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Closing Entries

What Are Closing Entries?

A closing entry is a journal entry made at the end of a reporting period that cancels or "zeroes out" a transaction. This is part of a larger process to reset the account in question and prepare it for the next reporting period. Closing entries will be done in so-called temporary or nominal accounts and involve shifting data from temporary accounts to permanent accounts.

In business accounting, some transactions have a short-term, or one-time, impact on the financial affairs of the operation. They affect the profit and loss of the business only within a specified reporting period, which is usually a month, quarter, or year. For this reason, they are reported on the income statement for that accounting period.

Other transactions have a more long-term and sustained effect on the business. Their impact carries over to, and is reported in, subsequent accounting periods. These financial activities do not affect the profit or loss of the business during a specific reporting period, but they do reflect on the overall financial well-being or status of the business. For this reason, they will appear on the balance sheet.

Temporary vs Permanent Accounts

Closing entries are made in temporary accounts to calculate the short-term impact of the transactions that are recorded there, and to clear the account for a new set of transactions that will be recorded in the next reporting period.

Temporary accounts include such transactions as revenue, expenses, and dividends, all of which affect the profitability of a business only in the period in which they are reported. They will be zeroed out, and the accounts closed, at the end of the period.

For example, $100,000 in sales revenue impacts the profitability of a business, but only in the reporting period in which it is received. It does not impact the business in the following period or any others because it does not occur then (other, new sales revenue will be received in those periods). Therefore, it is recorded in a temporary account during the period when it was received.

In contrast, permanent accounts include a variety of long-term assets, liabilities and equities, such as accounts receivable, loans, and stocks. These do not affect the profit or loss of the business during a reporting period, but they do have a sustained impact on the business. They will be reported in permanent accounts that carry over from one cycle to the next to ensure that they always factor into the relevant, broader calculations about the business.

For example, real estate property does not directly impact profitability, but it impacts the overall financial picture of the business. Throughout the time that it is owned by the business, it will be reported as a long-term asset, and it will carry over from one reporting period to the next.

How is a Closing Entry Made?

According to the double-entry system of accounting, transactions are always recorded in at least two places, and those entries will cancel each other out, one as a debit and the other as a credit.

The same principle applies to closing entries, which are made by recording two transactions that cancel each other out or add up to zero. One of these transactions will be recorded in a temporary account, and the other will be recorded in a permanent account.

Depending on the value and the nature of the transaction, the entry will be made in the temporary account as either a debit or a credit. This transaction will cancel the value in the temporary account and bring its ending value to zero, allowing the account to be closed out for the period. An opposite entry will be made in a permanent account to allow for an overall assessment of the business's financial status.

For example, revenue accounts are closed out by making a journal entry in the form of a debit for the period. Similarly, expense accounts are closed out by recording a journal entry that credits expenses.

Revenue is then credited to the income statement, and expenses are debited there. The income account is also closed out by calculating the net sum of the difference between revenue and expenses and making a corresponding journal entry there. A profit is canceled out with a debit, and a loss is canceled out with a credit.

Finally, the data is carried over to the balance sheet and the income summary is closed out. If the business earned a profit, this will be recorded as a credit to the retained earnings account. A loss is recorded as a debit.

Example of a Closing Entry

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.


What Are the Four Closing Entries?

Closing entries are typically made to four different accounts:

  1. Revenue

  2. Expenses

  3. Income

  4. Dividends

The closing entries made in these accounts reflect the temporary nature of the transactions that are recorded there.

All transactions in these four accounts report money going into and out of the business and reflect on the profit and loss of the business for a defined reporting period.

How Are Closing Entries Recorded in the General Ledger?

Closing entries are made like any other journal entry. They follow the double entry system and employ debits and credits, which reflect the nature of the transaction. They typically include the words "Closing Entry" in the description.

In Which Journal Are Closing Entries Recorded?

Closing entries are first recorded in a general journal. This is a book of original entries where raw data regarding business transactions is first recorded before it is posted to the appropriate accounts in the general ledger.

Are There Any Accounts That Do Not Require Closing Entries?

Closing entries are made only to temporary accounts. They are not made in permanent accounts. This is due to the nature of the transactions that are recorded in the accounts. Temporary accounts record transactions that have a short-term impact on the business. Therefore, they must be closed out at the end of the reporting period.

Permanent accounts record transactions that have a long-term impact that carries over from one reporting period to the next. Therefore, they do not need to be closed out, and they do not require closing entries.

Should Closing Entries Be Made Before or After Adjusting Entries?

Closing entries might be confused with adjusting entries. Although they serve similar purposes, they are not the same. Like closing entries, adjusting entries are made at the end of a reporting period. Unlike closing entries, they are not made to close out an account. Instead, they are made to update an account before financial statements are prepared.

Typically, adjusting entries are made to account for things like accrued revenue and expenses, prepaid expenses, and unearned revenue. These are all transactions that affect the profit and loss of the business during a reporting period, but which are not otherwise reported during the period because they take place at another time.

Because closing entries are made at the end of the accounting period after financial statements have been prepared, they are typically made after adjusting entries are made.

What is BlackLine Journal Entry?

Businesses typically prepare, post, and document hundreds or thousands of recurring and nonrecurring entries each period. A reliance on traditional processes introduces unnecessary risk, slows down reporting, and poses downstream audit testing challenges.

BlackLine Journal Entry is a comprehensive solution that centralizes and automates the creation, validation, review, and posting of closing entries. It increases efficiency, reduces risk, optimizes capacity, and streamlines reviews and audits.