What Is a Closing Entry? (Plus How To Use Them)

By Indeed Editorial Team

Published January 3, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

A closing entry is a common financial record-keeping tactic. They allow a company to balance its books and move financial entries to new ledgers and accounts as needed. Learning about when to use closing entries and how to complete them can help you keep more accurate and effective financial records. In this article, we discuss what a closing entry is, explore why they're important, explain how to create one and share an example of a closing entry to provide guidance.

What is a closing entry?

A closing entry is a series of recorded notes made to the financial records of an individual or company. It moves the value represented in temporary accounts, such as a yearly income report, over to the entity's long-term books. This allows you to gain any necessary utility from period-based accounting while still maintaining long-term financial records.

Related: The Ultimate Guide to Closing Entries (With Types and Examples)

Why are closing entries important?

Closing entries are a critical type of financial record-keeping. They allow a company to maintain short-term records as needed while also maintaining permanent records for the organization. Some of the benefits provided by this system include:

Paying taxes

Using closing entries allows a company to maintain annual or monthly financial records. This is essential for filing state and federal taxes. Because taxes apply to financial actions within a defined period, you maintain records for each period for easier calculation. After that period, closing entries allow you to shift any outstanding balances over to the company's permanent long-term records.

Simplifying processes

Using temporary records and closing entries can simplify processes a company completes by allowing them to track over smaller periods. For example, if you're monitoring spending and returns on a project, you may keep monthly records. By calculating monthly and then closing out the accounts with closing entries, it keeps the calculations smaller than if you performed a single calculation at the end of the term.

Tracking changes

The process of using temporary accounts and closing entries to transfer them at the end of the term can be a useful method for assessing progress and changes in an organization's finances. Monthly accounts, for example, allow you to compare how one or more elements, such as spending or income, change from month to month for your employer. This can be useful for identifying trends that may indicate areas in need of improvement or areas of success available for further exploitation.

Related: 7 Types of Metrics To Measure Business Success

Maintaining accurate long-term records

Closing entries are a critical component of providing the benefits of temporary accounts while maintaining accurate permanent records. By transferring value from temporary accounts to the permanent record at their conclusion, closing entries allow you to ensure the financial records of the company account for all spending and income. It may allow for more accurate financial planning and may help to keep the organization in compliance with any regulations.

Related: What Is Basic Accounting?

How to write a closing entry

If you're ready to close a set of temporary books and transfer their values to your permanent records, follow these steps:

1. Transfer revenue accounts to the income summary

Begin by closing out your income accounts for the period. Create a debit in the records for each income account equal to its closing value. To maintain balance in your records, record a credit in your income summary for the period. This transfers all revenue to the temporary income summary account.

2. Transfer expense accounts to the income summary

Next, close out any expense accounts for the period. Because they are expenses that record as debits, add credit equal to the total debit in the expense account to zero it out. To maintain balance, record a debit in your income summary equal to the total amount credited. This transfers all expenses to the temporary income summary account.

3. Close the income summary

With both revenue and expenses in the income summary, you have created a final summary of the period, which you may now transfer to your retained earnings. Create a debit if the income summary yields a positive result, or a credit if it yields a negative result, to move the income summary to zero. Record a corresponding entry in your retained earnings records, creating a debit if you credited your income summary and a credit if you debited your income summary.

Related: What To Know About Income Statements

4. Transfer dividends if paid

If your company paid dividends during the period for which you are closing records, close the dividend account for that period. Create a new credit entry in the dividends account equal to the value paid. Maintain balance in your records by recording a matching debit in your retained earnings records.

Closing entry example

This example closing entry calculation shows how a sports equipment manufacturer may close their books at the end of a financial period:

Closing revenue accounts

The manufacturer sells their products directly to customers through an online retail store. They generate $35,000 of sales during the period and record a corresponding debit to the revenue account and credit to the income summary. This transfers the money while maintaining balance in the books:

*Date****Account**Debit**Credit**12/31/2021Revenue$35,000*
*12/31/2021Income summary*
$35,000### Closing expense accounts

The company assesses its expenses during the term and notes the costs for raw materials, employee wages, property rent, interest on loans and equipment depreciation. The accountant completes the closing totals of these expenses and creates a matching debit in the income summary:

*Date****Account**Debit**Credit**12/31/2021Income summary$25,250*
*12/31/2021Material costs*
$8,00012/31/2021Wages
$10,00012/31/2021Rent
$6,00012/31/2021Interest
$50012/31/2021Depreciation
$750### Closing the income summary

By comparing the amount credited from the income statement and the amount debited from the expense statement, the company can calculate its net loss or gain during the period. This provides an assessment of performance during the period assessed. Since the company earned more money than it spent, the accountant closes the income summary by recording a debit equal to the difference between the amount of income and the amount of expense. They record a corresponding credit in retained earnings:

*Date****Account**Debit**Credit**12/31/2021Income summary$9,750*
*12/31/2021Retained earnings*
$9,750 ### Closing dividends

The company paid out dividends to its shareholders during the period. To transfer this spending to the permanent records, the financial professional records a credit to the dividends account and then a debit to the retained earnings. This maintains balance while recording the loss of retained income due to dividend payments:

*Date****Account**Debit**Credit**12/31/2021Retained earnings$1,250*
*12/31/2021Dividends*
$1,250

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