Closing Entries

After preparing financial statements, the balances of our temporary accounts are closed to prepare them for the following accounting period. Because the balances of temporary accounts are not carried forward, their balances are set to zero by closing entries. Temporary accounts are income statement accounts (revenues and expenses) and dividend accounts. The balances of the balance sheet accounts are carried forward; therefore, they are called permanent accounts and are not closed.

Let's look at some accounts to see how this works for MM TAX.

If MM TAX owns a computer on December 31, MM TAX and will still own that computer on January 1 of the next year—unless, of course, a tornado destroyed the town! If MM TAX owes money to a creditor (accounts payable) on December 31, it will still owe that money on January 1 of the next year. These accounts are considered permanent because they move through accounting periods. Balance sheet accounts are considered permanent accounts.

What about revenues? Revenues are earned for a period of time; at the end of that period, the revenue account closes and starts over for the next accounting period. Expenses are also accounts that are closed at the end of the accounting period, because expenses must match the same period as the revenues earned. These accounts are considered temporary accounts because they close at the end of an accounting period. Income statement accounts are considered temporary accounts. Dividends are also closed at the end of the period. We keep track of how much was paid in dividends for a period of time.

Closing the temporary accounts involves four journal entries:

Once the closing entries are recorded in the general journal and posted to the appropriate ledger accounts (T-Accounts), we will use the balance in the ledger accounts to prepare a post-closing trial balance.