Closing Entries: The Essential Reset in Accounting

At the end of every accounting period, before you can analyze results or move on to the next cycle, one thing must happen: the books need to be closed. Not figuratively—literally. And this means executing closing entries.

What Are Closing Entries?

Closing entries are journal movements made at the end of a reporting period to reset temporary accounts—revenues, expenses, and dividends—to zero.

Their balances are transferred to retained earnings, ensuring the income statement starts fresh in the next period.

The purpose is simple: isolate each period’s performance, avoid rollover distortions, and correctly update the equity section of the balance sheet.

Temporary vs Permanent Accounts

Let’s break this down...

• Temporary accounts:

  • Revenue accounts (e.g. Sales, Interest Income)

  • Expense accounts (e.g. Salaries, Rent, Depreciation)

  • Dividends (or drawings in partnerships)

These accounts reset to zero after each period.

• Permanent accounts:

  • Assets, liabilities, and equity

    
    

These accounts carry forward their balances.

Only temporary accounts are involved in closing entries; permanent ones are untouched.

The Four Steps of Closing Entries

The closing process typically involves four movements: let's check them out.

1. Close Revenue Accounts

All revenue balances are moved to an intermediate account called Income Summary.

For example, if Sales Revenue is 300,000, you would debit Sales Revenue for 300,000 and credit Income Summary for 300,000.

2. Close Expense Accounts

Each expense account is closed to the same Income Summary account.

If Salaries Expense is 120,000 and Rent Expense is 90,000, you would debit Income Summary for 210,000, and credit Salaries Expense for 120,000 and Rent Expense for 90,000.

3. Close Income Summary to Retained Earnings

The difference between revenues and expenses—i.e. the net income or loss—is moved to Retained Earnings.

If the net profit is 90,000, you would debit Income Summary for 90,000 and credit Retained Earnings for 90,000.

If it were a loss of 90,000, you would do the opposite: debit Retained Earnings and credit Income Summary.

4. Close Dividends to Retained Earnings

If dividends were declared, they reduce retained earnings.If Dividends total 15,000, you would debit Retained Earnings for 15,000 and credit Dividends for 15,000.

At this point, your temporary accounts are reset, and the profit (or loss) has been officially closed into equity.

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Why Closing Entries Matter

Some might see this process as routine, but its implications are significant:

• It ensures that net income is isolated by period;

• It avoids mixing prior and current performance, which could distort analysis;

• It correctly updates retained earnings, a key figure for investors and governance;

• It keeps the income statement focused only on what happened this period.

If you skip or mishandle closing entries, reports become inconsistent—and comparisons become unreliable.

In Practice: Manual vs Automated Closing

Many modern accounting systems handle closing entries automatically. But that doesn't mean you can skip reviewing them. Finance professionals still need to:

• Confirm that no revenue or expense accounts were missed;

• Check for final adjustments (accruals, deferrals, reclassifications);

• Validate the retained earnings impact;

• Maintain documentation for internal or external audit.

Automation saves time, but oversight ensures quality.

The Analyst’s Perspective

From a financial analysis viewpoint, accurate closing entries enable:

• Period-to-period comparisons (monthly, quarterly, annually);

• Clean profit metrics (EBIT, EBITDA, Net Income);

• Reliable rolling forecasts and actual vs. budget reviews;

• Consistent KPIs and dashboard reporting.

If you care about financial insights, you need reliable closings.

Tips for Better Closings

• Create a month-end or year-end closing checklist;

• Freeze entries after closing to avoid late adjustments;

• Involve both accounting and FP&A teams in review;

• Document manual entries and reasons behind them;

• Keep the process repeatable and traceable.