At the end of every accounting period, certain accounts have to be reset to zero so the next period starts fresh. That reset is the closing process, and it is done with four ordered journal entries that funnel everything through an account called Income Summary before landing in Retained Earnings. The mechanics look strange the first time — you are debiting revenue, which feels wrong — but the logic falls out cleanly once you separate temporary accounts from permanent ones.
Temporary vs. Permanent Accounts
The whole closing process is built on one distinction.
Permanent accounts are the balance sheet accounts — assets, liabilities, and equity. They carry their balances forward year after year. Cash at year-end is the cash you start with on January 1; Retained Earnings has been accumulating profits for the life of the company. These do not get closed.
Temporary accounts measure activity for one period only — the income statement accounts (revenues and expenses) plus Dividends. After their period-end totals have been used to compute net income and update Retained Earnings, they reset to zero for next period.
Income Summary is a special temporary account that exists only during the closing process. It collects all revenue and expense balances, computes net income inside itself, and then closes itself to Retained Earnings. It is always at zero once closing is complete.
The Goal of Closing
Two things have to happen by the end of the closing process:
- Every temporary account is at zero (ready for next period).
- Net income (and any dividends) has been moved into Retained Earnings (so the balance sheet reflects the new equity).
Four journal entries get you there, in order. The order matters — entry 3 needs the result of entries 1 and 2.
The Four Closing Entries
A company called Westwind has the following year-end balances after adjusting entries:
- Service Revenue: $80,000 credit
- Wage Expense: $40,000 debit
- Rent Expense: $12,000 debit
- Utilities Expense: $3,000 debit
- Dividends: $5,000 debit
- Retained Earnings (beginning balance): $25,000 credit
Net income should come out to revenue minus expense: $80,000 − $55,000 = $25,000. After closing, Retained Earnings should equal $25,000 (beginning) + $25,000 (net income) − $5,000 (dividends) = $45,000. The four entries below should produce exactly that result.
Entry 1: Close revenue accounts to Income Summary
Revenue accounts normally have credit balances. To bring them to zero, debit them by their balance. Credit the offsetting amount to Income Summary.
Service Revenue 80,000
Income Summary 80,000
(Close revenues to Income Summary)After this entry, Service Revenue is at zero. Income Summary has an $80,000 credit balance — that is the revenue total, sitting and waiting to absorb expense.
Entry 2: Close expense accounts to Income Summary
Expense accounts normally have debit balances. To bring them to zero, credit them by their balance. Debit the total to Income Summary.
Income Summary 55,000
Wage Expense 40,000
Rent Expense 12,000
Utilities Expense 3,000
(Close expenses to Income Summary)All three expense accounts are now at zero. Income Summary now has: $80,000 credit from entry 1 minus $55,000 debit from entry 2 = a $25,000 credit balance. That balance is net income. (If expenses had exceeded revenues, Income Summary would have a debit balance instead, representing a net loss.)
This is the key piece of the closing process: Income Summary's balance after entries 1 and 2 is the period's net income. The closing process effectively re-computes net income through the journal, ready to push it into Retained Earnings.
Entry 3: Close Income Summary to Retained Earnings
Move the net income balance out of Income Summary and into Retained Earnings.
Income Summary has a $25,000 credit balance (net income). Debit it to zero. Credit Retained Earnings for the same amount.
Income Summary 25,000
Retained Earnings 25,000
(Close Income Summary to Retained Earnings — net income)Income Summary is now at zero (it should always be after closing). Retained Earnings now has $25,000 + the beginning balance of $25,000 = $50,000, reflecting the year's earned profit.
If there had been a net loss, the debit and credit in this entry would flip: debit Retained Earnings and credit Income Summary to zero out the debit balance.
Entry 4: Close Dividends to Retained Earnings
Dividends are a distribution, not an expense — so they do not flow through Income Summary. They are closed directly to Retained Earnings.
Dividends has a $5,000 debit balance. Credit it to zero. Debit Retained Earnings to reduce it by the distribution.
Retained Earnings 5,000
Dividends 5,000
(Close Dividends to Retained Earnings)Dividends is now at zero. Retained Earnings drops from $50,000 to $45,000 — the figure the year-end balance sheet will report. The math ties: $25,000 beginning + $25,000 net income − $5,000 dividends = $45,000.
What the Trial Balance Looks Like Afterward
After all four entries, the post-closing trial balance contains only permanent accounts. Every revenue, expense, Income Summary, and Dividends account sits at zero; the balance sheet accounts carry their balances forward. A useful sanity check: if any income-statement account or Dividends still shows a balance, the closing process is incomplete — and if Income Summary is not at zero after entry 3, there is a math error in entry 1 or 2.
Why This Process Exists
You could ask why companies do not just update Retained Earnings directly with one entry. Two reasons. First, computing net income inside Income Summary creates a clear journal-entry trail — anyone auditing the books can see the revenue total, the expense total, net income, and the transfer to Retained Earnings as separate, dated entries. Second, the closing process is a check on the books: if balances do not reconcile into a sensible net income figure, the discrepancy shows up in Income Summary and has to be investigated before the year can be closed.
Getting Help
Closing entries are the period-end bookend to the journal entries you write all year. For the foundation those entries are built on, see recording journal entries, and for the timing rules that drive the adjusting entries you make right before closing, see accrual vs. cash basis accounting.
Conclusion
Closing entries are four ordered journal entries that reset temporary accounts to zero and update Retained Earnings for the period's net income and dividends. Close revenues to Income Summary, close expenses to Income Summary, close the resulting net income from Income Summary to Retained Earnings, and finally close Dividends directly to Retained Earnings. Each entry has a clear purpose, and the order is what makes the result land in the right place.
