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

• A. To record the purchase of new assets
• B. To prepare the financial statements for the next accounting period
• 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 purpose of closing entries: The primary purpose is to ensure that the temporary accounts do not carry over their balances into the next accounting period, allowing the company to start fresh with these accounts.
3. Recognize the accounts involved: Temporary accounts include revenue, expense, and dividend accounts. These are closed into retained earnings, which is a permanent account on the balance sheet.
4. Understand the impact on financial statements: Closing entries help prepare the financial statements for the next accounting period by ensuring that the income statement reflects only the revenues and expenses of the current period.
5. Clarify misconceptions: Closing entries are not used to record the purchase of new assets or adjust asset and liability accounts to their fair market value. These activities are handled through other accounting processes, such as adjusting entries or asset valuation methods.