Income Summary Definition
Income Summary is a temporary account in which all the closing entries of revenue and expenses accounts are netted at the end of the accounting period, and the resulting balance is considered as profit or loss. If the net balance of income summary is a credit balance, it means the company has made a profit for that year, or if the net balance is a debit balance, it means the company has made a loss for that year.
It is a summary of income and expenses arising from operating and non-operating activity; therefore, it is also called revenue & expense summary.
How to Prepare Income Summary?
Step 1 – Closing of Revenue Accounts
Revenue accounts always have credit balances; at the end of the accounting periodThe End Of The Accounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance., all the revenue accounts will be closed by transferring the credit balance to income summary. This will be done by debiting the revenue accounts and crediting the income summary account. After passing this entry, all revenue accountsRevenue AccountsRevenue accounts are those that report the business's income and thus have credit balances. Revenue from sales, revenue from rental income, revenue from interest income, are it's common examples. will become zero.
Step 2 – Closing of Expense Accounts
Expenses account always have debit balances; at the end of the accounting period, all the expenses accounts will be closed by transferring the debitDebitDebit is an entry in the books of accounts, which either increases the assets or decreases the liabilities. According to the double-entry system, the total debits should always be equal to the total credits. to income summary, and this will be done by crediting the expenses account and debiting the income summary account. After passing this entry, all expense accountsAll Expense AccountsExpense accounting is the accounting of business costs incurred to generate revenue. Accounting is done against the vouchers created at the time the expenses are incurred. balance will become zero.
Step 3 – Finalizing the Income Summary Account
Now, these accounts have all the revenue accounts balance in the credit side column as the total income of the organization and all the expense account balance in the debit side column as total expenditure of the organization. If the credit balance is more than the debit balance, it indicates the profit, and if debit balance is more than the credit balance, it indicates the loss. In the last credit balance or debit balance, whatever may become it will transfer into retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company. or capital accountCapital AccountThe capital account refers to the general ledger that records the transactions related to owners funds, i.e. their contributions earnings earned by the business till date after reduction of any distributions such as dividends. It is reported in the balance sheet under the equity side as “shareholders’ equity.” in the balance sheet, and the income summary will be closed.
Example of Income Summary
The following is an example of an income summary.
XYZ Inc is preparing income summary for the year ended 31st Dec’18, and below are the revenue and expense account balance as on 31st Dec’18.
The closing balance of revenue accounts are as below:
- Sales – $80000
- Interest IncomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. – $500
- Miscellaneous Income – $240
The closing balance of expense accounts are as below:
- Purchase – $50000
- Rent Expenses – $8000
- Salaries & Wages – $3500
- Printing & Stationery – $700
- Advertisement Expenses – $500
- Electricity Expenses – $260
Now all the above accounts will be closed by transferring their balances into income summary with the help of below journal entry:
Balance of income and expenditure will be transferred to retained earnings by passing the below entry:
After passing the above journal entry of income summary account will be prepared, which is as below:
- It gives the complete revenue and expense information of the organization in one place.
- It helps investors and shareholders in the analysis of company financial performance for a specific time period so that they can make the decision for future investment.
- One can track the company performance easily by reviewing the income summary of past years and get to know whether a company is making a profit regularly or not.
- It also helps at the filling of income tax returns because it gives all the necessary information to file tax returns in one place.
- It is easily understandable because there are only two columns are having in this statement.
- Income Summary helps in budget vs. actual variance analysisVariance AnalysisVariance analysis is the process of identifying and analyzing the difference between the standard numbers that a company expects to accomplish and the actual numbers that they achieve, in order to help the firm analyze positive or negative consequences..
- It is very easy to derive the cash profit by adding or deducting the accrual balances.
- It includes operating and non-operating revenue and expenses; therefore, sometimes, it is not giving the correct financial picture of the organization.
- It is prepared on accrual basis like it records the full value of sales whether money has been actually received or not similarly, expenses have been recorded on an accrual basis, whether it actually has been paid or not, therefore, there is a chance of misrepresentation.
- Income summary of one year is not useful for financial performance analysis. An investor has to take at least 10 years of summary for analyzing financial performance. Therefore, it is time taking and sometimes difficult to get the 10 years summary of the organization, which is not listed.
Income Summary, as per the name, is a summary of income and expenses, and the result of this summary is profit or loss for the specific period. It is a very important tool for preparing financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.. It works as a checkpoint and mitigates the errors which can occur in the preparation of financial statement directly transferring the balance from revenue and expense account.
Instead of sending a single – single balance of each account, it summarises all the ledger balances in one value and transfers it to a balance sheet, which given more meaningful output for investors, management, vendors, and other stakeholders. We can say it summarizes all the operating and non-operating business activity on one page and conclude the financial performance of the company.
This has been a guide to Income Summary and its definition. Here we discuss steps to prepare income summary along with examples, closing entries, advantages, and disadvantages. You can learn more from the following articles –