Closing the books¶
The income statement you just built for Summit Drone Photography answers "how did this year go?" For that question to make sense next year too, Service Revenue and every expense account need to start next January at zero. If they didn't, next year's income statement would include this year's sales all over again, and no one could tell one year's performance from another. Closing entries are the year-end housekeeping that resets those accounts to zero without losing a dollar of what they measured, because everything they held moves into Retained Earnings first.
Temporary accounts start over, permanent accounts carry forward¶
Every account in the ledger is one of two kinds. A temporary account measures one year's activity: revenues, expenses, and Dividends. At the end of the year its balance is swept into Retained Earnings and it opens the new year at zero. A permanent account carries its ending balance forward as next year's beginning balance and is never reset: every asset, every liability, Common Stock, and Retained Earnings itself.
| Temporary (closed at year end) | Permanent (carries forward) |
|---|---|
| Service Revenue, Interest Revenue | Cash, Accounts Receivable, all other assets |
| Salaries Expense, Rent Expense, and every other expense | Accounts Payable and every other liability |
| Dividends | Common Stock, Retained Earnings |
Cash never appears on the left. Closing entries move balances between temporary accounts and Retained Earnings; they never touch Cash or any other permanent account except Retained Earnings.
Common mistake: closing everything at year end
It's tempting to think the whole ledger resets every year, the way a scoreboard resets after a game. It doesn't. Only temporary accounts close. Cash, Accounts Receivable, Accounts Payable, and every other balance sheet account keep whatever balance they ended the year with, and that balance becomes next year's starting point.
Three closing entries, straight to Retained Earnings¶
This course skips the Income Summary account some textbooks use as a holding pen. Instead, revenues, expenses, and Dividends close directly to Retained Earnings in three entries, always in this order.
Summit Drone Photography's adjusted year-end balances include Service Revenue of $69,400 and four expenses: Salaries Expense $43,500, Utilities Expense $5,500, Insurance Expense $2,400, and Rent Expense $8,000, totaling $59,400. Dividends for the year were $4,200, and Retained Earnings started the year at $8,500.
Entry 1: close the revenue account. Debit it for its full balance, credit Retained Earnings for the same amount.
| Account | Debit | Credit |
|---|---|---|
| Service Revenue | 69,400 | |
| Retained Earnings | 69,400 |
Entry 2: close the expense accounts. One compound entry debits Retained Earnings for the sum of every expense balance and credits each expense account for its own balance.
| Account | Debit | Credit |
|---|---|---|
| Retained Earnings | 59,400 | |
| Salaries Expense | 43,500 | |
| Utilities Expense | 5,500 | |
| Insurance Expense | 2,400 | |
| Rent Expense | 8,000 |
Entry 3: close Dividends. Debit Retained Earnings, credit Dividends, for the dividend balance.
| Account | Debit | Credit |
|---|---|---|
| Retained Earnings | 4,200 | |
| Dividends | 4,200 |
Notice what didn't happen: nothing on the income statement changed. Net income was $69,400 minus $59,400, or $10,000, the moment the adjusted trial balance was final. Closing entries don't recompute it; they just relocate it, along with the dividends paid out of it, into Retained Earnings.
Common mistake: closing entries change net income
Debiting Retained Earnings for $59,400 of expenses can look like the expenses are happening again. They aren't. Net income was already fixed by the income statement before any closing entry was posted. Closing entries move that already-determined result into Retained Earnings; they never add to or subtract from a revenue or expense total.
The roll-forward and the post-closing trial balance¶
Retained Earnings absorbed all three entries, so its balance moves from what the year started with to what it ends with in one predictable roll-forward: beginning balance, plus net income, minus dividends.
| Amount | |
|---|---|
| Retained Earnings, beginning of year | $8,500 |
| + Net income (revenue $69,400 minus expenses $59,400) | $10,000 |
| − Dividends | $4,200 |
| Retained Earnings, end of year | $14,300 |
Once every temporary account reads zero, only permanent accounts remain, and listing them is the post-closing trial balance: the same idea as the trial balances from Chapter 2 and 3, but taken after closing instead of before. It should still balance, since closing entries are just transfers between existing accounts. Summit Drone Photography's post-closing trial balance carries forward as next year's opening balances.
| Account | Debit | Credit |
|---|---|---|
| Cash | 22,000 | |
| Accounts Receivable | 12,700 | |
| Prepaid Insurance | 850 | |
| Accounts Payable | 2,700 | |
| Salaries Payable | 1,300 | |
| Utilities Payable | 450 | |
| Deferred Revenue | 2,800 | |
| Common Stock | 14,000 | |
| Retained Earnings | 14,300 | |
| Total | 35,550 | 35,550 |
No revenue, no expense, and no Dividends account shows up here, and there's no Income Summary line either, since this course never opens one. Every account on this list is one Summit will carry into next January as a beginning balance, ready for a fresh year of temporary accounts to build on top of it. That fresh start is also where the story of this chapter's statements ends: the next section pulls every piece together and warms you up for exam-style problems.
Pause and work¶
Watch Summit Drone Photography's three closing entries worked in full, including the post-closing trial balance. Then fill in which account belongs on each line of Cobalt Tutoring's closing entries. Finally, close out a full year for a company of your own, with new numbers every time.