When the accounting period ends, all the expense accounts are closed when the debit balance transfers into the income statement. Then, inversely to revenue accounts, the expense accounts are credited to reset them with zero balance and debiting the final account. Closing entries are entries used to shift balances from temporary to permanent accounts at the end of an accounting period. These journal entries condense your accounts so you can determine your retained earnings, or the amount your business has after paying expenses and dividends. Creating closing entries is one of the last steps of the accounting cycle.
- Income summary is an account in which the balances of temporary accounts, i.e., revenues and expenses accounts, are transferred at the end of the accounting year.
- While the income statement is used for recording expenses and revenues for a given accounting period, the income summary account holds closing records of revenues and expenses.
- The Income Summary is a temporary general ledger account used by the company to adjust retained earnings for any income earned during the period.
- Temporary accounts are those that are closed at the end of an accounting cycle.
- Starting with zero balances in the temporary accounts each year makes it easier to track revenues, expenses, and withdrawals and to compare them from one year to the next.
In the event of a loss for the period, the income summary account needs to be credited and retained earnings reduced through a debit. There are generally two components of the income summary statement, namely the debit side and credit side. The income summary account is an account that receives all the temporary accounts of a business upon closing them at the end of every accounting period. This means that the value of each account in the income statement is debited from the temporary accounts and then credited as one value to the income summary account.
15 Closing Entries
This resets the balance of the temporary accounts to zero, ready to begin the next accounting period. Income summaries are temporary accounts that net all the revenue and expenses accounts to determine whether there was a credit balance (profit) or debit balance (loss). They make it easier for businesses to transition revenues and expenses into the balance sheet.
Remember from your past studies that dividends are not expenses, such as salaries paid to your employees or staff. Instead, declaring and paying dividends is a method utilized by corporations to return part of the profits generated by the company to the owners of the company—in this case, its shareholders. In this segment, we complete the final steps (steps 8 and 9) of the accounting cycle, the closing process. You will notice that we do not cover step 10, reversing entries.
Income Summary Report
The trial balance above only has one revenue account, Landscaping Revenue. If the account has a $90,000 credit balance and we wanted to bring the balance to zero, what do we need to do to that account? In order to cancel out the credit balance, we would need to debit the account. Income summary effectively collects NI for the period and distributes the amount to be retained into retained earnings. Balances from temporary accounts are shifted to the income summary account first to leave an audit trail for accountants to follow. Temporary account balances can either be shifted directly to the retained earnings account or to an intermediate account known as the income summary account beforehand.
I imagine some of you are starting to wonder if there is an end to the types of journal entries in the accounting cycle! So far we have reviewed day-to-day journal entries and adjusting journal entries. The fourth entry requires Dividends to close to the Retained Earnings account.
The Closing Process (Accounting) – Explained
When the accounting period ends, all the revenue accounts are closed when the credit balance is properly transferred. This involves debiting the revenue accounts to reset them with zero balance and crediting the final temporary account. A closing entry entails resetting the balances of temporary accounts and permanent accounts, in which the balance of temporary accounts is zero and the balance of the permanent accounts increase. The income summary is important in a closing entry, this is the summary used in the aggregation of all income accounts. It is, however, important to note that the account income summary does not appear on financial statements, rather, it is a summary used in the closing process/entry. The income summary account serves as a temporary account used only during the closing process.
What is the best way to record income?
By recording income daily, or weekly for smaller businesses, your record keeping will be more accurate than if you were to try and calculate a year's worth of income in one go.
The net profit, which in this case is $1, 500,000, can be transferred into the retained earnings account. Notice how only the balance in retained earnings has changed and it now matches what was reported as ending retained earnings in the statement of retained earnings and the balance sheet. Companies are required to close their books at the end of each fiscal year so that they can prepare their annual financial statements and tax returns. The formula for calculating the total retained earnings is revenue minus expenses. In this case, the total retained earnings are listed as credit because the revenue (credited) was more significant than the expenses. To gain a better understanding of what these temporary accounts are, take a look at the following example.
What is the income summary account?
The first entry closes revenue accounts to the Income Summary account. The second entry closes expense accounts to the Income Summary account. The third entry closes the Income Summary account bookkeeping for startups to Retained Earnings. The fourth entry closes the Dividends account to Retained Earnings. The information needed to prepare closing entries comes from the adjusted trial balance.