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Closing Entries

At the end of each fiscal year all temporary accounts must be cleared. This is done so that company can track those accounts as they pertain to a new fiscal year.


Temporary accounts consist of revenue and expense accounts.


The balances from those accounts are moved to retained earnings.


Example:


Company XYZ has the following entries for its temporary accounts at the end of 2021:


Revenue Cr. $300,000

Payroll Expense Dr. $190,000

Material Expense Dr. $120,000


As the company moves from 2021 into 2022, it does not make sense to keep adding new revenue and expenses to existing balances because they do not pertain to 2020.


Company XYZ must clear temporary accounts. To do that, a Summary Account is used.


The following entries will be made to the summary account:


Revenue Dr. $300,000

Summary Account Dr. $10,000

Payroll Expense Cr. $190,000

Material Expense Cr. $120,000


The entries will wipe temporary accounts and set them to $0 balance. Summary account now has a balance of Cr. $10,000.


A summary account now needs to be cleared itself as it never appears on financial statements. To clear this account we must debit (credit) retained earnings:


Summary Account Dr. $10,000

Retained earnings: Cr. $10,000