Purpose of Closing Entries

Closing entries serve two key purposes:

• Zeroing out temporary accounts: Temporary accounts like revenue, expense, and dividends accumulate data for a single accounting period. Closing entries reset these accounts to zero, so they can be used to record data for the next period.

• Updating Retained Earnings: The net balances from the temporary accounts, which reflect the net income or loss, are transferred to the Retained Earnings account, ensuring it reflects the company's cumulative earnings​​.

How to Prepare Closing Entries

There are typically four closing entries:

1. Close revenue accounts to the Income Summary account.

2. Close expense accounts to the Income Summary account.

3. Transfer the balance of the Income Summary (representing net income or loss) to the Retained Earnings account.

4. Close the Dividends account to the Retained Earnings account​.

This process ensures the financial records are ready for the next accounting cycle.