Closing entries, also known as closing journals, help an organization move from one period to the next and are a critical component of the accrual accounting method.
What is a Closing Entry?
A closing entry is a set of accounting transactions used to transfer the balances in temporary accounts to permanent accounts. Temporary accounts are also known as temporary accounts or nominal accounts. These accounts are used to record transactions that occur during a single accounting period. They include accounts such as revenue, expenses, and dividends. At the end of the accounting period, the balances in these accounts must be transferred to permanent accounts, such as the retained earnings account. This is accomplished with closing entries.
Closing entries are necessary to maintain the accounting equation, which states that assets must equal liabilities plus equity. Closing entries ensure that all of the debits are equal to all of the credits, which is essential for accurate financial records.
How to Use Closing Entries
To do this, a debit entry is made to the temporary account and a credit entry is made to the permanent account. This is done for all of the temporary accounts.
For example, a company has $1,000 in revenue and $500 in expenses during the accounting period. At the end of the period, the balances in the revenue and expenses accounts must be transferred to the retained earnings account. This is done with a closing entry. A debit entry of $1,000 is made to the revenue account, and a credit entry of $1,000 is made to the retained earnings account. Then, a debit entry of $500 is made to the expenses account, and a credit entry of $500 is made to the retained earnings account. This transfers the balances in the temporary accounts to the permanent account.
Closing entries are a critical component of the accrual accounting method. They ensure that the accounting equation is maintained and that the organization’s financial records are accurate. Without closing entries, the financial statements would be inaccurate, and decisions based on them would be unreliable. Therefore, it is important for organizations to understand how to use closing entries and to make sure they are done correctly.
