To close net income to retained earnings, the journal entry sequence is four steps: debit each revenue account and credit Income Summary; credit each expense account and debit Income Summary; debit Income Summary and credit Retained Earnings for the net income (reverse if it’s a loss); then debit Retained Earnings and credit Dividends. After the fourth entry posts, every temporary account reads zero and the period’s profit sits permanently in equity.
What You Need Before You Post
Start with the adjusted trial balance. That’s the list of every account and its balance after accruals, deferrals, and depreciation have been recorded. It gives you the final revenue and expense figures you’re about to zero out. Skip the adjustments and the closing entries will lock in wrong numbers that carry into the next period.
You also need the general journal, where the closing entries get written, and the general ledger, where they get posted. Each entry needs a date, the account names, and the debit and credit amounts. For publicly traded companies, Sarbanes-Oxley Section 404 requires management to assess internal controls over financial reporting each year, and that assessment covers the closing process.1SEC.gov. Study of the Sarbanes-Oxley Act of 2002 Section 404 Even at a private company, separating the person who prepares the entries from the person who approves them is a basic safeguard.
Entry 1: Close Revenue to Income Summary
Revenue accounts carry credit balances during the period. To zero them, debit each revenue account for its full balance and credit Income Summary for the total. If service revenue for the year is $50,000, the entry debits Service Revenue $50,000 and credits Income Summary $50,000. After posting, every revenue account reads zero and Income Summary holds a $50,000 credit.
Multiple revenue accounts (product sales, service fees, interest income) each get their own debit line, with one combined credit to Income Summary.
Entry 2: Close Expenses to Income Summary
Expenses run the other way. They carry debit balances, so you credit each expense account for its full balance and debit Income Summary for the total. Suppose rent expense is $12,000, salaries expense is $20,000, and utilities expense is $3,000. You credit each of those accounts to bring them to zero and record a single $35,000 debit to Income Summary.
Income Summary now holds both sides of the picture: the $50,000 revenue credit and the $35,000 expense debit. The net credit of $15,000 is net income for the period. If expenses had exceeded revenue, Income Summary would sit on a net debit balance instead, representing a net loss.
Entry 3: Close Income Summary to Retained Earnings
This is where the period’s result permanently lands on the balance sheet. When Income Summary has a credit balance (net income), you debit Income Summary to zero it and credit Retained Earnings for the same amount. In the running example, debit Income Summary $15,000 and credit Retained Earnings $15,000. Equity grows by the amount of the period’s profit.
For a net loss, Income Summary carries a debit balance. You credit Income Summary to close it and debit Retained Earnings, shrinking equity. When Retained Earnings accumulates enough losses to turn negative, accountants call the balance a deficit, and it stays on the balance sheet until future profits erase it.
Entry 4: Close Dividends to Retained Earnings
This is the step people forget. Dividends are a temporary account, but they don’t move through Income Summary because they aren’t revenue or expense. Dividends reduce equity without being a cost of doing business, so they close directly to Retained Earnings.
The entry debits Retained Earnings and credits Dividends for the full balance. If $5,000 in dividends was declared during the period, debit Retained Earnings $5,000 and credit Dividends $5,000. After posting, Dividends reads zero and Retained Earnings reflects both the period’s profit and any distributions to shareholders.
Full Worked Example
Cedar Lane Corp. ends its fiscal year with Service Revenue of $50,000, Rent Expense of $12,000, Salaries Expense of $20,000, Utilities Expense of $3,000, and Dividends of $5,000. Beginning Retained Earnings is $40,000. The four entries look like this:
- Entry 1. Debit Service Revenue $50,000; credit Income Summary $50,000.
- Entry 2. Debit Income Summary $35,000; credit Rent Expense $12,000, Salaries Expense $20,000, and Utilities Expense $3,000.
- Entry 3. Debit Income Summary $15,000; credit Retained Earnings $15,000. The $15,000 is the net credit remaining in Income Summary after entries 1 and 2.
- Entry 4. Debit Retained Earnings $5,000; credit Dividends $5,000.
After all four entries post, every temporary account reads zero. Retained Earnings shows $50,000: the $40,000 opening balance, plus $15,000 net income, minus $5,000 in dividends. The books are ready for the new period.
Verifying With the Post-Closing Trial Balance
Run a post-closing trial balance after the four entries post. This report should contain only permanent accounts: assets, liabilities, and equity. If any revenue, expense, dividend, or Income Summary account still shows a balance, one of the entries didn’t close properly and you need to trace it back.
The post-closing trial balance also confirms total debits still equal total credits. A mismatch almost always means an entry was recorded with unequal debits and credits, or a posting was missed. Catch it now rather than months later.
Sole Proprietorships and Partnerships
The mechanics above assume a corporation. For a sole proprietorship, the entries are the same but the destination changes: Income Summary closes to Owner’s Capital instead of Retained Earnings, and withdrawals close directly to Owner’s Capital the way dividends close to Retained Earnings.
Partnerships follow the same pattern, then split net income among the partners based on the profit-sharing agreement. Each partner’s capital account picks up its share of income or loss, and each partner’s drawings account closes directly to that partner’s capital.
What Accounting Software Does Differently
Most modern accounting platforms automate the year-end close. The software zeroes revenue and expense accounts and transfers the net balance to Retained Earnings (or Owner’s Equity) in the background. Many cloud systems skip Income Summary entirely and post straight to Retained Earnings, since Income Summary is a manual bookkeeping convenience the software doesn’t need.
Automation removes transposition errors but introduces a different one: trusting the output without checking it. Before accepting the automated close, compare the ending Retained Earnings on your post-closing trial balance to what you’d expect from the income statement and dividend records. If an account was miscategorized as permanent when it should be temporary, it won’t close automatically, and that error can carry forward for years.
Why the Ending Balance Has to Be Right
C-corporations reconcile beginning and ending retained earnings on Schedule M-2 of Form 1120: opening balance, plus net income (or minus net loss), minus distributions, equals ending balance.2Internal Revenue Service. Form 1120 U.S. Corporation Income Tax Return The numbers your closing entries produce feed that schedule directly, and Schedule M-2 has to tie to Schedule L (the balance sheet). Corporations that stockpile earnings beyond the reasonable needs of the business can also face the accumulated earnings tax, a 20 percent charge on top of the regular corporate income tax, and the IRS looks at retained earnings to decide whether that applies.3Office of the Law Revision Counsel. 26 U.S. Code 531 – Imposition of Accumulated Earnings Tax
State corporate laws also restrict dividend payments to protect creditors, and many states tie the legality of a distribution to retained earnings or a solvency test. A misstated Retained Earnings balance can push a company into declaring a dividend it can’t legally pay, which can expose directors to personal liability for the amount. Clean closing entries are what keep that from happening.