Question

What is the purpose of closing entries?What is the effect on the financial statements
if closing entries are not made? What accounts are closed?

Answer 1

• Purpose of Closing Entries:

---The basic purpose is to close various revenues and expenses account at the end of period.

---Revenues accounts with credit balances are closed by debiting them in closing entry,

---Expenses accounts with debit balances are closed by crediting them in closing entry.

---Another purpose is to increase or decrease the value of Retained Earnings (or Capital a/c) by the amount of Net Income or Net Loss respectively.

---Closing entries are also made to:

>Transfer and decrease Retained Earning balance by the amount of dividends

>Close Withdrawals and Drawing account and decrease the amount of Capital balance by the amount.

• If closing entries are not made:

---Retained Earnings balance would be incorrect.

---Revenues and expenses account will continue to exist.

---Next year’s Trial Balance will have balances of accounts that are not required.

• What accounts are closed?

---Accounts of temporary nature are closed, while account of permanent nature continue to exist.

---Accounts of temporary nature are generally Revenues and Expenses accounts like: Sales Revenue, Cost of Goods Sold, Rent Expenses, Sales discount, etc

---Other accounts that are closed are:

>Drawings account

> Dividend accounts.