Question

You are an accountant for an electric company and you are recording closing entries. In a brief essay, relate the steps in recording closing entries. Also outline which accounts are affected and which accounts are not affected by closing entries. What two purposes are accomplished by recording closing entries?

Answer 1

Accounts are categorized in two different groups: permanent accounts and temporary accounts

Permanent accounts refers to balance sheet accounts such assets, liabilities, equity and so on. The balances of these accounts are carried forward to next year.

Temporary accounts related to income statement such as revenues, expenses, dividends, etc. The balances of these accounts are not carried forward to next year after their closing. The closing process is undertaken to reduce their balances to zero.

Mainly four basic steps are involved in the process of closing entry process. They are as follows:

Firstly revenues accounts are closed by transferring them to clearing account named as income summary (are debited to income summary). Its entry will be

DR. Revenues

Cr. Income summary

Then expenses accounts are closed by transferring them to clearing account named as income summary (are credited to income summary). Its entry will be

DR. Income Summary

CR. Expenses

Then income summary is closed by transferring the balance of income summary to retained earnings account (is debited to retained earnings account) Its entry will be

DR. Income Summary

CR. Retained earnings

Lastly, dividend account is closed by transferring the balance of dividend to retained earnings account (is debited to retained earnings account). Its entry will be

DR. Dividends

CR. Retained earnings

As discussed above, the accounts which are affected by closing entries are temporary accounts such revenues, expense and dividend. These accounts are related to income statement and statement of retained earnings. The accounts which are not affected by closing entries are permanent accounts such as assets, liabilities and equity. These accounts are related to balance sheet and statement of owner’s equity.

The two main purposes of closing entries are as follows:

• To bring the balance of accounts affected by closing entries to 0.
• To update or introduce necessary changes the owner’s equity account