What will happen to the balance of the nominal accounts after closing entries?

Let’s review our accounting cycle again.  We have completed the first two columns and now we have the final column which represents the closing (or archive) process.

Accounting Cycle  1.  Analyze Transactions5.  Prepare Adjusting Journal Entries9.  Prepare Closing Entries2.  Prepare Journal Entries6.  Post Adjusting Journal Entries10.  Post Closing Entries3.  Post journal Entries7.  Prepare Adjusted Trial Balance11. Prepare Post-Closing Trial Balance4.  Prepare Unadjusted Trial Balance8.  Prepare Financial Statements

Accounts are two different groups:

• Permanent – balance sheet accounts including assets, liabilities, and most equity accounts.  These account balances roll over into the next period.  So, the ending balance of this period will be the beginning balance for next period.
• Temporary – revenues, expenses, dividends (or withdrawals) account.  These account balances do not roll over into the next period after closing.  The closing process reduces revenue, expense, and dividends account balances (temporary accounts) to zero so they are ready to receive data for the next accounting period.

Accountants may perform the closing process monthly or annually.  The closing entries are the journal entry form of the Statement of Retained Earnings.  The goal is to make the posted balance of the retained earnings account match what we reported on the statement of retained earnings and start the next period with a zero balance for all temporary accounts.

Remember how at the beginning of the course we learned that net income is added to equity.  This is the process to make that happen!

The following video summarizes how to prepare closing entries.

In accounting, we often refer to the process of closing as closing the books. Only revenue, expense, and dividend accounts are closed—not asset, liability, Common Stock, or Retained Earnings accounts. The four basic steps in the closing process are:

• Closing the revenue accounts—transferring the credit balances in the revenue accounts to a clearing account called Income Summary.
• Closing the expense accounts—transferring the debit balances in the expense accounts to a clearing account called Income Summary.
• Closing the Income Summary account—transferring the balance of the Income Summary account to the Retained Earnings account.
• Closing the Dividends account—transferring the debit balance of the Dividends account to the Retained Earnings account.

 Let’s review what we know about these accounts:

Increase withDecrease withRevenueCreditDebitExpenseDebitCreditDividendsDebitCredit

If we want to make the account balance zero, we will decrease the account.  We use a new temporary closing account called income summary to store the closing items until we get close income summary into Retained Earnings.  To close means to make the balance zero.  We will look at the following information for MicroTrain from the adjusted trial balance:

DebitCreditRetained Earnings   $  6,100Service Revenue     36,500Interest Revenue          600Salaries Expense        18,360Rent Expense          1,200Utilities Expense            500Insurance Expense            200Supplies Expense         7,000Depreciation Expense            750

Notice how the retained earnings balance is $6,100?  On the statement of retained earnings, we reported the ending balance of retained earnings to be $15,190.  We need to do the closing entries to make them match and zero out the temporary accounts.

Step 1:  Close Revenue accounts

Close means to make the balance zero.  We see from the adjusted trial balance that our revenue accounts have a credit balance.  To make them zero we want to decrease the balance or do the opposite.  We will debit the revenue accounts and credit the Income Summary account.  The credit to income summary should equal the total revenue from the income statement.

DebitCreditService Revenue  36,500Interest Revenue     600    Income Summary  37,100

Step 2:  Close Expense accounts

The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts.  Just like in step 1, we will use Income Summary as the offset account but this time we will debit income summary.  The total debit to income summary should match total expenses from the income statement.

 DebitCreditIncome Summary 28,010    Salaries Expense 18,360    Rent Expense1,200    Utilities Expense500    Insurance Expense200    Supplies Expense7,000    Depreciation Expense750

Step 3:  Close Income Summary account

At this point, you have closed the revenue and expense accounts into income summary.  The balance in income summary now represents $37,100 credit – $28,010 debit or $9,090 credit balance…does that number seem familiar?  It should — income summary should match net income from the income statement.  We want to remove this credit balance by debiting income summary.  What did we do with net income?  We added it to retained earnings in the statement of retained earnings.  How do we increase an equity account in a journal entry?  We credit!

DebitCreditIncome Summary (37,100 – 28,010)  9,090    Retained Earnings  9,090

If expenses were greater than revenue, we would have net loss.  A net loss would decrease retained earnings so we would do the opposite in this journal entry by debiting Retained Earnings and crediting Income Summary.

Step 4:  Close Dividends (or withdrawals) account

After we add net income (or subtract net loss) on the statement of retained earnings, what do we do next?  We subtract any dividends to get the ending retained earnings.  This will be the journal entry form of doing this calculation but be careful because you do not want to use the amount of retained earnings but DIVIDENDS.  We want to decrease retained earnings (debit) and remove the balance in dividends (credit) for the amount of the dividends.  MicroTrain did not pay dividends this year but the entry would appear as:

DebitCreditRetained EarningsDiv Amt    DividendsDiv Amt

Div Amt means we will use the DIVIDEND amount and not the balance in retained earnings.

Anytime we complete journal entries, we always need to post to the same ledger cards or T-accounts we have been using all along.  When we post, we do not change anything from the journal entries — we debit (left side) where we did in the entries and credit (right side) wherever we did in the entries.  The ledger card for income summary and retained earnings would look like this:

Account: Income SummaryDebitCreditBalance(1) Close Revenues 37,100 37,100(2) Close Expenses28,010  9,090(3) Close Income Summary  9,090    0Account: Retained EarningsDebitCreditBalanceBeginning Balance6,100(3) Close Income Summary9,09015,190(4) Close Dividends015,190

The balance in dividends, revenues and expenses would all be zero leaving only the permanent accounts for a post closing trial balance.  The trial balance shows the ending balances of all asset, liability and equity accounts remaining.  The main change from an adjusted trial balance is revenues, expenses, and dividends are all zero and their balances have been rolled into retained earnings.  We do not need to show accounts with zero balances on the trial balances.

MicroTrain’s post closing trial balance would be:

DebitCreditCash         10,000Accounts Receivable         25,000Interest Receivable               600Supplies           1,500Prepaid Insurance           2,200Trucks         40,000Accum. Depreciation-Trucks               750Accounts Payable         25,000Unearned Revenue           3,000Salaries Payable               360Common Stock         35,000Retained Earnings         15,190TOTALS         79,300         79,300

Notice how only the balance in retained earnings has changed and it now matches what was reported as ending retained earnings in the statement of retained earnings and the balance sheet.

What happens when closing entries are made?

Which accounts will have zero balances after closing entries?

Are nominal accounts closed at the end of the accounting period?

What happens to the balance of the retained earnings account after a closing entry?