Closing Entry in Accounting: Definition and Recording Steps

Search Fintrev

Search our guides, reviews and glossary.

A closing entry is a journal entry made at the end of an accounting period that transfers the balances of temporary accounts (revenues, expenses, gains, losses and dividends or owner withdrawals) into a permanent equity account, usually retained earnings. After the closing entries are posted, every temporary account starts the next period at zero, and the period’s net income or loss is part of the balance sheet’s equity.

What Closing Entries Do

Every account in the general ledger is either temporary or permanent.

Temporary (nominal) accounts measure activity within one period. If $100 of sales were carried forward, next year’s income statement would overstate performance. These accounts must start each period empty.

Permanent (real) accounts carry balances that remain true across periods, so their balances roll forward. They appear on the balance sheet: assets, liabilities and equity.

Closing entries connect the two. They take the period’s profit or loss, which was built up across many temporary accounts, and fold it into equity. For a corporation, that equity account is retained earnings: profits kept in the business rather than paid to shareholders. For a sole proprietorship or partnership, the destination is the owner’s or each partner’s capital account, and the drawing account plays the role that dividends play in a corporation.

The Income Summary Account

Temporary balances can be closed straight to retained earnings with the same ending result, but many businesses use an intermediate account called income summary. It exists only during the closing process. All revenues and expenses are moved into it, so its balance equals net income (a credit balance) or net loss (a debit balance). That single figure is then transferred to retained earnings, leaving income summary at zero.

Income summary never appears on a financial statement. Its value is the audit trail: separate entries show total revenues closed, total expenses closed and the net result moving into equity, which makes it easier to reconcile the closing against the income statement.

Dividends are not run through income summary because they are not an expense. They are a distribution of earnings to owners and do not affect net income.

How to Record Closing Entries

The closing process follows four journal entries, dated the last day of the accounting period (such as December 31 for a calendar-year company), even if they are recorded days or weeks later during the close:

1. Close revenue accounts. Debit each revenue account for its balance and credit income summary for the total. This applies to sales, service revenue, interest income and gains.
2. Close expense accounts. Credit each expense account for its balance and debit income summary for the total. This includes cost of goods sold, wages, rent, depreciation, interest expense and losses.
3. Close income summary. If it has a credit balance (profit), debit income summary and credit retained earnings. If it has a debit balance (loss), credit income summary and debit retained earnings.
4. Close dividends. Credit the dividends account and debit retained earnings for the amount declared.

Closing happens only after adjusting entries (accruals, deferrals, depreciation) have been posted. Closing balances that are still unadjusted would carry errors into retained earnings.

For a merchandising business, contra-revenue accounts such as sales returns and allowances and sales discounts have debit balances, so they are closed alongside expenses (credited) rather than with revenues.

Example of Closing Entries

Hypothetical company, year ended December 31. Balances are after all adjusting entries.

• Sales revenue: $120,000 (credit)
• Service revenue: $5,000 (credit)
• Cost of goods sold: $60,000 (debit)
• Wages expense: $30,000 (debit)
• Rent expense: $12,000 (debit)
• Utilities expense: $3,000 (debit)
• Dividends: $8,000 (debit)
• Retained earnings, beginning: $50,000 (credit)

Entry 1, close revenues: Debit sales revenue $120,000 and service revenue $5,000; credit income summary $125,000.

Entry 2, close expenses: Debit income summary $105,000; credit cost of goods sold $60,000, wages expense $30,000, rent expense $12,000 and utilities expense $3,000.

Income summary now has a $20,000 credit balance ($125,000 minus $105,000), which equals net income.

Entry 3, close income summary: Debit income summary $20,000; credit retained earnings $20,000.

Entry 4, close dividends: Debit retained earnings $8,000; credit dividends $8,000.

Ending retained earnings = $50,000 + $20,000 - $8,000 = $62,000. That figure matches the statement of retained earnings and appears on the year-end balance sheet.

If the same company had $125,000 of revenue and $135,000 of expenses, income summary would show a $10,000 debit balance. Entry 3 would then debit retained earnings $10,000 and credit income summary $10,000, reducing equity by the loss.

Checking the Close: Post-Closing Trial Balance

After closing entries are posted, accountants prepare a post-closing trial balance. It lists only permanent accounts (assets, liabilities and equity, including the updated retained earnings) and confirms that total debits still equal total credits. Any revenue, expense or dividend account that still shows a balance means a closing entry was missed or posted incorrectly.

How Often Closing Entries Are Made

An accounting period is whatever span the financial statements cover: a calendar year, a fiscal year or a fiscal quarter. Many companies close their books monthly or quarterly for internal reporting and perform a formal year-end close.

Limitations and Common Confusions

Closing entries are bookkeeping mechanics. They do not create, change or verify any figure. If revenue was recognized in the wrong period or an accrual was missed, the closing process simply moves the error into retained earnings. They also say nothing about cash: net income closed to retained earnings is an accounting profit, not money available to spend.

Several terms are easy to mix up:

• Closing entries vs. adjusting entries. Adjusting entries correct and complete account balances before statements are prepared. Closing entries come afterward and only transfer balances.
• Closing entry vs. closing balance. A closing balance is the amount in any account at period end. Permanent accounts carry their closing balance forward as the next period’s opening balance; temporary accounts are closed to zero.
• Retained earnings vs. net income. Net income is one period’s result. Retained earnings is the cumulative total of past net income minus dividends.

The Bottom Line

Bookkeepers, accounting students and small business owners who close their own books need this process to start each period with clean revenue and expense accounts. Post adjusting entries first, then close revenues, expenses, income summary and dividends in order. A post-closing trial balance should show only permanent accounts. Closing moves any earlier error into equity unchanged, and it says nothing about available cash.