What Accounts Get Closed at Year-End: Temporary vs. Permanent

At year end, the accounts that get closed are the temporary ones: revenue, expense, gain, loss, and owner distribution accounts (dividends or drawings). Their balances reset to zero so the new period starts clean, and the net result flows into a permanent equity account such as retained earnings or owner’s capital. Permanent accounts — assets, liabilities, and equity — stay open and carry their balances forward.

Temporary Accounts and Permanent Accounts

Every account in the general ledger belongs to one of two groups. Temporary accounts measure activity over a specific period and answer the question “how did we do this year?” Permanent accounts measure position at a point in time and answer “what do we own, owe, and have left over right now?”

Because temporary accounts track a single period’s performance, their balances lose meaning once that period closes. Leaving last year’s revenue sitting in the revenue account would make the new year’s sales figures unreadable. The closing process sweeps those balances into equity, turning period-specific data into a cumulative ownership record. This is the accounting principle of periodicity in action: financial results reported in distinct, comparable time intervals.

Revenue Accounts

Revenue accounts capture every dollar the business earns during the period. Product sales, service fees, interest on bank accounts, rental income, royalties, and other operating inflows all land here. Under accrual accounting, revenue is recorded when earned, not when cash arrives. That distinction matters at year end. Cash collected for work you haven’t performed sits as a liability (often called deferred or unearned revenue) until you deliver, at which point it moves into a revenue account.

Once the year closes, the total in each revenue account transfers to the income summary and then into retained earnings or owner’s capital. The revenue account itself drops to zero, which is what lets the new year’s books show sales figures that reflect only the new period.

Expense Accounts

Expense accounts work the same way in reverse. They track every cost incurred during the year: payroll, rent, utilities, insurance, cost of goods sold, marketing, office supplies. Non-cash charges count too. Depreciation calculated under the Modified Accelerated Cost Recovery System spreads an asset’s cost across multiple years, and each year’s share lands in a depreciation expense account.1Internal Revenue Service. Instructions for Form 4562

The IRS allows businesses to deduct ordinary and necessary expenses incurred during the taxable year.2Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses Accurate expense tracking is what makes those deductions defensible if the return is examined.3Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments

At year end, expense account balances move into the income summary, where they offset revenue to produce net income or net loss. The expense accounts then reset to zero.

Gain and Loss Accounts

Revenue and expenses get the attention, but gain and loss accounts close too. These track one-time events outside normal operations. Selling equipment for more than book value creates a gain; disposing of an asset below book value creates a loss. Foreign currency exchange fluctuations and lawsuit settlements can also land here.

Gains and losses appear on the income statement and affect net income for the period, so they close alongside revenue and expenses. Leaving a one-time gain from selling a building in the account would distort the next year’s picture entirely.

Dividends and Owner Drawings

The last group of temporary accounts tracks money pulled out of the business by its owners. The name depends on the business structure.

  • Dividend accounts (corporations). When a C corporation distributes profits to shareholders, those payments are tracked in a dividends account and reported to both the shareholder and the IRS on Form 1099-DIV for distributions of $10 or more.4Internal Revenue Service. About Form 1099-DIV, Dividends and Distributions
  • Drawing accounts (sole proprietorships and partnerships). Owners who withdraw cash for personal use record those amounts in a drawing account. Drawings aren’t wages and don’t appear on the income statement; they’re a direct reduction of equity.
  • S corporation distributions. S corps pass income through to shareholders via Schedule K-1 rather than paying dividends in the traditional sense. The corporation reports its overall results on Form 1120-S, and each shareholder receives their proportional share.5Internal Revenue Service. About Form 1120-S, U.S. Income Tax Return for an S Corporation

Dividends and drawings don’t factor into net income; they happen after profit is calculated. But they still close because they reflect equity that left the business during the year. At closing, these balances transfer directly against retained earnings (for corporations) or the owner’s capital account (for sole proprietors and partnerships), reducing the permanent equity balance accordingly.

Adjusting Entries Come First

Before any account can close, the books need adjusting entries so revenue and expenses land in the right period. Skipping this step is where most year-end errors start.

Four common adjustments show up almost every year:

  • Accrued expenses. Costs incurred but not yet paid. If employees worked the last week of December and payday falls in January, the wage expense is recorded in December with a matching liability.
  • Accrued revenue. Income earned but not yet billed or collected. Consulting work completed in December but invoiced in January is recorded in December with a corresponding receivable.
  • Prepaid expenses. Costs paid in advance for services that span two periods. A 12-month insurance policy purchased in July puts six months of expense in the current year and shifts the rest into a prepaid asset.
  • Unearned revenue. Cash collected for services not yet delivered. A November payment for February work sits as a liability until the work is done; at year end, only the earned portion has moved into revenue.

Once every dollar of revenue and expense is sitting in the correct period, the temporary accounts are ready to close.

The Four Closing Steps

The mechanics follow a specific sequence. Most accountants route the numbers through a transitional account called the income summary, though some software posts directly to retained earnings.

  • Step 1. Close revenue accounts. Debit each revenue account for its full balance and credit the income summary. Revenue accounts now show zero.
  • Step 2. Close expense accounts. Credit each expense account for its full balance and debit the income summary. Expense accounts now show zero. The income summary balance at this point equals net income (credits exceed debits) or net loss (debits exceed credits).
  • Step 3. Close the income summary. Transfer the income summary balance to retained earnings (corporations) or owner’s capital (sole proprietors and partnerships). Profit: debit the income summary, credit retained earnings. Loss: reverse it.
  • Step 4. Close dividends or drawings. Debit retained earnings (or owner’s capital) and credit the dividends or drawing account. This final entry zeros out the last temporary account and reduces equity by the amount distributed during the year.

After these four steps, every temporary account in the ledger sits at zero. The income summary, which existed only to facilitate the process, is also at zero.

What Stays on the Books

Permanent accounts survive the closing process. Their balances carry forward because they represent ongoing financial position, not one year’s activity. These are the balance sheet accounts:

  • Assets. Cash, accounts receivable, inventory, prepaid expenses, equipment, buildings, and contra accounts such as accumulated depreciation.
  • Liabilities. Accounts payable, unearned revenue, accrued wages, notes payable, and long-term debt.
  • Equity. Retained earnings, owner’s capital, and common stock. These are the accounts that received the closed balances from the temporary accounts.

After the closing entries are posted, the accountant runs a post-closing trial balance. That report lists only the permanent accounts and confirms that total debits still equal total credits. If they don’t, something went wrong during closing. The post-closing trial balance is the starting point for the new fiscal year: every account on it carries forward as the opening balance.

How Long to Keep the Supporting Records

Closing the books doesn’t mean the supporting documents can be shredded. The IRS requires businesses to keep records that support income, deductions, or credits for as long as the relevant limitations period stays open. For most businesses, that works out as follows:6Internal Revenue Service. How Long Should I Keep Records

  • 3 years. The standard retention period, measured from the date the return was filed.
  • 6 years. If more than 25 percent of gross income was not reported.
  • 7 years. If a deduction was claimed for worthless securities or bad debt.
  • 4 years. Employment tax records, measured from the date the tax was due or paid, whichever is later.
  • Indefinitely. If no return was filed, or a fraudulent return was filed.

For property records specifically, hold the documentation until the limitations period expires for the year the property is sold or otherwise disposed of. Those records are what let you calculate cost basis, and reconstructing them years later is rarely possible. If a year-end close involved significant asset purchases, depreciation schedules, or large accruals, keep the workpapers that support those entries for at least as long as the underlying return remains open to audit.