Income summary account is the account that is temporary in nature and used at the end of the accounting period under consideration while closing the books of accounts of the company where all the revenue and expenses that are present in the income statement are transferred.
What is Income Summary Account?
Income summary account is where all the income and expenses are settled at the end of the period and it helps determine if the company has made profits or loss. It is also known as Revenue and Expense Summary Account. The net amount is then transferred to retained earnings in the balance sheet (for a corporation or to owners’ capital for sole partnership). Hence, this account is classified under owner’s equity
- As per the standards, all accounts have to be closed or settled at the end of each financial period mainly called “closing the accounting books”. Temporary accounts like income summary are created to keep a track of a particular financial period and are closed at the end of the year. This is how these accounts are reset to zero when a new financial period starts.
- One thing to note is that the income summary account differs from other temporary accounts because it does not have a normal balance. Normal balance is a term used when there is an expectation that a particular type of account will have some balance either credit or debit
How to Calculate and Use the Income Summary Account?
The sequence of the closing process is as follows:
- Close the revenue account and transfer the balance to Income summary account
- Close the expense account and transfer the balance to Income summary account
- Transfer the balance (profit/loss) from income summary account to retained earnings
- Transfer the dividend expense or drawings to retained earnings
#1 Closing Revenue –
The balance of this account is the total revenue generated for the financial period. Assuming the company has $5,000 revenue in its account. To balance this account, it has to debit the revenue account by $5000. This entry will balance the account and take the entry off its books and the account balance is now zero.
This amount will then be credited to the income summary account. This entry transfers the revenue balance from the revenue account to the income summary account
#2 Closing Expenses –
Since all the expenses will be debited in the expense account, these expenses will now be credited. For example, if the company has $2000 worth of expenses debited in its expense account, it will now be credited for $2000 to balance the account and take this entry of the books. This entry is then transferred to the income summary account which is debited for $2000
#3 Balancing the Income Summary Account –
The account now has revenue in the credit column and the expenses in the debit column. According to our example, the account consists of Revenue of $5000 and expenses of $2000. The net income is thus $3000 ($5000-$2000), which is now credited to retained earnings which is a balance sheet capital account
#4 Closing Dividends to Retained Earnings –
If the company pays any dividend (for the corporation) or makes any withdrawals (drawing for partnership/proprietorship), and creates a separate account for the same then this account is also closed at the end of the accounting period. Please note that this transaction is not transferred through the income summary account but is directly deducted from retained earnings. This is because dividends or drawings are not a part of net income calculation Payment of dividends is a capital withdrawal and will reduce retained earnings by that amount.
In our example, if dividends of $500 are paid, this amount will not be affected to the income summary account but instead will be reduced directly from the retained earnings which has a balance of $3000 and after deducting the number of dividends will have a balance of $2500.
These entries are then posted to the respective general ledger accounts and only permanent accounts that have a non-zero balance after the entire process is closed are included in the post-closing trial balance. This trial balance is prepared to check the debits and credits i.e. if the account is rightly balanced.
A post-closing trial balance contains only permanent accounts because the temporary accounts all have a zero balance after the closing process. A post-closing trial balance is prepared to check on the equality of debits and credits after the closing process.
Why Not Close the Revenue and Expenses Directly to the Capital Account?
At the time when manual accounting existed, the income summary account ledger could easily help determine the firm’s performance and check the revenue, expenses and calculate the profits and losses making it a vital requirement
Difference Between Income Statement and Income Summary Account
Two important accounting concepts are often confused with one another i.e. income statement and income summary account. The only similarity in these accounts is that they are built to help determine a company’s profit and loss.
- The income statement is a detailed record of a company’s financial performance and contains revenues and expenses for a particular period. It provides a basis for evaluating past performance and then predicting future performance. This is a permanent account in the accounting standards. In comparison, as discussed earlier income summary account is temporary and is only created to close entries for a particular period.
- In other words, income summary account at the beginning of every period resets the balance of income statement to zero for its recording, whereas the purpose of the income statement is to show the current financial year performance and evaluate profitability.
This has been a guide to what is Income Summary Account. Here we discuss how to calculate and balance income summary account along with its differences from the income statement. You may learn more about accounting basics from the following articles –
- Is Dividend Expense?
- Examples of Total Equity Formula
- Owner’s Equity Examples
- What is Owner’s Equity Formula?
- What is T Accounts?
- Definition of Drawing Accounting
- What is Partial Income Statement?
- Income Statement vs Balance Sheet – Differences You Must Know!
- What is the Consolidated Financial Statement?
- What is Statement of Comprehensive Income?