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

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

Answer: (B)

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 the purpose of temporary accounts: Temporary accounts are used to track financial activity during a specific accounting period. At the end of the period, their balances must be transferred to permanent accounts to reflect the cumulative financial position of the company.
3. Recognize the role of retained earnings: Retained earnings is a permanent account that accumulates the net income or loss of the company over time. Closing entries ensure that the net income or loss for the period is added to retained earnings, maintaining the integrity of the financial records.
4. Clarify why closing entries do not adjust asset or liability accounts: Asset and liability accounts are permanent accounts and are not affected by closing entries. Adjustments to these accounts are typically made through adjusting entries, not closing entries.
5. Conclude the primary purpose: The primary purpose of closing entries is to transfer the balances of temporary accounts to retained earnings, ensuring that the financial statements are prepared for the next accounting period with a clean slate for temporary accounts.