Closing Entries

Closing Entries: The Final Step in the Accounting Cycle

The trading and profit and loss account is not prepared directly from the trial balance. Before it can be compiled, every account whose balance belongs in that statement must be closed — that is, its balance must be transferred out of the nominal account and into the trading or profit and loss account. These transfer entries are called closing entries.

The logic is simple: nominal accounts (expenses, losses, incomes, gains) are temporary. They exist only to accumulate transactions for one accounting period. At the end of the period, their balances are moved to the trading and profit and loss account, which then shows the net result. After the closing entry, each nominal account has a zero balance and is ready to start fresh for the next year.

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Closing Direct Expenses and Purchases

All accounts that appear on the debit side of the trading account — opening stock, purchases, wages, carriage inwards, and any other direct expense — are closed by transferring their balances to the debit of the trading account. The journal entry is:

Why debit Trading? Because the trading account is the destination — it receives the expenses that belong to it. Each expense account is credited to cancel its balance.

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Closing Purchases Returns (Return Outwards)

The purchases returns account (also called return outwards) has a credit balance — it reduces the cost of purchases. It is not transferred directly to the trading account. Instead, it is first closed by transferring its balance to the purchases account. The entry:

This nets off the returns against purchases. Only the net purchases figure (Purchases − Purchases Returns) will ultimately go to the trading account.

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Closing Sales Returns (Return Inwards)

Sales returns (return inwards) has a debit balance — it reduces the revenue from sales. It is closed by transferring its balance to the sales account:

Again, the net sales figure (Sales − Sales Returns) is what gets transferred to the trading account.

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Closing Sales (Revenue from the Trading Account)

The sales account (after adjusting for returns) has a credit balance. It is closed by transferring it to the credit of the trading account:

Sales is debited to close it; Trading is credited because it receives the revenue.

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Closing Expenses and Losses (Profit and Loss Account Items)

All indirect expenses and losses — salaries, rent, bad debts, repairs, insurance, etc. — are closed by transferring their balances to the debit of the profit and loss account:

Each expense account is credited to close it; Profit and Loss is debited because it accumulates all expenses.

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Closing Incomes and Gains (Profit and Loss Account Items)

All indirect incomes and gains — commission received, interest received, discount received, rent received, etc. — are closed by transferring their balances to the credit of the profit and loss account:

Each income account is debited to close it; Profit and Loss is credited because it receives the revenue.

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Worked Example (from the textbook)

Using the figures from Example 1 of the chapter, the closing entries are:

(i) Closing expenses of the trading account:

(ii) Closing expenses of the profit and loss account:

(iii) Closing revenue of the trading account:

(iv) Closing revenue of the profit and loss account:

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How the Ledger Accounts Look After Posting

After these entries are posted, each nominal account shows a zero balance. The ledger accounts from the example appear as follows:

Purchases Account

Wages Account

Salaries Account

Rent of Building Account

Bad Debts Account

Sales Account

Commission Received Account