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

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

Answer: (D)

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 company's cumulative financial position.
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.
4. Understand why temporary accounts are reset: Resetting temporary accounts to zero allows the company to start fresh in the next accounting period, ensuring that financial activity is tracked accurately for each period.
5. Conclude the primary purpose: The primary purpose of closing entries is to transfer the balances of temporary accounts to retained earnings, not to record asset purchases, adjust accounts to fair market value, or prepare the trial balance for the next period.