What is the purpose of preparing closing entries?

The purpose of preparing closing entries is to reset income statement accounts for the new accounting period. At the end of an accounting period, it is necessary to close or reset the temporary accounts, such as revenues and expenses, to ensure that they start at zero for the next period. This process involves transferring the balances from these temporary accounts to a permanent account, typically the retained earnings account, which reflects the cumulative income retained in the business. By doing this, the next accounting period can accurately reflect the performance of the business without mixing results from previous periods.

Closing entries are crucial for maintaining accurate financial records and ensuring that all income and expenses are properly accounted for in their respective periods. This aligns with the matching principle in accounting, which states that expenses should be matched with the revenues they help to generate within the same period.