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 record the purchase of new assets
• C. To transfer the balances of temporary accounts to retained earnings
• D. To adjust asset and liability accounts to their fair market value

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 the temporary accounts: Temporary accounts include revenue accounts, expense accounts, and dividend accounts. These accounts accumulate balances during the accounting period and need to be closed 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 prepare the accounts for the next accounting period by resetting temporary accounts to zero. This allows the company to accurately track performance in the new period without interference from prior period balances.
5. Clarify what closing entries do not do: Closing entries do not adjust asset and liability accounts to their fair market value, nor do they record the purchase of new assets. These activities are handled through other types of journal entries, such as adjusting entries or transaction entries.