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Lesson 5 of 6The Accounting Cycle
Unit 1 · Lesson 5 of 6

Closing and Reversing Entries

Closing entries reset revenue, expense and drawings accounts to zero and transfer the period's net income and drawings into Capital; optional reversing entries on the first day of the new period undo accrual adjustments so routine transactions can be recorded normally.

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Key things to remember

  1. 1Temporary accounts (revenue, contra-revenue, expenses including COGS, drawings) are closed; permanent accounts (assets, liabilities, capital) carry forward.
  2. 2Closing order: revenue to Income Summary; expenses to Income Summary; Income Summary (net income) to Capital; Drawings to Capital.
  3. 3Ending capital = beginning capital + net income - drawings.
  4. 4The post-closing trial balance lists only permanent accounts.
  5. 5Reversing entries are optional, dated the first day of the new period, and used mainly for accruals (and for prepayments first recorded in an expense or revenue account); final balances are the same either way.

A hockey scoreboard resets at the start of every game, but the standings carry forward all season. Accounting works the same way. Revenue, expenses and drawings measure one fiscal period only, so they must start the next period at zero; their net effect is carried forward into the owner's Capital account, which, like the standings, keeps its running total. Closing entries do the reset. Reversing entries are an optional extra step that makes January's routine bookkeeping simpler after December's accruals.

Temporary and permanent accounts

ATemporary (closed each period)
  • All revenue accounts
  • Contra-revenue accounts (Sales Returns and Allowances, Sales Discounts)
  • All expense accounts, including Cost of Goods Sold
  • Owner's Drawings
  • Income Summary (used only during closing)
BPermanent (balances carry forward)
  • Assets, including Merchandise Inventory
  • Contra-assets such as Accumulated Amortization
  • Liabilities, including Unearned Revenue and Wages Payable
  • Owner's Capital

Closing through Income Summary

Revenue (temp)Expenses (temp)Drawings (temp)Income SummaryCapital (permanent)Permanent accountsAssetsLiabilitiesCapitalbalances carry forwardinto the next period —never closed out
Fig 1Revenues and expenses flow into Income Summary; net income and drawings flow into Capital.

Lakeshore Design Studio's adjusted trial balance at December 31, 2026 shows Service Revenue $96,000 and expenses: Wages $41,000, Rent $18,000, Amortization $6,000, Supplies $1,070, Insurance $900 and Interest $480, a total of $67,450. A. Okafor, Drawings is $20,000 and A. Okafor, Capital is $50,000. Net income is

DateAccountDebitCredit
Dec 31Service Revenue96,000
Income Summary96,000
1. Close revenue.
Dec 31Income Summary67,450
Wages Expense41,000
Rent Expense18,000
Amortization Expense6,000
Supplies Expense1,070
Insurance Expense900
Interest Expense480
2. Close expenses.
Dec 31Income Summary28,550
A. Okafor, Capital28,550
3. Close net income to Capital.
Dec 31A. Okafor, Capital20,000
A. Okafor, Drawings20,000
4. Close drawings.
After entry 3 Income Summary is zero. Ending capital: $50,000 + $28,550 - $20,000 = $58,550.
  • If the business had a net loss, entry 3 is reversed: debit Capital, credit Income Summary.
  • Drawings bypasses Income Summary because drawings are not an expense; they never affect net income.
  • Merchandisers close Sales Returns and Allowances, Sales Discounts and Cost of Goods Sold with the expenses (they have debit balances). Under a periodic system the closing process also replaces beginning inventory with the counted ending inventory.
  • Closing directly: some businesses, and most accounting software, skip Income Summary and close revenue and expense accounts straight into Capital (or Retained Earnings for a corporation). Software usually does this automatically when the year is closed, after the accountant has finished the adjustments.

The post-closing trial balance

After closing, only permanent accounts have balances. The post-closing trial balance proves that the ledger still balances and that every temporary account is zero before the new year begins. Notice that Capital now shows the ending balance from the statement of owner's equity.

Lakeshore Design Studio, Post-Closing Trial Balance, December 31, 2026DebitCredit
Cash44,500
Accounts Receivable9,800
Supplies380
Prepaid Insurance2,700
Equipment42,000
Accumulated Amortization, Equipment6,000
Accounts Payable4,100
Wages Payable2,250
Interest Payable480
Unearned Revenue4,000
Bank Loan24,000
A. Okafor, Capital58,550
Totals99,38099,380
Only balance sheet accounts remain; debits equal credits.
VideoWalks through closing revenues, expenses and drawings through Income Summary, then shows that only permanent accounts remain on the post-closing trial balance.Watch on YouTube

Reversing entries: why and when

A reversing entry is made on the first day of the new period and is the exact opposite of a year-end adjusting entry. It is optional: the final balances are the same with or without it. Its purpose is convenience and fewer errors. Without it, whoever records the January 8 payroll must remember that part of that cheque was already expensed in December and split the entry. With it, the payroll is recorded the routine way (and in software, exactly the way the payroll module always records it), and the accounts sort themselves out.

  • Reverse accruals: accrued expenses (wages, interest) and accrued revenue, because a later cash transaction will settle them.
  • Do not reverse amortization or the allowance for doubtful accounts: no later cash transaction settles them.
  • Do not reverse deferrals that were first recorded in balance sheet accounts (prepaids recorded as assets, advances recorded as Unearned Revenue). If a business records prepayments directly to an expense account instead, its adjustment can be reversed.
  • Many accounting programs let you mark an adjusting entry as auto-reversing, and they post the reversal on the first day of the next period.
Example: weekly wages of $5 000 ($1 000 a day) are paid on January 4. Three of the week'sfive days were worked in December, two in January.Dec 31AdjustWages Expense3 000Wages Payable3 000Records the 3 days alreadyworked in December (3 ×$1 000).Dec 31CloseWages Expense (with the 3 000)closes to Income Summary.Wages Expense starts the newyear at 0; Wages Payable 3 000carries into January.Jan 1ReverseWages Payable3 000Wages Expense3 000The exact opposite of theadjusting entry. Wages Expensenow shows a 3 000 credit.Jan 4PaydayWages Expense5 000Cash5 000The routine payday entry forthe full week: no need to lookback at the accrual.DrCryear end → new fiscal yearWages PayableDrCrJan 13 000Dec 313 000Balance: 0Wages Expense (Jan)DrCrJan 45 000Jan 13 000Balance: 2 000 Dr= the 2 January daysWhy reverse?Without it, payday must besplit: Dr Wages Payable3 000, Dr Wages Expense2 000, Cr Cash 5 000.Reversing lets everypayday be recorded thesame way.
Fig 2The December 31 accrual, its January 1 reversal, and the routine January 8 payday entry.

Lakeshore accrued $2,250 of wages on December 31 (3 days at $750). On January 8, 2027 it pays $6,000 for 8 working days, which includes those 3 December days. For clarity, payroll deductions are ignored here; only gross pay is shown. Wages Expense was closed to zero on December 31.

DateAccountDebitCredit
Without reversing
Jan 8Wages Payable2,250
Wages Expense3,750
Cash6,000
Payroll split between the December liability and January expense.
With reversing
Jan 1Wages Payable2,250
Wages Expense2,250
Reverse the December 31 accrual.
Jan 8Wages Expense6,000
Cash6,000
Routine payroll entry, full amount.
Both methods end with Wages Payable at zero and January Wages Expense of $3,750.
Prove it with the T-account
With reversing, Wages Expense starts January with a 2,250 credit balance (an unusual side, on purpose). The 6,000 payday debit leaves 6,000 - 2,250 = 3,750 debit: exactly the 5 January days at 750 each. Without reversing, the clerk debits 3,750 directly. Same answer, but only one method needed someone to remember the accrual.
Quick checkTry it before you read on
1
Which of these year-end adjusting entries is a good candidate for a reversing entry?
VideoFollows an accrual from the adjusting entry through closing to the reversing entry, then shows how the reversal keeps the next payment entry simple.Watch on YouTube

Worked examples

Reveal one step at a time and try to beat it to the next line.

Example 1
A merchandiser's adjusted balances are: Sales $150,000; Sales Returns and Allowances $3,000; Sales Discounts $1,500; Cost of Goods Sold $90,000; Wages Expense $30,000; Rent Expense $12,000; Delivery Expense $2,500; Drawings $8,000. Prepare the closing entries.
Example 2
Lakeshore accrued $480 of interest on December 31, 2026 on its $24,000, 6% loan (Sept 1 to Dec 31). The full year's interest of $1,440 is paid on August 31, 2027. Show the 2027 entries with a reversing entry, and prove the 2027 expense is correct.
Example 3
Lakeshore's December 31 adjustments were: insurance expired $900; supplies used $1,070; unearned revenue earned $2,000; accrued revenue $1,800; accrued wages $2,250; accrued interest $480; amortization $6,000. Which should be reversed on January 1, and what are the reversing entries?

Where marks get lost

  • Closing Drawings into Income Summary, which wrongly reduces net income. Drawings goes straight to Capital.
  • Closing a permanent account such as Unearned Revenue or Accumulated Amortization.
  • Forgetting that Cost of Goods Sold and the contra-revenue accounts are temporary and must be closed.
  • Reversing amortization or a prepaid adjustment, which reinstates an expense or asset that no later transaction will correct.
  • Dating a reversing entry December 31 instead of the first day of the new period, which cancels the adjustment before the statements are prepared.

Flashcards 7

Temporary accounts
Permanent accounts
Income Summary
Closing entry order
+ 3 more

Practice

1
Which account is closed at the end of the period?
2
After revenue of $72,000 and expenses of $51,500 are closed, Income Summary is closed to Capital. What amount is debited to Income Summary? Answer to the nearest dollar.
$
3
Beginning capital $40,000, net income $20,500, drawings $15,000. What is the Capital balance on the post-closing trial balance? Answer to the nearest dollar.
$
4
Reversing entries are appropriate for:
5
Accrued wages of $1,500 are reversed on January 1. Immediately afterward, Wages Expense has:
6
Accrued wages of $2,000 were reversed on January 1. On payday, January 6, the full $5,000 payroll is debited to Wages Expense. What is the January Wages Expense balance? Answer to the nearest dollar.
$
7
Put these closing entries in the usual order.
  1. 1Close expense accounts to Income Summary
  2. 2Close Drawings to Capital
  3. 3Close Income Summary to Capital
  4. 4Close revenue accounts to Income Summary
8
The post-closing trial balance contains:
9
Match each entry to when it is recorded.
Adjusting entry
Closing entry
Reversing entry
Routine payroll entry
10
Name the temporary account used during closing to collect all revenue and expense balances.

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