Closing entries are journal entries made at the end of an accounting period that transfer balances from temporary accounts—revenue, expenses, and dividends—to permanent accounts like retained earnings, resetting temporary accounts to zero.
Without closing entries, last quarter's sales would blend into this quarter's numbers, making it impossible to measure how the business actually performed in any given period.
This guide covers the four-step closing process, walks through journal entry examples, and shares best practices that help finance teams close faster with fewer errors.
A closing entry is a journal entry made at the end of an accounting period that transfers balances from temporary accounts—revenue, expenses, and dividends—to permanent accounts like retained earnings.
The process resets temporary accounts to zero so each new period starts fresh, allowing you to measure financial performance for that specific timeframe without carryover from previous periods.
Here's a simple way to think about it: temporary accounts work like a trip odometer that you reset after each journey, while permanent accounts function like the main odometer that tracks total miles driven. Without closing entries, last year's revenue would blend into this year's numbers, making it impossible to see how the business actually performed in any given period.
Closing entry: A journal entry that zeros out temporary account balances by transferring them to permanent accounts
Purpose: Prepares the books for the next accounting cycle and ensures accurate period-to-period financial reporting
Closing entries act as the final checkpoint before financial statements become official. They keep each period's financial activity separate, which means stakeholders can trust that the income statement reflects only what happened during that specific timeframe.
Beyond accuracy, closing entries create a documented trail showing exactly how account balances moved at period end. Auditors expect clear evidence that temporary accounts were properly closed, and a well-documented closing process makes audit preparation significantly less stressful.
Accurate financial statements: Prevents mixing of financial data across periods
Clean audit trail: Documents every transfer from temporary to permanent accounts
Compliance readiness: Supports GAAP requirements for proper period separation
The closing process follows a specific four-step sequence. The order matters because posting entries out of sequence produces incorrect balances that cascade through financial statements.
1. Close Revenue Accounts to Income Summary
Revenue accounts normally carry credit balances. To close them, debit each revenue account for its full balance and credit income summary for the total. After this entry, all revenue accounts show zero.
2. Close Expense Accounts to Income Summary
Expense accounts normally carry debit balances. Close them by crediting each expense account and debiting income summary for the total. This entry zeroes out all expense accounts.
3. Close Income Summary to Retained Earnings
After closing revenues and expenses, the income summary balance represents net income (if it has a credit balance) or net loss (if it has a debit balance). Transfer this amount to retained earnings.
4. Close Dividends to Retained Earnings
Dividends bypass income summary entirely. Close the dividends account directly to retained earnings by debiting retained earnings and crediting dividends.
The distinction between temporary and permanent accounts determines which accounts require closing entries. Temporary accounts track activity for a single period and get reset to zero. Permanent accounts, on the other hand, carry their balances forward indefinitely.
Temporary Accounts:
Reset to zero each period
Revenue, expenses, dividends
Require closing entries
Permanent Accounts:
Carry balances forward indefinitely
Assets, liabilities, equity
Do not require closing entries
Temporary accounts, also known as nominal accounts, track financial activity exclusively within a single accounting period. These critical accounts include all revenue accounts, expense accounts, dividends, drawings, and the income summary account.
Revenue Accounts
Revenue accounts track all income earned during a specific period, whether from product sales, services rendered, or other sources. Throughout the period, revenue accounts accumulate credit balances. At period end, closing entries transfer those balances out so the accounts start the next period at zero.
Expense Accounts
Expense accounts capture every cost incurred during the period—salaries, rent, utilities, supplies, depreciation, and more. Closing expense accounts prevents costs from being counted twice in subsequent periods, which would understate profitability going forward.
Dividends and Drawings Accounts
Dividends represent distributions to shareholders in a corporation, while drawings reflect owner withdrawals in sole proprietorships or partnerships. Both reduce equity and require closing directly to retained earnings at period end. Unlike revenue and expenses, dividends and drawings bypass the income summary account entirely.
In contrast, permanent accounts, or real accounts, are those whose balances are carried forward from one accounting period to the next, never being closed out. These foundational accounts comprise all assets, liabilities, and equity accounts, reflecting the cumulative financial position of an entity.
Unlike temporary accounts, they maintain their ending balances, which then become the opening balances for the subsequent period. It is crucial to remember that these accounts are never subjected to the closing entry process.
Assets, Liabilities, and Equity
Assets, liabilities, and equity accounts are permanent. A company's cash balance on December 31st becomes its starting cash balance on January 1st. The same applies to accounts payable, loans, and the equity accounts themselves. No closing entry touches permanent accounts.
The income summary account serves as a temporary holding area during the closing process. It exists solely to consolidate all revenue and expense balances before transferring the net result—either profit or loss—to retained earnings.
Function: Calculates net income or net loss by combining closed revenue and expense balances
Lifespan: Created during closing entries, zeroed out immediately after transferring to retained earnings
Some accounting systems skip the income summary entirely and close revenue and expenses directly to retained earnings. However, using an income summary provides a clearer picture of how net income was calculated, which can simplify troubleshooting if the numbers don't balance as expected.
In the example above, a business earned $100,000 in sales revenue for one reporting period. If this was earned for the first quarter of the year, a closing entry would be made at the end of March.
The first step in this instance would be to close out the revenue account where the transaction was recorded. A debit of $100,000 would be entered there to close out the account. A corresponding credit of $100,000 would then be recorded in the income account.
To calculate profit or loss, expenses will also have to be accounted for. In the same example, if the business incurred $45,000 of expenses related to its sales, the expense account would be closed out with a closing entry credit for that amount. A corresponding debit of $45,000 would also be entered into the income account.
To calculate net profit, the business would subtract the value of the expenses from the value of total sales revenue. The net sum of $100,000 minus $45,000 leaves the business with a profit of $55,000.
A debit for this amount would be entered as income and the account would be closed. A credit of the same amount would be made in the retained earnings account, and the value of $55,000 would be reported on the balance sheet for the business.
Getting closing entries right consistently requires more than knowing the mechanics. The following practices help finance teams maintain accuracy while reducing period-end stress.
1. Establish Review and Approval Controls
Separating who prepares closing entries from who approves them catches errors before they hit the general ledger. A second set of eyes often spots transposed numbers or missed accounts that the preparer overlooked.
2. Reconcile All Accounts Before Closing
Attempting to close the books with unreconciled accounts is like building on a shaky foundation. Completing all account reconciliations using account reconciliation software first ensures the balances being closed are actually correct.
3. Follow a Standardized Close Checklist
A documented checklist ensures every closing task happens in the right sequence, every period. This consistency becomes especially valuable when team members are out or when onboarding new staff.
4. Document Every Closing Entry for Audit
Each closing entry benefits from supporting documentation explaining what was closed and why. This documentation saves significant time during audits and provides defensible evidence if questions arise later.
5. Automate Repetitive Journal Entries
Many closing entries follow identical patterns period after period. Platforms like BlackLine's Financial Close & Consolidation can automate recurring entries with built-in controls, reducing manual effort while maintaining audit-ready documentation. Organizations using BlackLine report up to 97% journal entry automation.
Even experienced accountants occasionally stumble during the closing process. Knowing the most common pitfalls helps teams catch errors before they compound.
Closing Permanent Accounts by Mistake
Accidentally closing an asset, liability, or equity account corrupts the balance sheet and requires correcting entries. Always verify that only temporary accounts are included in closing entries.
Posting Entries in the Wrong Sequence
Closing income summary before all revenues and expenses are closed produces an incorrect net income figure. The four-step sequence exists for a reason.
Forgetting to Close the Dividends Account
Because dividends bypass the income summary, they're easy to overlook. An unclosed dividends account overstates retained earnings and misrepresents the equity section.
Failing to Zero Out All Temporary Accounts
After posting all closing entries, running a post-closing trial balance verifies that every temporary account shows a zero balance. Any remaining balance indicates a missed or incorrect closing entry.
While the fundamental purpose and mechanics of closing entries remain consistent, the specific account names and their treatment differ based on the legal structure of the business.
Understanding these distinctions is crucial, as they directly impact how owner-related equity is presented and adjusted during the closing process.
This section clarifies these nuances to address a common area of confusion in accounting.
Sole Proprietorships and Partnerships
In sole proprietorships and partnerships, the ownership equity is managed through accounts like Owner's Capital and Owner's Drawings, rather than the retained earnings and dividends found in corporations.
Despite these different labels, the closing process itself mirrors that of corporations: revenue and expense accounts are closed to an income summary, and the net income or loss, along with drawings, is then transferred to the Owner's Capital account.
The core objective of resetting temporary accounts and updating equity remains identical, just with alternative nomenclature.
Corporations
Corporations, being distinct legal entities, utilize Retained Earnings to accumulate profits and Dividends to record distributions to shareholders. During the closing process, the balance from the income summary account—representing the corporation's net income or loss for the period—is transferred directly into the Retained Earnings account.
This adjustment to Retained Earnings then directly impacts the overall stockholders' equity, reflecting the period's profitability and any distributions made to owners.
Manual closing processes often stretch for days, with accountants working late to ensure every entry is correct and documented. Modern financial close platforms change this equation significantly.
BlackLine's Financial Close & Consolidation solution automates journal entry creation for recurring closing entries, enforces proper sequencing through workflow controls, and maintains complete audit trails automatically. Verity AI adds intelligence by flagging anomalies and surfacing potential errors before entries are posted.
Automated journal entry creation: Eliminates manual data entry for standard closing entries
Built-in controls and approval workflows: Ensure proper review before any entry posts to the ledger
Real-time visibility: Dashboards display close progress and highlight outstanding tasks
Audit-ready documentation: Every entry is logged with full traceability and supporting detail