Why are Closing Entries Prepared

Closing entries are prepared for complete record of all transactions. When  year reaches at end date, we close our income accounts, expenses accounts and other some accounts. For closing income and expenses, we pass closing entries in which we transfer these accounts to profit and loss account. Its benefit will be that all income and expenses account will become zero in next financial period. In our mind, there will be no doubt in our mind regarding expenses payment or income receipt.

We also pass one more important closing entry for transferring our net profit or net loss to balance sheet which has not been distributed to shareholders. After this, our profit and loss account will be closed. Next year profit and loss account will show next year income and expenditures not current year.

We also close dividend and withdrawals account by transferring to profit and loss appropriation account and capital account. With personal withdrawals or drawing, our capital will decrease. With dividend, our retained earning will decrease. So, our investor will view our correct balance sheet.

One more important thing, you should know that outstanding and advance incomes and expenses will not close but expenses and incomes accounts will transfer to these outstanding and advance income or expenses account. These outstanding income or expenses may be account payable or account receivable in our balance sheet.