Are you scratching your head wondering how to properly close those pesky dividend accounts at the end of your accounting period? Don’t worry – you’re not alone! Closing dividends is an essential step in the accounting cycle that often confuses business owners and accounting professionals alike.
In this guide, we’ll break down exactly how you close dividends in your accounting books, why it matters, and provide you with clear examples that’ll make the process a breeze. Let’s dive right in!
What Are Closing Entries and Why Do They Matter?
Before we jump into closing dividends specifically, let’s understand what closing entries are:
Closing entries are journal entries made at the end of an accounting period to transfer balances from temporary accounts to permanent accounts They effectively “reset” temporary accounts to zero so you can start fresh in the new accounting period
Here’s why closing entries matter:
- They help maintain accurate financial records
- They ensure your financial statements properly reflect your business’s performance
- They update your retained earnings account with the current period’s results
- They provide a clean slate for the next accounting period
Temporary vs. Permanent Accounts
To understand the dividend closing process, we need to know the difference between temporary and permanent accounts:
Temporary Accounts
These accounts track financial activity during a specific accounting period and must be reset to zero when a new period begins:
- Revenue accounts
- Expense accounts
- Dividend accounts
Permanent Accounts
These accounts maintain their balances from period to period
- Assets
- Liabilities
- Equity (including Retained Earnings)
The Step-by-Step Process to Close Dividends
Now, let’s get to the heart of the matter – closing your dividend account! Here’s the process:
Step 1: Understand Where Dividends Fit in the Closing Process
The complete closing entry process typically follows this sequence:
- Close revenue accounts to Income Summary
- Close expense accounts to Income Summary
- Close Income Summary to Retained Earnings
- Close Dividends to Retained Earnings
Dividends are handled in the final step of the closing process, after the Income Summary account has been closed.
Step 2: Create the Journal Entry to Close Dividends
To close dividends, you need to:
- Debit Retained Earnings
- Credit Dividends
This journal entry reduces your retained earnings and zeroes out the dividends account.
The format looks like this:
| Date | Account | Notes | Debit | Credit |
|---|---|---|---|---|
| 12/31/2023 | Retained Earnings | Closing entry | $X,XXX | |
| 12/31/2023 | Dividends | Closing entry | $X,XXX |
Step 3: Verify Your Work
After posting this entry, your Dividends account should have a zero balance, and your Retained Earnings account should be reduced by the amount of dividends paid during the period.
A Practical Example of Closing Dividends
Let’s see how this works with some real numbers!
Imagine your company had the following financial activity during 2023:
- Revenue: $100,000
- Expenses: $75,000
- Dividends paid to shareholders: $10,000
Here’s how you’d handle the closing entries:
Step 1: Close Revenue
Revenue $100,000 Income Summary $100,000Step 2: Close Expenses
Income Summary $75,000 Expenses $75,000Step 3: Close Income Summary
Income Summary $25,000 Retained Earnings $25,000Step 4: Close Dividends
Retained Earnings $10,000 Dividends $10,000After these entries, your Income Summary and Dividends accounts will have zero balances, and your Retained Earnings will reflect the net change: an increase of $15,000 ($25,000 profit minus $10,000 dividends).
Common Questions About Closing Dividends
Why don’t dividends close to the Income Summary account?
Dividends aren’t considered expenses or losses – they’re distributions of profits to shareholders. Since they don’t affect the calculation of net income, they bypass the Income Summary account and close directly to Retained Earnings.
When should I close my dividend account?
Typically, dividend accounts are closed at the end of each accounting period (monthly, quarterly, or annually) depending on your company’s accounting practices. Most businesses handle closing entries annually.
What happens if I forget to close dividends?
If you don’t close your dividends account, it’ll carry a balance into the next accounting period. This will make your financial statements inaccurate because:
- Your dividend account will show more than what was actually distributed in the current period
- Your retained earnings won’t accurately reflect the impact of dividends
Tips for Successfully Closing Dividends
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Be consistent with your accounting periods – Whether you close monthly, quarterly, or annually, stick to the same schedule.
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Use accounting software – Modern accounting programs automatically handle closing entries, including dividends, saving you time and reducing errors.
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Double-check your work – After posting closing entries, verify that temporary accounts (including dividends) have zero balances.
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Keep detailed records – Document when and why dividends were issued throughout the period to make the closing process smoother.
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Consult with a professional – If you’re unsure about the closing process, a qualified accountant can provide guidance specific to your business.
The Bigger Picture: Closing Entries in the Accounting Cycle
Closing dividends is just one part of the entire accounting cycle. Here’s where it fits in:
- Analyze and record transactions
- Post journal entries to the general ledger
- Prepare an unadjusted trial balance
- Make adjusting entries
- Prepare an adjusted trial balance
- Create financial statements
- Make closing entries (including closing dividends!)
- Prepare a post-closing trial balance
By properly closing your dividend accounts, you’re ensuring the integrity of your financial records and setting yourself up for success in the next accounting period.
Real-World Benefits of Properly Closing Dividends
When you close dividends correctly, you gain several advantages:
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Accurate financial reporting – Your financial statements will accurately reflect business performance.
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Better decision-making – With clear visibility into retained earnings, you can make informed decisions about future dividend distributions.
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Simplified tax preparation – Properly closed accounts make tax season less stressful.
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Easier comparison between periods – You can meaningfully compare performance across different accounting periods.
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Improved investor relations – Accurate financial reporting builds trust with shareholders and potential investors.
Conclusion
Closing dividends doesn’t have to be complicated! By following the simple steps outlined in this guide – debiting Retained Earnings and crediting Dividends – you can ensure your accounting records accurately reflect your company’s financial position.
Remember that closing dividends is the final step in the closing entry process, occurring after you’ve closed your revenue and expense accounts to the Income Summary account and closed the Income Summary to Retained Earnings.
Have you encountered any challenges when closing dividend accounts? What accounting tips would you share with other readers? We’d love to hear about your experiences in the comments below!
Unit 4: Completion of the Accounting Cycle Search for:
Let’s review our accounting cycle again. We have completed the first two columns and now we have the final column which represents the closing (or archive) process.
| Accounting Cycle | ||
| 1. Analyze Transactions | 5. Prepare Adjusting Journal Entries | 9. Prepare Closing Entries |
| 2. Prepare Journal Entries | 6. Post Adjusting Journal Entries | 10. Post Closing Entries |
| 3. Post journal Entries | 7. Prepare Adjusted Trial Balance | 11. Prepare Post-Closing Trial Balance |
| 4. Prepare Unadjusted Trial Balance | 8. Prepare Financial Statements | |
Accounts are two different groups:
- Permanent – balance sheet accounts including assets, liabilities, and most equity accounts. These account balances roll over into the next period. So, the ending balance of this period will be the beginning balance for next period.
- Temporary – revenues, expenses, dividends (or withdrawals) account. These account balances do not roll over into the next period after closing. The closing process reduces revenue, expense, and dividends account balances (temporary accounts) to zero so they are ready to receive data for the next accounting period.
Accountants may perform the closing process monthly or annually. The closing entries are the journal entry form of the Statement of Retained Earnings. The goal is to make the posted balance of the retained earnings account match what we reported on the statement of retained earnings and start the next period with a zero balance for all temporary accounts.
Remember how at the beginning of the course we learned that net income is added to equity. This is the process to make that happen!
The following video summarizes how to prepare closing entries.
In accounting, we often refer to the process of closing as closing the books. Only revenue, expense, and dividend accounts are closed—not asset, liability, Common Stock, or Retained Earnings accounts. The four basic steps in the closing process are:
- Closing the revenue accounts—transferring the credit balances in the revenue accounts to a clearing account called Income Summary.
- Closing the expense accounts—transferring the debit balances in the expense accounts to a clearing account called Income Summary.
- Closing the Income Summary account—transferring the balance of the Income Summary account to the Retained Earnings account.
- Closing the Dividends account—transferring the debit balance of the Dividends account to the Retained Earnings account.
Let’s review what we know about these accounts:
| Increase with | Decrease with | |
| Revenue | Credit | Debit |
| Expense | Debit | Credit |
| Dividends | Debit | Credit |
If we want to make the account balance zero, we will decrease the account. We use a new temporary closing account called income summary to store the closing items until we get close income summary into Retained Earnings. To close means to make the balance zero. We will look at the following information for MicroTrain from the adjusted trial balance:
| Debit | Credit |
| Retained Earnings | $ 6,100 |
| Service Revenue | 36,500 |
| Interest Revenue | 600 |
| Salaries Expense | 18,360 |
| Rent Expense | 1,200 |
| Utilities Expense | 500 |
| Insurance Expense | 200 |
| Supplies Expense | 7,000 |
| Depreciation Expense | 750 |
Notice how the retained earnings balance is $6,100? On the statement of retained earnings, we reported the ending balance of retained earnings to be $15,190. We need to do the closing entries to make them match and zero out the temporary accounts.
Step 1: Close Revenue accounts
Close means to make the balance zero. We see from the adjusted trial balance that our revenue accounts have a credit balance. To make them zero we want to decrease the balance or do the opposite. We will debit the revenue accounts and credit the Income Summary account. The credit to income summary should equal the total revenue from the income statement.
| Debit | Credit |
| Service Revenue | 36,500 |
| Interest Revenue | 600 |
| Income Summary | 37,100 |
Step 2: Close Expense accounts
The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts. Just like in step 1, we will use Income Summary as the offset account but this time we will debit income summary. The total debit to income summary should match total expenses from the income statement.
| Debit | Credit |
| Income Summary | 28,010 |
| Salaries Expense | 18,360 |
| Rent Expense | 1,200 |
| Utilities Expense | 500 |
| Insurance Expense | 200 |
| Supplies Expense | 7,000 |
| Depreciation Expense | 750 |
Step 3: Close Income Summary account
At this point, you have closed the revenue and expense accounts into income summary. The balance in income summary now represents $37,100 credit – $28,010 debit or $9,090 credit balance…does that number seem familiar? It should — income summary should match net income from the income statement. We want to remove this credit balance by debiting income summary. What did we do with net income? We added it to retained earnings in the statement of retained earnings. How do we increase an equity account in a journal entry? We credit!
| Debit | Credit |
| Income Summary (37,100 – 28,010) | 9,090 |
| Retained Earnings | 9,090 |
If expenses were greater than revenue, we would have net loss. A net loss would decrease retained earnings so we would do the opposite in this journal entry by debiting Retained Earnings and crediting Income Summary.
Step 4: Close Dividends (or withdrawals) account
After we add net income (or subtract net loss) on the statement of retained earnings, what do we do next? We subtract any dividends to get the ending retained earnings. This will be the journal entry form of doing this calculation but be careful because you do not want to use the amount of retained earnings but DIVIDENDS. We want to decrease retained earnings (debit) and remove the balance in dividends (credit) for the amount of the dividends. MicroTrain did not pay dividends this year but the entry would appear as:
| Debit | Credit |
| Retained Earnings | Div Amt |
| Dividends | Div Amt |
Div Amt means we will use the DIVIDEND amount and not the balance in retained earnings.
Anytime we complete journal entries, we always need to post to the same ledger cards or T-accounts we have been using all along. When we post, we do not change anything from the journal entries — we debit (left side) where we did in the entries and credit (right side) wherever we did in the entries. The ledger card for income summary and retained earnings would look like this:
| Account: Income Summary | Debit | Credit | Balance |
| (1) Close Revenues | 37,100 | 37,100 | |
| (2) Close Expenses | 28,010 | 9,090 | |
| (3) Close Income Summary | 9,090 | 0 |
| Account: Retained Earnings | Debit | Credit | Balance |
| Beginning Balance | 6,100 | ||
| (3) Close Income Summary | 9,090 | 15,190 | |
| (4) Close Dividends | 0 | 15,190 |
The balance in dividends, revenues and expenses would all be zero leaving only the permanent accounts for a post closing trial balance. The trial balance shows the ending balances of all asset, liability and equity accounts remaining. The main change from an adjusted trial balance is revenues, expenses, and dividends are all zero and their balances have been rolled into retained earnings. We do not need to show accounts with zero balances on the trial balances.
MicroTrain’s post closing trial balance would be:
| Debit | Credit | |
| Cash | 10,000 | |
| Accounts Receivable | 25,000 | |
| Interest Receivable | 600 | |
| Supplies | 1,500 | |
| Prepaid Insurance | 2,200 | |
| Trucks | 40,000 | |
| Accum. Depreciation-Trucks | 750 | |
| Accounts Payable | 25,000 | |
| Unearned Revenue | 3,000 | |
| Salaries Payable | 360 | |
| Common Stock | 35,000 | |
| Retained Earnings | 15,190 | |
| TOTALS | 79,300 | 79,300 |
Notice how only the balance in retained earnings has changed and it now matches what was reported as ending retained earnings in the statement of retained earnings and the balance sheet.
Congratulations! You made it through the complete accounting cycle.
Answer the following questions on closing entries and rate your confidence to check your answer.