Closing Entries: Reset the Scoreboard, Keep the Story
Closing entries can feel like a strange final step in the accounting cycle. Why do some accounts go back to zero while others keep their balances?
The key is to understand that some accounts measure this period's activity, while others describe the company's ongoing financial position.
The Big Idea
Think of the temporary accounts like a scoreboard for one game.
Revenues, expenses, and dividends track what happened during the current accounting period. When the period ends, that scoreboard has done its job.
Closing entries reset those temporary accounts to zero so the next period starts with a clean scoreboard.
Permanent accounts do not reset. They carry the company's financial story forward.
Meet Harbor Consulting
$80,000
$52,000
$6,000
$20,000
First, Find the Period's Result
Revenues and expenses tell us how the company performed during the period.
That $28,000 belongs in retained earnings because retained earnings accumulates profits kept in the business.
Then Account for Dividends
Dividends are not expenses.
They are distributions to owners, so they reduce retained earnings separately.
Now Ask: Which Accounts Reset?
Temporary Accounts
These measure activity for one accounting period.
- revenues
- expenses
- dividends
They close to zero.
Permanent Accounts
These describe the company's continuing financial position.
- assets
- liabilities
- common stock
- retained earnings
Their balances carry forward.
What Does "Closing" Actually Do?
Closing transfers the effects of revenues, expenses, and dividends into retained earnings.
Before Closing vs. After Closing
| Account | Before Closing | After Closing |
|---|---|---|
| revenue | $80,000 | $0 |
| expenses | $52,000 | $0 |
| dividends | $6,000 | $0 |
| retained earnings | $20,000 beginning | $42,000 ending |
| cash | whatever the ending balance is | same ending balance |
| accounts payable | whatever the ending balance is | same ending balance |
The Scoreboard Analogy
During the Game
Revenue, expenses, and dividends keep track of what happens during the period.
End of the Game
The period's results are transferred to retained earnings.
Next Game
Revenue, expenses, and dividends begin again at zero.
What Closing Entries Are NOT
Closing entries erase the company's financial history. Tap to check
Permanent accounts carry forward. Retained earnings keeps the cumulative effect of prior profits and dividends.
Cash is closed to zero at the end of the year. Tap to check
Cash is a permanent asset account. Its ending balance becomes the beginning balance for the next period.
Dividends are closed because they are expenses. Tap to check
Dividends are temporary accounts, but they are not expenses. They reduce retained earnings separately from net income.
Retained earnings should be zero after closing. Tap to check
Retained earnings is a permanent account. Its ending balance carries into the next period.
Can You Reset the Scoreboard?
At year-end, a company reports:
Before revealing the answer, determine:
Reveal the completed solution
Step 1: Net income
$95,000 - $68,000 = $27,000
Step 2: Ending retained earnings
$14,000 + $27,000 - $5,000 = $36,000
After closing:
Revenue = $0
Expenses = $0
Dividends = $0
Retained earnings carries forward at $36,000. Asset, liability, and other permanent account balances also carry forward.
If You Remember Only Four Things...
Revenues, expenses, and dividends are temporary accounts.
Temporary accounts reset to zero at the end of the period.
Assets, liabilities, common stock, and retained earnings carry forward.
Closing transfers the period's effects into retained earnings.