Closing entries and the income summary account
At the end of every period, revenue, expense and drawing accounts are brought back to zero so the next period starts fresh. Four entries do it. Learn which accounts close, where they go, and the one account students forget.
01Which accounts close, and which don't
| Nominal (temporary) accounts | Real (permanent) accounts | |
|---|---|---|
| Examples | Revenues, expenses, the owner's Drawing account | Assets, liabilities, the owner's Capital account |
| At period end | Closed to zero | Carried forward to the next period |
| Why | They measure one period's activity | They show what the business owns and owes at a point in time |
Income Summary is a temporary clearing account used only during closing. It collects all revenues and expenses, so its balance equals the period's net income or net loss. Then it is closed too.
02The four closing entries
- Close revenues: debit each revenue account, credit Income Summary.
- Close expenses: debit Income Summary, credit each expense account.
- Close Income Summary to Capital: for a net income, debit Income Summary and credit Capital.
- Close Drawing directly to Capital: debit Capital, credit Drawing.
Why Drawing skips Income Summary: withdrawals are not an expense. They don't help determine profit; they are a distribution of it. Closing Drawing through Income Summary would understate the period's performance.
03Worked example: a laundry business closes its year
An original illustration. Mara Reyes owns Luntian Laundry Services. After adjusting entries, the December 31 ledger shows:
| Mara Reyes, Capital (beginning of the year) | 350,000 |
| Mara Reyes, Drawing | 60,000 |
| Service Revenue | 480,000 |
| Salaries Expense | 180,000 |
| Rent Expense | 72,000 |
| Utilities Expense | 36,000 |
| Depreciation Expense | 18,000 |
| Supplies Expense | 14,000 |
Total expenses: ₱180,000 + ₱72,000 + ₱36,000 + ₱18,000 + ₱14,000 = ₱320,000. Net income: ₱480,000 − ₱320,000 = ₱160,000.
1 · Close revenues
2 · Close expenses
3 · Close Income Summary to Capital
4 · Close Drawing to Capital
The result
| Mara Reyes, Capital, beginning | 350,000 |
| Add: Net income | 160,000 |
| Less: Drawing | (60,000) |
| Mara Reyes, Capital, ending | 450,000 |
Every revenue, expense, Drawing and Income Summary account is now zero. The ending capital of ₱450,000 matches the statement of changes in owner's equity, which is a good way to check your closing work.
The post-closing trial balance
After closing, a post-closing trial balance lists only the real accounts: assets, liabilities and the owner's ending Capital. If a revenue, expense, Drawing or Income Summary account still shows a balance, a closing entry was missed.
04What changes with a net loss
If expenses are larger than revenues, Income Summary ends step 2 with a debit balance. Step 3 is reversed:
Steps 1, 2 and 4 are the same. A net loss and the owner's drawings both reduce capital.
Common mistakes: closing Drawing through Income Summary; forgetting Drawing entirely; closing Accumulated Depreciation or Unearned Revenue (they are real accounts and stay open); and reversing the direction of step 3 for a net income.
05Self-check (with answers)
1. Revenues total ₱300,000 and expenses total ₱340,000. What is the third closing entry?
Net loss of ₱40,000: Dr Owner, Capital 40,000 · Cr Income Summary 40,000.
2. Beginning capital ₱200,000, net income ₱90,000, drawings ₱35,000. What is ending capital?
₱200,000 + ₱90,000 − ₱35,000 = ₱255,000.
3. Which of these appear on the post-closing trial balance: Cash, Accumulated Depreciation, Owner's Drawing, Unearned Revenue, Income Summary?
Cash, Accumulated Depreciation and Unearned Revenue: they are real accounts. Drawing and Income Summary are temporary and have been closed to zero.
See the whole cycle run
Chapter 5 of the book walks through the accounting cycle for a service business. The companion portal adds a full-cycle workbench that builds the ten-column worksheet as you post, plus board-exam-style CPALE questions with rationales. Start with the free sample questions from every chapter, no sign-up needed.