Unit VI: Year-End Closing and Reversing Entries

Closing entries reset temporary nominal accounts (Revenues, Expenses, Drawings) to a zero balance at the end of the year, preventing past operational data from bleeding into the next financial cycle.

Step 1 — Clear Revenue Accounts: Debit all individual revenue accounts to clear their credit balances, and credit the total sum into the Income Summary clearing account.

Step 2 — Clear Expense Accounts: Credit all individual expense accounts to clear their debit balances, and debit the total sum into the Income Summary account.

Step 3 — Clear Income Summary to Capital:

If the business generated a Net Income (Income Summary holds a net credit balance), clear it out via:

$\text{Debit: Income Summary} \\ \text{Credit: Owner's Capital Account}$

If the business incurred a Net Loss (Income Summary holds a net debit balance), clear it out via:

$\text{Debit: Owner's Capital Account} \\ \text{Credit: Income Summary}$

Step 4 — Clear Drawing Account: Transfer the personal drawing balance directly into capital:

$\text{Debit: Owner's Capital Account} \\ \text{Credit: Owner's Drawing Account}$

Reversing entries are optional bookkeeping adjustments performed on the first day of a new accounting cycle. They exactly switch the debits and credits of specific period-end adjustments to simplify subsequent routine cash transactions.

General Rule for Reversals

Items to Reverse: Adjustments that create a brand-new asset or liability (e.g., Accrued Expenses, Accrued Revenues, Prepayments tracked via the Expense Method, and Unearned Revenue tracked via the Revenue Method).

Items Never Reversed: Structural entries that do not cause a future cash transaction (e.g., Depreciation adjustments, changes to Allowance for Bad Debts).