ACCT1001 · Financial Accounting 1
Closing the Books
Closing the books is the reset that runs at the end of every reporting period — cycle stations 8 and 9. The point is to zero out the temporary accounts (revenue, expenses and drawings, which measure one period's activity) and carry forward the permanent accounts (assets, liabilities and capital, which carry from period to period) so the books are ready for the next loop. The mechanism is a four-step routine run through a clearing account called Income Summary: close revenue to Income Summary, close expenses to Income Summary, close the resulting profit (or loss) in Income Summary to Capital, and close drawings to Capital. The chapter also covers the optional convenience of reversing entries (which adjustments to reverse next period and which to leave alone) and ends with the post-closing trial balance, which should contain only permanent accounts — the proof that the books are correctly reset.
What this chapter covers
- 013.1 Temporary vs permanent accounts
- 023.2 The four-step closing process via Income Summary
- 03Revenue → Expenses → Income Summary → Drawings
- 043.3 The closing routine on a worked adjusted trial balance
- 053.4 Reversing entries — an optional convenience
- 063.5 The post-closing trial balance
Worked example: the four-step close
- +1Step 1 — close revenue: Dr Service Revenue $40,000 / Cr Income Summary $40,000.
- +1Step 2 — close expenses: Dr Income Summary $28,000 / Cr (each expense, total) $28,000. Income Summary now holds a $12,000 credit balance = profit.
- +1Step 3 — close profit to Capital: Dr Income Summary $12,000 / Cr Capital $12,000.
- +1Step 4 — close drawings: Dr Capital $6,000 / Cr Drawings $6,000.
- +1Net effect on Capital: +$12,000 profit − $6,000 drawings = +$6,000; revenue, expense and drawings accounts are now zero, ready for the next period.
Key terms
- Temporary account
- An account that measures one period's activity and is reset to zero at period end — revenue, expenses and drawings. Closing them transfers their balances to Capital so the next period starts fresh; they are also called nominal accounts.
- Permanent account
- An account whose balance carries forward from period to period — assets, liabilities and capital. They are never closed; their ending balances become the next period's opening balances and are the only accounts left on the post-closing trial balance.
- Income Summary
- A temporary clearing account used only during closing. Revenue is closed into it and expenses out of it, so its balance equals the period's profit or loss; that balance is then closed to Capital. It exists purely to funnel the period result into equity in one place.
- Post-closing trial balance
- A trial balance taken after the closing entries are posted. It should list only permanent accounts (assets, liabilities, capital) with equal debit and credit totals — the confirmation that the temporary accounts are zeroed and the books are ready for the next period.
- Reversing entry
- An optional entry made on the first day of the new period that reverses certain balance-day accruals, so routine cash entries next period can be recorded normally without double-counting. They are a convenience, not a requirement, and only some adjustments should be reversed.
Closing the Books FAQ
Why do we close the books at all?
To separate one period's performance from the next. Revenue, expenses and drawings measure activity for a single period; if they were not reset, next period's income statement would include this period's figures. Closing zeroes those temporary accounts and rolls their net effect into Capital, so the new period starts with a clean slate while assets, liabilities and capital carry forward unchanged.
What is the Income Summary account for?
It is a temporary holding account used only during closing. Revenue is closed into it and expenses are closed out of it, so its balance ends up equal to the period's profit or loss. That single figure is then closed to Capital in one entry. Using Income Summary keeps the profit calculation visible in one place rather than closing each revenue and expense account directly to Capital.
Which accounts appear on the post-closing trial balance?
Only permanent accounts — assets, liabilities and capital. If any revenue, expense, drawings or Income Summary balance still appears, the closing process was not completed. The post-closing trial balance is the proof that every temporary account has been zeroed and the books are correctly reset for the next period.
Do I have to do reversing entries?
No — reversing entries are an optional convenience, not a required step. They reverse certain accruals on the first day of the next period so that routine cash receipts and payments can then be recorded normally without double-counting. Only some adjustments (typically accruals) are suitable for reversing; prepayments and depreciation usually are not. Know which to reverse and which to leave alone.
Exam move
Drill the four-step close until it is muscle memory: revenue to Income Summary, expenses to Income Summary, profit (or loss) in Income Summary to Capital, drawings to Capital. The most common slip is the direction on step three after a loss, so practise both a profit and a loss case. Keep clear in your head which accounts are temporary (revenue, expenses, drawings — closed) and which are permanent (assets, liabilities, capital — carried), because the post-closing trial balance question is really just a test of that distinction. Treat reversing entries as a lighter topic: understand why they exist and which accruals they apply to, but do not over-invest relative to the closing routine itself.
