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What are Accounts Closed at Year End?

Accounts Closed at Year End

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Accounts Closed at Year End

Accounts closed at year end are temporary accounts that are used to track financial activity within a specific accounting period. These accounts are closed or reset to zero at the end of the fiscal year to ensure that the balances do not carry over into the next accounting period. Closing temporary accounts allows businesses to segregate revenues, expenses, and dividend distributions related to a particular period, which is essential for accurate financial reporting and analysis.

Temporary accounts include:

  • Revenue accounts: These accounts record income generated from a business’s operations, such as sales revenue, service revenue, and interest income.
  • Expense accounts: These accounts track the costs incurred by a business in the process of earning revenues, such as cost of goods sold, salaries and wages expense, rent expense, and depreciation expense.
  • Dividends or owner’s withdrawals: These accounts record distributions of earnings to shareholders (for corporations) or withdrawals by the owner(s) in the case of partnerships and sole proprietorships. This account is separate from equity accounts, which are considered permanent accounts.

At the end of the fiscal year, temporary accounts are closed by transferring their balances to a permanent account, typically the Retained Earnings account for corporations or the owner’s capital account for sole proprietorships and partnerships.

The closing process involves four main steps:

  1. Close revenue accounts: Debit each revenue account for its balance and credit the Income Summary account.
  2. Close expense accounts: Credit each expense account for its balance and debit the Income Summary account.
  3. Close the Income Summary account: If the Income Summary account has a credit balance (net income), debit the Income Summary account and credit the Retained Earnings account (or owner’s capital account). If the Income Summary account has a debit balance (net loss), debit the Retained Earnings account (or owner’s capital account) and credit the Income Summary account.
  4. Close the Dividends or Owner’s Withdrawals account: Debit the Retained Earnings account (or owner’s capital account) and credit the Dividends or Owner’s Withdrawals account.

After completing the closing process, all temporary accounts have zero balances, and the net income or net loss for the accounting period has been transferred to the Retained Earnings or owner’s capital account. This process readies the temporary accounts for the next accounting period, ensuring accurate tracking of financial activity and reporting.

Example of Accounts Closed at Year End

Let’s use a fictional company, “Green Thumb Garden Supplies,” to illustrate the closing process for temporary accounts at the end of the fiscal year. Here are the balances of its temporary accounts before closing:

  • Sales Revenue: $50,000 (credit balance)
  • Rent Expense: $10,000 (debit balance)
  • Salary Expense: $25,000 (debit balance)
  • Dividends: $5,000 (debit balance)

Here are the journal entries for the closing process:

  1. Close revenue accounts:
    • Debit Sales Revenue: $50,000
    • Credit Income Summary: $50,000
  2. Close expense accounts:
    • Debit Income Summary: $35,000 (total expenses: $10,000 Rent Expense + $25,000 Salary Expense)
    • Credit Rent Expense: $10,000
    • Credit Salary Expense: $25,000

At this point, the Income Summary account has a credit balance of $15,000 ($50,000 Sales Revenue – $35,000 Total Expenses), which represents the net income for the fiscal year.

  1. Close the Income Summary account:
    • Debit Income Summary: $15,000
    • Credit Retained Earnings: $15,000
  2. Close the Dividends account:
    • Debit Retained Earnings: $5,000
    • Credit Dividends: $5,000

After completing the closing process, all temporary accounts (Sales Revenue, Rent Expense, Salary Expense, and Dividends) have zero balances, and the net income of $15,000 has been transferred to the Retained Earnings account.

The closing process ensures that Green Thumb Garden Supplies can accurately track its financial activity in the next accounting period and prepare its financial statements for the new fiscal year.

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