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 period, 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 accounts 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 debit 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 accounts balance will become zero.
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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 earnings or capital account 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 Income – $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 analysis.
- 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 statements. 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 –