Understanding Closing Entries in Accounting
Accounting is a cyclical process in business. Most companies treat every month as one period. The accounting cycle details the activities a company will complete in order to record and report financial information. Closing entries represent the final stage of the accounting cycle. Their purpose is to move temporary account balances to retained earnings, and start the accounting cycle anew.
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Temporary Accounts
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Two types of accounts appear in a company's general ledger: temporary and permanent. Temporary accounts contain information from a company's revenue, expense and dividend transactions. The accounts only report the current period's information. A balance transfer is necessary to "close" the accounts to retained earnings --- hence the label "temporary" in the account title. Permanent accounts carry their balance forward through each accounting period and do not close.
Closing Entries
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Accountants will post three general closing entries. First, they must transfer all revenue account balances go to the income summary general ledger account. The journal entry debits each individual revenue account and credits the aggregate total to income summary. Expenses close to income summary by debiting the income summary account and crediting each individual expense account. The net effects result in a period's gain or loss from operations. Accountants will then debit retained earnings and credit dividends to close the current period's dividend account.
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Review Process
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A final review is necessary to ensure each temporary account has a zero balance. Accountants may run a trial balance that lists the current account balance for all temporary accounts. Once confirmed, accountants can finish closing the company's books. Companies will typically save a copy of financial records detailing the closing entries and final accounting period reports. Federal and state governments typically require companies to retain these documents for a specific time period.
Computerized Accounting
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Computerized accounting programs greatly reduce the work accountants put in to close their company's books. Rather than handwriting copious closing entries, the click of a button will complete this process. Many accounting software packages also provide a self-balancing tool. This prints an exception report prior to closing temporary accounts; the report details all issues requiring correction prior to closing the books. This can greatly reduce time spent on month-end close activities.
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