete solution for business needs. From tax compliance to bank reconciliation, it handles everything accurately and effortlessly.

What are you waiting for? Try the free demo now!

FAQ on Closing Entries

• What is the difference between closing entries and adjusting entries?

  Adjusting entries are made at the end of an accounting period to update account balances before financial statements are prepared, ensuring that revenues and expenses are recognized in the period they occur. Final journal entries, on the other hand, are made after financial statements are prepared to reset temporary accounts (like revenues and expenses) to zero, transferring their balances to permanent accounts such as retained earnings.

• Can final journal entries be reversed?

  Typically, end-of-period adjustments are not reversed because their purpose is to clear out temporary accounts for the new accounting period. Reversing entries are usually related to certain adjusting entries made in the previous period to simplify the recording of transactions in the new period.

• Are closing entries necessary for companies using accounting software?

  Many modern accounting software systems automate the period-end adjustments, reducing the need for manual final journal entries. However, understanding the closing process remains important for ensuring the accuracy of financial records and for situations where manual adjustments may be required.

• How do final adjustments affect the trial balance?

  After end-of-period journal adjustments are posted, a post-closing trial balance is prepared. This trial balance includes only permanent accounts (assets, liabilities, and equity) since all temporary accounts have been reset to zero. It ensures that debits equal credits after the final adjustments, verifying the ledger’s accuracy.