What is the purpose of closing entries in accounting?

The purpose of closing entries in accounting is to transfer the balances of temporary accounts, such as revenues and expenses, to permanent accounts, specifically the retained earnings account, at the end of an accounting period. This process resets the temporary accounts to zero, allowing the business to start fresh in the new accounting period, thus ensuring that the new period's revenue and expense activity is not mixed with that of the previous period.

This practice is essential for accurately measuring financial performance over each accounting period, as it helps in presenting a clear financial picture. By closing the temporary accounts, businesses can effectively track profit or loss for each period and maintain ongoing records of retained earnings, which contribute to the overall equity of the company.

In contrast, recording long-term investments does not involve closing entries, as it pertains to the management of fixed or non-current assets. Preparing initial financial statements is part of the overall accounting cycle but is not the specific role of closing entries. Similarly, the reporting of cash flow activities relates to the cash flow statement and is separate from the process of closing entries. Hence, the option concerning the transfer of temporary account balances to permanent accounts encapsulates the primary function and necessity of closing entries in the accounting cycle.