What is the primary purpose of closing entries in the accounting cycle?

• A. To prepare the financial statements for the next accounting period
• B. To adjust asset and liability accounts to their fair market value
• C. To transfer the balances of temporary accounts to retained earnings
• D. To record the purchase of new assets

Answer: (C)

Verified step by step guidance

1. Understand the concept of closing entries: Closing entries are journal entries made at the end of an accounting period to transfer the balances of temporary accounts (such as revenues, expenses, and dividends) to permanent accounts (like retained earnings). This process resets the temporary accounts to zero for the next accounting period.
2. Identify temporary accounts: Temporary accounts include revenue accounts, expense accounts, and dividend accounts. These accounts accumulate balances during the accounting period but need to be cleared to start fresh in the next period.
3. Recognize the purpose of closing entries: The primary purpose is to transfer the balances of temporary accounts to retained earnings, which is a permanent account. This ensures that the financial statements reflect the cumulative financial position of the company.
4. Understand the impact on financial statements: Closing entries help prepare the financial statements for the next accounting period by ensuring that temporary accounts do not carry over balances, which could distort the financial results of the new period.
5. Learn the process of recording closing entries: Closing entries typically involve debiting revenue accounts and crediting retained earnings, as well as debiting retained earnings and crediting expense accounts. Dividends, if applicable, are also closed to retained earnings.