To update the balance in the owner's capital account, accountants close revenue,
expense, and drawing accounts at the end of each fiscal year or, occasionally, at the
end of each accounting period. For this reason, these types of accounts are
calledtemporary or nominal accounts. Assets, liabilities, and the owner's capital
account, in contrast, are called permanent or real accounts because their ending
balance in one accounting period is always the starting balance in the subsequent
accounting period. When an accountant closes an account, the account balance returns
to zero. Starting with zero balances in the temporary accounts each year makes it
easier to track revenues, expenses, and withdrawals and to compare them from one
year to the next. There are four closing entries, which transfer all temporary account
balances to the owner's capital account.
1. Close the income statement accounts with credit balances (normally revenue
accounts) to a special temporary account named income summary.
2. Close the income statement accounts with debit balances (normally expense
accounts) to the income summary account. After all revenue and expense
accounts are closed, the income summary account's balance equals the
company's net income or loss for the period.
3. Close income summary to the owner's capital account or, in corporations, to the
retained earnings account. The purpose of the income summary account is simply
to keep the permanent owner's capital or retained earnings account uncluttered.
4. Close the owner's drawing account to the owner's capital account. In corporations,
this entry closes any dividend accounts to the reta