State BPA Fundamental Accounting Practice Exam

In accounting, what does a closing entry involve?

1. Adjusting permanent accounts

2. Closing temporary accounts

3. Re-evaluating asset values

4. Finalizing the cash flow statement

The correct answer is: Closing temporary accounts

A closing entry is an essential process in the accounting cycle that specifically deals with the management of temporary accounts, which include revenues, expenses, and dividends during a particular accounting period. These accounts are labeled "temporary" because they are reset to zero at the end of each period, allowing for the next accounting period's transactions to be tracked independently. When a closing entry is made, it transfers the balances of these temporary accounts to a permanent account, typically retained earnings. This process ensures that the financial statements accurately reflect only the activities of the current period and facilitates the preparation of accurate financial statements for the next period. This practice is crucial for maintaining clarity in financial reporting and ensuring that performance can be accurately assessed over time. The other options, while relevant to different aspects of accounting, do not accurately describe what a closing entry specifically involves. Adjusting permanent accounts focuses on changes required for accounts that carry their balances into future periods, such as assets and liabilities. Re-evaluating asset values relates to impairment assessments or fair value adjustments, and finalizing a cash flow statement pertains to summarizing cash movements rather than closing out accounts. Thus, the focus of a closing entry on temporary accounts stands out as the correct understanding.