How closing entries work
Income and expense accounts go back to zero. The year’s profit lands in equity. Balance-sheet accounts stay.
Temporary accounts and permanent ones
Revenue, expense, and draws measure a period. Assets, liabilities, and the owner’s capital measure a moment. Closing moves the period accounts into equity so the next period starts at zero without erasing the cash and the loans. The profit and loss is the period. The balance sheet is the moment after the close. Software often posts the close when you lock the year. Knowing the entries matters when the software’s equity number does not match the profit you just read.
The close, in order
- Close revenue. Debit each revenue account for its credit balance. Credit income summary, or credit equity directly, for the total. Revenue is now zero.
- Close expenses. Credit each expense account for its debit balance. Debit income summary for the total. Expenses are now zero.
- Close the summary. If income summary has a credit balance, profit is left. Debit income summary and credit owner’s equity or retained earnings. A loss runs the other way.
- Close draws. A sole-prop draw is not an expense, so it was never on the profit and loss. Debit equity and credit the draws account to zero it. See owner’s draw versus salary. Wages already closed with the other expenses. Do not close them twice.
- Leave the balance sheet open. Cash, receivables, equipment, payables, and loans are not closed. Their balances roll forward. A trial balance after the close should show only those permanent accounts, and it should still balance. The trial balance page is that check.
A numeric sketch
Revenue $20,000. Expenses $14,000. Draws $3,000. Close revenue with a $20,000 debit. Close expenses with a $14,000 credit. Income summary holds $6,000 of profit; move it to equity. Then move $3,000 of draws against equity. Equity increased by $3,000 for the year, which is profit minus draws. Cash did not increase by $3,000. That reconciliation is the runway conversation, not the closing entry.
Month-end is not this close
The month-end checklist reconciles and reviews. It does not have to zero the income accounts if your software keeps year-to-date totals. The year-end checklist is the inventory, contractors, and estimates. Closing entries are the journal that follows, once those balances are the ones you are willing to roll forward. Closing a month you have not reconciled just freezes the error.