Closing Entries

Closing entries are the journal entries made after a company's financial statements have been prepared at the end of its accounting year, transferring the balances of temporary accounts — revenues, expenses, gains, losses, and any owner's drawing account — into a permanent equity account, resetting those temporary accounts back to a zero balance to start the new year fresh.

Revenue and expense accounts exist specifically to accumulate activity for one accounting period at a time, so that the income statement for that period reflects only that period's results. If these accounts were never closed, revenue and expenses from one year would simply keep piling up on top of the next year's activity, making it impossible to produce a clean, period-specific income statement without closing entries resetting the slate at each year-end.

The process generally runs in a sequence: revenue accounts are debited and closed into an income summary account, expense accounts are credited and closed into the same income summary account, the resulting balance in income summary, representing the period's net income or loss, is closed into retained earnings or the owner's capital account, and finally any drawing account balance is closed directly into the owner's capital account as well. Modern accounting software typically performs this entire sequence automatically at year-end, though the underlying logic remains exactly the same as the traditional manual process.

Balance sheet accounts, sometimes called permanent accounts, are never closed; their ending balance at the end of one year simply becomes the beginning balance for the next year, since assets, liabilities, and equity represent an ongoing cumulative position rather than activity confined to a single period the way revenue and expenses are.

Closing entries are one of the final steps in the accounting cycle, and completing them correctly is what allows a company to produce a post-closing trial balance containing only permanent accounts, confirming that the books are properly reset and ready for the next period's transactions to begin accumulating cleanly from a zero starting point in every temporary account.

A company with $800,000 of revenue and $650,000 of total expenses for the year would close revenue into income summary with a $800,000 credit, close expenses into income summary with a $650,000 debit, leaving a $150,000 credit balance in income summary representing net income, which is then closed into retained earnings, bringing all the temporary accounts back to zero for the new year.

Closing entries apply only to temporary accounts — revenues, expenses, gains, losses, and a sole proprietor's drawing account — because these accounts exist specifically to measure activity for one accounting period at a time and need to start fresh at zero the next period. Permanent accounts, which include every balance sheet account, are never closed, since their balances genuinely represent an ongoing position, such as how much cash the company has or how much it owes, that should simply carry forward unchanged into the next period's opening balance.

Closing entries are the mechanical step that makes each accounting period's income statement a clean, standalone measure of that period's performance, rather than an ever-accumulating running total — without them, revenue and expense accounts would simply keep growing year after year with no way to isolate how the business actually performed in any single period on its own.