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Closing Entries

Closing Entries

Author: Evan McLaughlin
Description:
In this lesson, the student will learn about closing entries and how they are used.
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Tutorial

"Closing Entries"

Source: Instrumental “Drops of H2O ( The Filtered Water Treatment )" by J.Lang (feat. Airtone),” Creative Commons, http://ccmixter.org/files/djlang59/37792

Video Transcription

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Hey everyone, and welcome to our video today on Closing Entries. So what is today's video all about? Well, you might have guessed that we're going to talk about closing entries. We're going to look at why we make closing entries, which accounts are closed, and where those accounts get closed to. We're going to look at the types of closing entries that are made. And then we're going to look at the specific procedure for making closing entries.

So let's start out with a discussion of closing entries. Now, what is a closing entry? Let's take a look at the definition. Closing entries, that's an entry that's made at the-- key word here-- end of an accounting period that is used to close out a temporary account. So we close out our temporary accounts. Now, where are these entries made? Well, our closing entries are made in the general journal, and now general journal gets posted to the general ledger.

So again, closing entry is entered in the general journal and posted to the general ledger. Now, which accounts get closed? Do we close temporary accounts or permanent accounts? Well, it says there in the definition, we don't close our permanent accounts. We close our temporary accounts. That's our revenue and expenses.

But there's another account that needs to get closed the drawing account or the owner draw account. Now, what is the drawing account? What is that? Let's look at the definition. That's an account that keeps a record of money taken out of the business by its owner or owners. So any time an owner or some of the owners pull money out of the business, that gets tracked in the drawing account.

And it's important to note that a C corp does not have a drawing account. So why are they made? Why do we make closing entries? Well, temporary accounts are closed to ensure accurate reporting. Those temporary accounts, those revenues and expenses and the drawing account, are period-based accounts. So they report on specific activity for a given period. So they track activity.

Temporary accounts are reopened for the following period in order so that they can report activity for only one specific period. So closing entries, that's the what is, where are they made, which accounts, and why we do them. So closing entries, again, what are the objectives? What is the purpose of closing the accounting system? Why do we do this?

Well, first it helps us determine net income or net loss. How do we do that? Through closing our temporary accounts. Now, what are the temporary accounts? Let's look at the definition of temporary accounts, accounts whose balances are closed at the end of an accounting period and reopened at the beginning of the next period.

And we talked about it in the last slide. Our temporary accounts are our revenue, which is earnings from interest or from the sale of goods or services, and expense. And expense is costs associated with operating or maintaining a company. So we need to determine net income or loss, and we do that by closing our temporary accounts. Think of that as hitting the reset button.

And we transfer net income or loss to equity. So we need to determine net income or loss, and we do that through closing our temporary accounts, revenue expense, and that owner's draw account, hitting our reset button, and then transferring net income or loss into our cumulative equity.

So let's look at the closing procedure and what's called the REDI method, R-E-D-I. Temporary account groups are closed by processing netting journal entries on their unnatural balance side. So let's look at that idea of netting. What does that mean? You look at the total balance of the account, whether it's debit or credit, and book an entry or record a closing entry for that amount to the opposite side.

So if you have an account that has a current debit balance, you would book an entry for that same amount to the opposite side so that that account nets to zero. So let's look at R, E, D, and I. What does R stand for? Revenues. So we close out our revenues first. Close those revenues, then we move onto expenses. So after we've closed our revenues, then we close our expenses.

And D is that other type of temporary account we need to close, Drawings. So we close our owner drawings accounts. Now, where do all those go? Those go to income summary. So we close our revenues, our expenses, and our drawings to the income summary, which then gets closed to our retained earnings.

All right, let's summarize. In a nutshell, what did we talk about today? We discussed closing entries and why they're done. So let's look at the closing entry, an entry made at the blank of an accounting period that is used to close out a blank account. So our closing entry's made at the end of an accounting period that is used to close out a temporary account. So those are our closing entries.

Now, we also looked at the temporary accounts. And temporary accounts are those accounts whose balances are closed at the end of an accounting period and reopened at the beginning of the next period. And those two types of accounts are revenues and expenses. There's also those owner's drawing accounts that we need to close out.

So that's what we talked about today, our closing entries and our temporary accounts. And then we looked at the REDI method. Revenues, expenses, drawings all closed to our income summary. I hope everybody enjoyed this video, and I hope to see you next time.

Notes on "Closing Entries"

Terms to Know

Temporary Accounts

Accounts whose balances are closed at the end of an accounting period and reopened at the beginning of the next period.

Revenue

Earnings from interest or from the sale of goods or services.

Expenses

Costs associated with operating or maintaining a company.

Closing entry

An entry made at the end of an accounting period that is used to close out a temporary account.

Drawing account

An account that keeps a record of money taken out of the business by its owner or owners.