If this is the case, the corporation’s accounting department makes a compound entry to close each dividend account to the retained earnings account. There are 4 closing entries done at the end of the accounting cycle. The first one is to close out the revenue account to the income summary account. The dividend account is a temporary account where monies to be paid to the stockholders are accounted for. At the end of the year, this account is closed out to the retained earnings account.

The goal is to make the posted balance of the retained earnings account match what we reported on the statement of retained earnings and start the next period with a zero balance for all temporary accounts. Closing entries prepare a company for the next accounting period by clearing any outstanding balances in certain accounts that should not transfer over to the next period. Closing, or clearing the balances, means returning the account to a zero balance. Having a zero balance in these accounts is important so a company can compare performance across periods, particularly with income. It also helps the company keep thorough records of account balances affecting retained earnings. Revenue, expense, and dividend accounts affect retained earnings and are closed so they can accumulate new balances in the next period, which is an application of the time period assumption.

Step 2 – closing the expense accounts:

Advisory services provided by Carbon Collective Investment LLC (“Carbon Collective”), an SEC-registered investment adviser. Most organizations appear to be doing well on the surface while underlying accounting management issues silently sabotage. Lengthy accounting cycles and inaccurate projections can result in revenue leaks costing companies millions. Closing entry to account for draws taken for the month, for sole proprietors and partnerships. Here we see that total expenses for both were $9,650 for January 2020. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

To close the account, we need to debit the income summary account and credit all the relevant individual expenses accounts such as utilities expense, wages expense depreciation expense, etc. If your revenues are greater than your expenses, you will debit your income summary account and credit your retained earnings account. Closing entries may be defined as the journal entries made at the end of an accounting period to transfer the balances of various temporary ledger accounts to one or more permanent ledger accounts. You are a newly hired accountant for Boss Consultants Inc (“Boss”), a consulting firm located in Chicago. Boss just started its business this year as a simple operation that offers a premium, boutique service.

Closing Entry #1 for Bob

Delivered as SaaS, our solutions seamlessly integrate bi-directionally with multiple systems including ERPs, HR, CRM, Payroll, and banks. Because you paid dividends, you will need to reduce your retained earnings account, which is what this entry accomplishes. If your business is a corporation, https://www.bookstime.com/articles/closing-entries you will not have a drawing account, but if you paid stockholders, you will have a dividends account. If you paid dividends for the month, you will need to close that account as well. This transaction increases your capital account and zeros out the income summary account.

This means that the current balance of these accounts is zero, because they were closed on December 31, 2018, to complete the annual accounting period. Both methods are correct with each having its advantages and disadvantages. The direct method is faster and less complicated as there is no intermediate account involved https://www.bookstime.com/ and requires ones less step. The method of first moving the balances to an income summary account and then shifting the balances to the retained earnings account will be more time consuming for the company. However, it will provide a better audit trail for the accountants who review these at a later point in time.

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These journal entries condense your accounts so you can determine your retained earnings, or the amount your business has after paying expenses and dividends. Creating closing entries is one of the last steps of the accounting cycle. The closing entries are the journal entry form of the Statement of Retained Earnings.