Lesson Seven: Closing Entries and the Post-Closing Trial Balance
Before we dive right in, let’s review the general steps of the accounting cycle. As a note, these steps may differ slightly from your textbook, so please be sure to compare this resource to your textbook’s presentation of the accounting cycle.
- Journalize general journal entries for business transactions throughout the accounting period
- Post each journal entry to the general ledger
- Prepare an unadjusted trial balance
- Journalize adjusting entries
- Post each adjusting entry to the general ledger
- Prepare an adjusted trial balance
- Prepare the company’s financial statements
- Journalize closing entries
- Post closing entries to the general ledger
- Prepare a post-closing trial balance
As we are nearing the end of the accounting cycle process, we need to prepare adjusting entries to help ready our books for then next accounting cycle. In order to start the closing process, we preparing closing entries.
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Permanent vs. Temporary Accounts
Before we dive right into closing entries, it is important to understand why we need to close certain accounts. Let’s review the five account types along with a couple examples of each:
- Assets: Cash, Accounts receivable, Equipment
- Liabilities: Accounts payable, Unearned fees
- Capital/Equity: Tracy S., Capital
- Income/Revenue: Fees earned
- Expenses: Rent expense, Wages expense
For each of these account types, think about the nature of the account examples as it relates to a new accounting period. For example: Cash. If you had $10,000 in you bank account at 11:59pm on December 31st, would that $10,000 disappear one minute later when it’s a new year at 12:00am January 1st? No, balance is considered permanent (also know as real). All assets are permanent accounts and do not go away just because we start a new accounting cycle.
Accounts payable, a liability account, works the same way. Do you think the amount you owe your vendors disappears just because its a new year? No, it is also a permanent account, as are all liabilities.
Bear with me as I skip capital to discuss revenues and expenses. Revenues and expenses are those account types that are specific to one accounting period. We need to close out revenue and expense accounts at the end of each accounting cycle, so we can start fresh next period. This is what allows us to break down revenues and expenses according to specific periods (think of your income statement from Lesson Six). Since all revenue and expense accounts need to be closed out at the end of the accounting cycle, we call these temporary accounts.
Another trick for remembering your temporary and permanent accounts is to remember that your balance sheet accounts (assets, liabilities, and capital) are all permanent. Your income statement (revenue and expenses) are all temporary. The one additional account that we should consider is our special contra-capital account, the [Owner’s Name], Drawing account. See the chart below for a break-down of temporary and permanent accounts types.
| Permanent (The balance rolls to the next accounting cycle) | Assets Liabilities Capital |
| Temporary (The balance is closed to zero at the end of the accounting cycle) | Revenues Expenses Drawing* |
Closing Entries
Now that we know which accounts types need to be closed out at year end, let’s learn about the closing entry process.
The number of journal entries used to closing entries differs from textbook to textbook, but in this lesson, we will use a 2-entry closing process. The two entries that we will use will accomplish the following:
Closing Entry 1: Close all REVENUE and EXPENSE accounts to capital.
Closing Entry 2: Close the DRAWING account to capital.
Let’s see how we can accomplish this by watching the video in the next section. As a reminder, in order to successfully master the closing entry process, you should have a strong grasp of how to categorize accounts into their respective account types. If you need a review of this before moving on the the video below, please see Understanding the Five Basic Account Types (Elements).
As a note, the video below skips Step 9 in our accounting cycle: Posting the closing entries to the general ledger. As a note, the posting works the same way as it does for journal entries and adjusting entries with on exception: In the ITEM column, you will place “Closing” to indicate that this posting is for a closing entry.
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Test Your Understanding
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