Closing Entries in Accounting: Meaning, Steps & Examples
Closing Entries in Accounting: Meaning, Examples, Steps & Journal Entries
Closing entries in accounting are journal entries made at the end of an accounting period to transfer the balances of temporary accounts (revenues, expenses, and dividends or drawings) to permanent equity accounts. This standard bookkeeping step resets temporary account balances to zero and prepares the general ledger for the next accounting period.
Depending on the entity's accounting system and reporting process, closing may be performed monthly, quarterly, or annually; annual closing is the usual focus of accounting-cycle examples. The accounts involved are revenue accounts, expense accounts, the Income Summary clearing account, and owner's drawings or corporate dividends.
Debited to zero
Credited to zero
Net income to equity
Closed to equity
What Are Closing Entries in Accounting?
Accounting keeps a continuous record of business activity, but financial reporting evaluates defined periods. Closing entries clear nominal (temporary) accounts so the next period starts at zero for those categories. Without them, revenue and expense figures would accumulate indefinitely, making current-period profitability impossible to measure.
Why Are Closing Entries Necessary?
Closing entries serve three main purposes:
- Reset Temporary Balances: Revenue, expense, and drawing/dividend accounts return to zero so they can collect data fresh for the next period.
- Update Capital or Retained Earnings: The period's net income or loss is transferred to equity, so the balance sheet agrees with the statement of changes in equity.
- Support Period-to-Period Reporting: Each period accumulates its own revenues, expenses, and distributions without carrying forward the prior period's temporary balances.
Temporary vs Permanent Accounts
Understanding this distinction is the foundation of the closing process. If you need a refresher, see our guide to the types of accounts.
| Feature | Temporary Accounts (Nominal) | Permanent Accounts (Real) |
|---|---|---|
| Definition | Track activity for a single accounting period. | Carry their ending balances into the next period. |
| Lifespan | Closed to zero at the end of every period. | Not closed; balance becomes next period's opening balance and keeps changing with new transactions. |
| Examples | Revenues, Expenses, Dividends, Owner's Drawings, Income Summary. | Assets, Liabilities, Common Stock, Retained Earnings, Owner's Capital. |
Temporary Accounts
Temporary accounts measure activity over a set timeframe. If a business earns 500,000 PKR in Year 1, that revenue belongs strictly to Year 1; Year 2 must start at 0 PKR to measure Year 2 performance.
Permanent Accounts
Permanent accounts show long-term financial position. Assets (cash, equipment) and liabilities (accounts payable, loans) do not vanish at period-end; they roll forward.
Reset to a zero balance when the period ends.
Carry their ending balances forward to open the next period.
Which Accounts Are Closed?
- All revenue accounts (Sales Revenue, Service Revenue, Interest Income).
- All expense accounts (Salaries, Rent, Utilities, Depreciation Expense).
- The Income Summary clearing account.
- Dividends (corporations) or Owner's Drawings (sole proprietorships and partnerships).
Which Accounts Are Not Closed?
Not all equity-related accounts remain open. Permanent equity accounts such as Owner's Capital and Retained Earnings carry forward, while temporary distributions such as Drawings and Dividends are closed.
- All asset accounts (Cash, Accounts Receivable, Inventory, Equipment).
- All liability accounts (Accounts Payable, Notes Payable, Accrued Expenses).
- Equity accounts representing cumulative capital or earnings (Retained Earnings, Common Stock, Owner's Capital).
How Closing Entries Work
The closing process uses a clearing account called Income Summary. Revenues and expenses are transferred to Income Summary, and its resulting balance (net income or net loss) is transferred to Retained Earnings or Owner's Capital. Drawings or dividends are closed directly to equity.
Four Main Steps of Closing Entries
- Close Revenues: Debit all revenue accounts; credit Income Summary.
- Close Expenses: Credit all expense accounts; debit Income Summary.
- Close Income Summary: Transfer net income or loss to Owner's Capital or Retained Earnings.
- Close Drawings/Dividends: Transfer withdrawals or dividends directly to equity.
Step 1: Close Revenue Accounts
Revenue accounts normally have credit balances, so debit each revenue account for its balance and credit Income Summary for the total.
Step 2: Close Expense Accounts
Expense accounts normally have debit balances, so credit each expense account for its balance and debit Income Summary for the total.
Step 3: Close Income Summary
A credit balance in Income Summary means net income; a debit balance means net loss. Transfer it to Retained Earnings (corporation) or Owner's Capital (sole proprietorship). In a partnership, income or loss and drawings are transferred to the partners' capital accounts according to the partnership agreement.
Step 4: Close Dividends or Drawings
Transfer dividends or owner withdrawals directly from the drawing/dividend account to Retained Earnings or Owner's Capital. This entry does not pass through Income Summary.
Closing Entries Summary Table
| Closing Step | Debit | Credit |
|---|---|---|
| Close Revenues | Revenue accounts | Income Summary |
| Close Expenses | Income Summary | Expense accounts |
| Close Net Income | Income Summary | Owner's Capital (or Retained Earnings) |
| Close Drawings / Dividends | Owner's Capital (or Retained Earnings) | Drawings (or Dividends) |
If the business has a net loss, the third entry reverses: debit Owner's Capital (or Retained Earnings) and credit Income Summary.
Closing Entries Example
Consider PakTech Solutions, a fictional service firm operating in Pakistani Rupees (PKR) for the accounting year ended June 30, 2026.
Entity type: sole proprietorship. For a corporation, the equivalent entries would credit Retained Earnings instead of Owner's Capital and would close Dividends instead of Owner's Drawings.
Example Data
After adjustments, the temporary accounts show:
- Service Revenue: 1,200,000 PKR (credit)
- Rent Expense: 200,000 PKR (debit)
- Salaries Expense: 500,000 PKR (debit)
- Utilities Expense: 100,000 PKR (debit)
- Owner's Drawings: 150,000 PKR (debit)
Calculation: Revenue 1,200,000 − Expenses 800,000 = Net Income of 400,000 PKR. This is the same figure reported on the profit and loss statement.
Journal Entry 1: Close Revenue
| Date | Account Titles and Explanation | Debit (PKR) | Credit (PKR) |
|---|---|---|---|
| Jun 30 | Service Revenue | 1,200,000 | |
| Income Summary | 1,200,000 | ||
| (To close revenue to Income Summary) | |||
Debiting Service Revenue clears it to zero; crediting Income Summary accumulates total revenue.
Journal Entry 2: Close Expenses
| Date | Account Titles and Explanation | Debit (PKR) | Credit (PKR) |
|---|---|---|---|
| Jun 30 | Income Summary | 800,000 | |
| Rent Expense | 200,000 | ||
| Salaries Expense | 500,000 | ||
| Utilities Expense | 100,000 | ||
| (To close expenses to Income Summary) | |||
Crediting each expense zeroes it out; debiting Income Summary records total operating costs.
Journal Entry 3: Close Income Summary
| Date | Account Titles and Explanation | Debit (PKR) | Credit (PKR) |
|---|---|---|---|
| Jun 30 | Income Summary | 400,000 | |
| Owner's Capital | 400,000 | ||
| (To transfer net income to Owner's Capital) | |||
Income Summary has a credit balance of 400,000 PKR (1,200,000 − 800,000). Debiting it zeroes the account and moves the profit into equity.
Journal Entry 4: Close Drawings
| Date | Account Titles and Explanation | Debit (PKR) | Credit (PKR) |
|---|---|---|---|
| Jun 30 | Owner's Capital | 150,000 | |
| Owner's Drawings | 150,000 | ||
| (To close Owner's Drawings to Owner's Capital) | |||
Drawings have a debit balance, so crediting them zeroes the account, and debiting Owner's Capital reduces equity by the cash withdrawn.
Effect on Owner's Capital
| Item | Amount (PKR) |
|---|---|
| Net Income | 400,000 |
| Less: Owner's Drawings | (150,000) |
| Increase in Owner's Capital | 250,000 |
What If There Is a Net Loss?
Suppose another year shows revenue of 300,000 PKR and expenses of 350,000 PKR. After closing, Income Summary has a debit balance of 50,000 PKR (a net loss), so the third entry reverses direction: debit Owner's Capital 50,000 PKR and credit Income Summary 50,000 PKR. The loss reduces equity.
Closing Entries vs Adjusting Entries
Adjusting entries are made at period-end to record revenues and expenses in the correct period under accrual accounting (for example, accrued wages or prepaid insurance). Closing entries come after the financial statements are prepared in the standard accounting cycle and reset temporary accounts. To understand the accruals behind adjusting entries, read our guide on cash vs accrual accounting.
Closing Entries vs Reversing Entries
Reversing entries are optional bookkeeping shortcuts made on the first day of the new period to simplify recording routine transactions such as accrued expenses. Closing entries, by contrast, are a standard period-end procedure in the accounting cycle used to reset temporary accounts.
Effect of Closing Entries on the Trial Balance
After closing entries are posted, the post-closing trial balance contains only the permanent accounts. Revenue, expense, drawings/dividends, and Income Summary accounts should show zero balances.
Post-Closing Trial Balance
The post-closing trial balance lists all permanent accounts (assets, liabilities, and equity) with their ending balances. It verifies that the remaining debit and credit balances are mathematically equal and confirms that temporary accounts have been cleared. It does not prove that the records are free of every possible error. These permanent accounts are the ones reported on the balance sheet.
For illustration only, assume the post-closing permanent accounts have the following ending balances. These balances are separate from the earlier PakTech Solutions example and are shown only to demonstrate the format of a post-closing trial balance. Every temporary account is at zero and therefore does not appear.
| Account | Debit (PKR) | Credit (PKR) |
|---|---|---|
| Cash | 900,000 | |
| Accounts Receivable | 350,000 | |
| Equipment | 200,000 | |
| Accounts Payable | 200,000 | |
| Owner's Capital | 1,250,000 | |
| Total | 1,450,000 | 1,450,000 |
Common Mistakes When Preparing Closing Entries
- Failing to close drawings or dividend accounts directly to equity.
- Closing permanent accounts (such as Equipment or Accumulated Depreciation) by mistake.
- Miscalculating the Income Summary balance through transposition errors.
- Omitting one or more minor expense accounts from the closing batch.
- Using Owner's Capital and Retained Earnings interchangeably for different entity types.
Closing Entries in the Accounting Cycle
Reversing entries, when used, are optional and are recorded at the beginning of the next period. For the full sequence, see our accounting cycle guide, and for the entries themselves, read journal entries for beginners.
Practical Accounting Workflow
In accounting software and ERP systems, closing entries are often automated, and some systems close revenue and expense accounts directly to Retained Earnings without an Income Summary account. Understanding the manual journal entries remains essential for auditing, financial analysis, and troubleshooting ledger imbalances.
Frequently Asked Questions
What are closing entries in accounting?
Journal entries recorded at the end of an accounting period to transfer temporary account balances (revenues, expenses, and dividends or drawings) to permanent equity accounts.
Why are closing entries prepared?
They reset temporary accounts to zero so the next period's performance can be tracked independently.
Which accounts are closed?
Revenue accounts, expense accounts, the Income Summary account, and dividend or drawing accounts.
Are assets and liabilities closed?
No. Assets and liabilities are permanent accounts, so their ending balances carry into the next accounting period. Permanent equity accounts such as Owner's Capital and Retained Earnings also carry forward.
What is the difference between closing and adjusting entries?
Adjusting entries update accounts for accruals and deferrals before financial statements are prepared; closing entries zero out temporary accounts afterward.
What is a post-closing trial balance?
A list of permanent accounts and their balances after closing entries are posted, showing that debits equal credits.
Conclusion: Closing Checklist
- Confirm adjusting entries are posted and financial statements are prepared.
- Close revenues to Income Summary.
- Close expenses to Income Summary.
- Close Income Summary to Owner's Capital or Retained Earnings.
- Close drawings or dividends to equity.
- Prepare the post-closing trial balance and check that temporary accounts are zero.
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