Income Summary Definition, How to Close, and Example

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.

Step 2: Closing the expense accounts

1. The process of creating and then closing an Income Summary account is the same whether you end the year in the red or in the black.
2. Remember that net income is equal to all income minus all expenses.
3. We’ll use a company called MacroAuto that creates and installs specialized exhaust systems for race cars.
4. While this example highlights exactly what preparing the account looks like, there are times when companies never actually have to go through the process of producing it.

Note that by doing this, it is already deducted from Retained Earnings (a capital account), hence will not require a closing entry. This is closed by doing the opposite – debit the capital account (decreasing the capital balance) and credit Income Summary. After the accounts are closed, the income summary is then transferred to the capital account of the owner and then closed.

Income Summary

Remember, dividends are a contra stockholders’ equity account. If we pay out dividends, it means retained earnings decreases. The remaining balance in Retained Earnings is $4,565 (Figure 5.6). This is the same https://www.quick-bookkeeping.net/19-accounting-bookkeeping-software-tools-loved-by/ figure found on the statement of retained earnings. 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.

How to Prepare Your Closing Entries

To add something to Retained Earnings, which is an equity account with a normal credit balance, we would credit the account. An income summary is a summary of income and expenses for a certain period, with the result being profit or loss. It is a necessary instrument for the preparation of financial statements. It acts as a checkpoint international tools and resources and reduces errors in financial statement preparation by directly transferring the balance from revenue and spending accounts. An income statement’s objective is to compile all of the account information on revenues and expenses recorded during an accounting period and display it in standard income-statement format.

Closing Entries Using Income Summary

However, it also gives an audit record of the year’s revenues, expenses, and net income. If the resulting balance in the account is a profit (a credit balance), debit the income summary account and credit the retained earnings account to shift the profit into retained earnings. If the resulting https://www.quick-bookkeeping.net/ balance in the account is a loss (a negative balance), credit the income summary account for the loss and debit the retained earnings account to move the loss into retained earnings. This is the second stage in using the income summary account; the account should now have a zero balance.

Let’s look at the trial balance we used in the Creating Financial Statements post. Without these accounts, accounting errors from transitioning the revenue and expense balances would be significantly more frequent. Additionally, all the information is condensed into one location, making it a fantastic tax labor efficiency variance formula cause tool. This indicates that a profit was made because a credit balance must be debited to the income summary. In essence, we are updating the capital balance and resetting all temporary account balances. To close that, we debit Service Revenue for the full amount and credit Income Summary for the same.

Since the income summary account is only a transitional account, it is also acceptable to close directly to the retained earnings account and bypass the income summary account entirely. Accounts such as Sales Income, Accounts Receivable and Interest Payable are permanent, the Corporate Finance Institute explains. Even if you don’t have any interest payable this period, the account exists, just with nothing in it. You create it at the end of the accounting period and then erase it from existence before starting the next 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. This is the second step to take in using the income summary account, after which the account should have a zero balance. 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.