Closing Entry: How Temporary Accounts Reset

What Is a Closing Entry?

A closing entry is a journal entry made at the end of an accounting period to transfer the balances of temporary accounts into an appropriate equity account and reset those temporary accounts for the next period. Revenue, expense, and certain owner-distribution accounts measure activity for a defined period; balance-sheet accounts generally continue into the next period.

Closing entries are a step in the accounting cycle, not the entire month-end or year-end close. Modern accounting systems may perform this rollover automatically rather than displaying the same manual entries used in an accounting textbook.

Temporary versus permanent accounts

Temporary accounts accumulate activity for a period and then begin the next annual reporting period at zero. They commonly include:

• Revenue and other income.
• Cost of goods sold.
• Operating and other expenses.
• Income summary, if used.
• Dividends or certain draw/distribution accounts, depending on the entity and system.

Permanent accounts carry their ending balances forward. They commonly include:

• Cash and other assets.
• Accounts receivable and inventory.
• Fixed assets and accumulated depreciation.
• Accounts payable, credit cards, loans, and other liabilities.
• Capital, retained earnings, and other equity balances.

The account names and exact process depend on whether the business is a sole proprietorship, partnership, corporation, or other entity. A closing entry should not casually move balances among owner accounts without considering the entity's legal and tax structure.

Basic closing-entry example

Assume Coastal Design LLC has $120,000 of annual revenue and $82,000 of annual expenses, producing $38,000 of net income. A simplified manual closing process may:

1. Debit revenue accounts for $120,000 and credit Income Summary.
2. Debit Income Summary for $82,000 and credit expense accounts.
3. Debit Income Summary for the $38,000 net credit balance and credit the appropriate equity account.

After posting, revenue and expense accounts have zero balances for the new annual period. The $38,000 result is reflected in equity, subject to the business's entity and reporting structure.

Some systems close revenue and expenses directly to equity without an Income Summary account. Others calculate current-year earnings dynamically and roll the amount into retained earnings when the new fiscal year begins.

When closing entries occur

Textbook closing entries are most commonly associated with the end of an annual accounting period. Businesses may also describe monthly system rollovers or management-reporting procedures as "closing," but they should confirm how their software handles year-to-date income and equity.

The close sequence generally places closing entries after:

1. Routine transactions are posted.
2. Bank, credit-card, loan, payroll, receivable, and payable balances are reconciled.
3. Adjusting entries are recorded.
4. An adjusted trial balance and financial statements are reviewed.
5. Net income and equity treatment are approved.

A post-closing trial balance can then verify that the remaining permanent-account debits and credits balance. It still does not prove that every balance is correct.

Closing entry versus adjusting entry

An adjusting entry updates the period being reported. It might record accrued payroll, earned but unbilled revenue, prepaid insurance expense, or depreciation. These entries help determine the period's correct profit and ending balances.

A closing entry uses the completed period results to reset temporary accounts and transfer their net effect to equity. Posting closing entries before adjustments are complete can lock in an incomplete result and create confusing corrections.

Closing entry versus a closing-date lock

A software closing date restricts or warns against edits before a selected date. It protects reviewed periods from accidental changes. It does not reconcile accounts, investigate uncategorized transactions, calculate accruals, or create supporting workpapers.

If a closed period must change, use controlled procedures: identify the reason, obtain approval when required, document the entry, update affected reports and reconciliations, and communicate the effect to tax preparers or other report users.

Tax considerations

Closing entries are accounting records; they do not file a tax return or determine deductibility by themselves. Book net income often requires tax adjustments for depreciation, meals, penalties, owner items, timing differences, and other rules. California adjustments may differ from federal adjustments.

Do not post a lump-sum entry merely to make book income equal taxable income unless a qualified reviewer has determined that the bookkeeping itself is wrong. A book-to-tax reconciliation is often the better record.

Common mistakes

• Closing assets or liabilities that should carry forward.
• Leaving material revenue or expense balances in the new annual period.
• Closing before adjustments and reconciliations are complete.
• Posting net income to the wrong equity account.
• Treating owner draws, partner distributions, and corporate dividends as interchangeable.
• Manually duplicating a closing process already performed by the software.
• Deleting the audit trail after a period is closed.
• Changing a closed period without updating reports and workpapers.
• Assuming a post-closing balanced trial balance proves accuracy.
• Confusing a tax return entry with a closing entry.

Frequently asked questions

Related terms

• Adjusting Entry
• Trial Balance
• Month-End Close
• Year-End Close

Official sources

• IRS — Publication 583, Starting a Business and Keeping Records
• IRS — Topic No. 305, Recordkeeping
• IRS — Publication 538, Accounting Periods and Methods
• California FTB — Keeping your tax records

The definitions and examples on this page are for informational purposes only and do not constitute tax advice. Tax laws change frequently and individual circumstances vary. Consult a qualified tax professional before making decisions based on this content.