After closing the revenue accounts, the next step in compiling the document is to close all the expense accounts. Expense accounts are always losses or costs, meaning they have debit balances. Closing journal entries are made at the end of an accounting period to prepare the accounting records for the next period. They zero-out the balances of temporary accounts during the current period to come up with fresh slates for the transactions in the next period. The income summary account is an intermediary between revenues and expenses, and the Retained Earnings account. It stores all of the closing information for revenues and expenses, resulting in a “summary” of income or loss for the period.

What Is the Difference Between an Income Summary and an Income Statement?

State whether each account is a permanent or temporary account. It is the end of the year, December 31, 2018, and you are reviewing your financials for the entire year. You see that you earned $120,000 this year in revenue and had expenses for rent, https://www.online-accounting.net/monthly-personal-interest-expense-debt-servicing/ electricity, cable, internet, gas, and food that totaled $70,000. The business has been operating for several years but does not have the resources for accounting software. This means you are preparing all steps in the accounting cycle by hand.

Income Summary vs. Income Statement

1. Whatever remains in the last credit or debit balance will be transferred to the balance sheet’s retained profits or the capital account.
2. Let’s look at the trial balance we used in the Creating Financial Statements post.
3. You will notice that we do not cover step 10, reversing entries.
4. If the balance on the final account is a loss (debit balance), companies have to credit the lost amount to the retained earnings.
5. The net result of these activities is to move the net profit or net loss for the period into the retained earnings account, which appears in the stockholders’ equity section of the balance sheet.

We have completed the first two columns and now we have the final column which represents the closing (or archive) process. The income statement reflects your net income for the month of December. This entry zeros out dividends and reduces retained earnings by total dividends paid. There are many advantages for businesses when they use income summaries.

What is the closing entry process?

Its use as an organizational skill is underlined by how it summarizes all the necessary ledger balances in one value instead of a single account balance. In addition, it summarizes all the business functions, especially the operating and non-operating activities. Notice that the balance of the Income Summary account is actually the net income for the period. Remember that net income is equal to all income minus all expenses.

AccountingTools

You can do this by debiting the income summary account and crediting your capital account in the amount of $250. This reflects your net income for the month, and increases your capital account by $250. Sam’s books are now totally closed for the year, and he may create the post-closing trial balance and reopen his books with reverse entries in the following https://www.online-accounting.net/ steps of the accounting cycle. All of these entries have emptied the revenue, expense, and income summary accounts, and shifted the net profit for the period to the retained earnings account. Modern-day accounting software typically does the process of automatically debiting or crediting revenue and expense balances once the accounting period ends.

We see from the adjusted trial balance that our revenue accounts have a credit balance. To make them zero we want to decrease the balance or do the opposite. We will debit the revenue accounts and credit the Income Summary account. The credit to income summary should equal the total revenue from the income statement. You begin the closing process by transferring revenue and expense account balances to the income summary account, a temporary account used specifically to transfer revenue and expense account balances.

Have you ever done an entry that included Retained Earnings? If you have only done journal entries and adjusting journal entries, the answer is no. Let’s look at the trial balance we used in the Creating Financial Statements post. Think about some accounts that would be permanent accounts, like Cash and Notes Payable.

Shifting revenue out of the income statement, therefore, entails debiting the revenue account for the total amount of revenue recorded in the period and crediting the income summary account. Debit all revenue accounts to offset existing revenue balances and credit income summary to reset how do share capital and paid-up capital differ revenue balances to zero. To zero off current expense balances, debit the income summary and credit all expense accounts. The earnings transfer also closes the income summary account. All of the revenue accounts balance in the credit side column as the organization’s total income.

This is the same figure found on the statement of retained earnings. Notice that the balances in interest revenue and service revenue are now zero and are ready to accumulate revenues in the next period. The Income Summary account has a credit balance of $10,240 (the revenue sum). Corporations will close the income summary account to the retained earnings account. Closing entries are completed at the end of each accounting period after your adjusted trial balance has been run. You record the income summary amount by adding the total expenses and total income and then transferring them to the balance sheet.

Revenue, expense, and dividend accounts affect retained earnings and are closed so they can accumulate new balances in the next period, which is an application of the time period assumption. Likewise, shifting expenses out of the income statement requires you to credit all of the expense accounts for the total amount of expenses recorded in the period, and debit the income summary account. This is the first step to take in using the income summary account. After Paul’s Guitar Shop prepares its closing entries, the income summary account has a balance equal to its net income for the year. This balance is then transferred to the retained earnings account in a journal entry like this.

You will notice that we do not cover step 10, reversing entries. This is an optional step in the accounting cycle that you will learn about in future courses. Steps 1 through 4 were covered in Analyzing and Recording Transactions and Steps 5 through 7 were covered in The Adjustment Process. 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.