Example Closing Process Explanation

Kristin is also the creator of Accounting In Focus, a website for students taking accounting courses. Since 2014, she has helped over one million students succeed in their accounting classes. Balance Sheet is the financial statement that is prepared to show the financial position of the organisation on a specific date. It reflects the assets and liabilities of a concern at a particular point of time.

An income summary account is a temporary account used by businesses at the end of the year to organize their finances. Businesses earn money (revenue) and incur expenses throughout the year. At the end of the year, businesses gather all revenue and expenses and place them into an income summary account. The income summary entries are the total expenses and total income from your company’s income statement. Then, you transfer the total to the balance sheet and close the account.

How to Calculate Income Summary for Closing

After this analysis, they move the total profit or loss into their main savings account, also called retained earnings, and the income summary account is emptied and ready to be used again next year. This serves as an excellent way for businesses to keep their financial records organized and start fresh each year. The income summary account is also known as the temporary income statement account. Temporary accounts are those that are closed at the end of an accounting cycle.

Think back to all the journal entries you’ve completed so far. 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. 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 income summary accounts all expenses.

The financial data in the income summary is all on the income statement. However, there are a couple of significant differences between them. I imagine some of you are starting to wonder if there is an end to the types of journal entries in the accounting cycle! So far we have reviewed day-to-day journal entries and adjusting journal entries. In essence, we are updating the capital balance and resetting all temporary account balances.

Let us understand how income summary closing entries are passed. Before passing those entries, there are a few processes and steps to be followed to reach that stage. Let us understand how to calculate the income of a company or an individual through the discussion below. The final amount you arrived at for the Income summary account is then recorded as a credit to the Accumulated income (loss) if it is a net profit. The net loss is entered as the debit, which is reflected under Equity in the company’s reports.

Income Summary vs Income Statement

In a corporation’s case, one must close the retained earnings account. At the end of the accounting period, all fees will be closed by transferring the debit to the income summary by crediting the expenses account and debiting the income summary account. After passing this entry, the all-expense accounts balance will become zero. At the end of the accounting period, all the revenue accounts will be closed by transferring the credit balance to the income summary. It will be done by debiting the revenue accounts and crediting the income summary account.

How to close a revenue account?

Similarly, the debit balances on the expense’s accounts are transferred and zeroed out by debiting the income summary and crediting the individual expenses account. The income summary account receives the balance at year end from the revenue and expense accounts. Once that’s completed, the income summary account is closed as well by transferring its balance to a capital account. The income summary account does not have a normal balance because it is a temporary account used to summarize revenues and expenses.

Using Income Summary in Closing Entries

• We added it to Retained Earnings on the Statement of Retained Earnings.
• At the end of the accounting period, all the revenue accounts will be closed by transferring the credit balance to the income summary.
• You can either close these accounts directly to the retained earnings account or close them to the income summary account.
• At the end of the accounting period, all fees will be closed by transferring the debit to the income summary by crediting the expenses account and debiting the income summary account.
• For closing transactions, the bookkeepers use an account called the Income summary account.

We know the change in the balance includes net income and dividends. Therefore, we need to transfer the balances in revenue, expenses and dividends (the temporary accounts) into Retained Earnings to update the balance. If the net balance of the 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.

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Step 1: Close all income accounts to Income Summary

In the new reporting year, each account is opened by recording the first business transaction on them. The following points are important to highlight related to the above income summary account for Bob and his company, Bob’s Donut Shoppe, Inc. Post the transactions to the income summary account and close the income summary account. The trial balance,  after the closing entries are completed, is now ready for the new year to begin. For partnerships, each partners’ capital account will be credited based on the agreement of the partnership (for example, 50% to Partner A, 30% to B, and 20% to C). For corporations, Income Summary is closed entirely to « Retained Earnings ».

The Income summary is not only not permanent, but it can also not exist in a particular business at all. Some businesses choose to forgo creating and then closing this Income summary account. This typically happens when a company uses accounting software to maintain its financial records.

• To close that, we debit Service Revenue for the full amount and credit Income Summary for the same.
• This typically happens when a company uses accounting software to maintain its financial records.
• This way each accounting period starts with a zero balance in all the temporary accounts.
• At the end of a financial period, the ending balance from the revenue accounts and expense accounts are transferred to the income summary account.

This may seem like pointless extra work, as you can transfer the data directly from the income statement to the balance sheet. Transferring revenue and expenses to the income summary creates a paper trail. That makes it much easier for auditors to later confirm that amounts in the balance sheet and elsewhere are legitimate. Calculating the income summary for a month, quarter or year is surprisingly easy. You do 99% of the work when making out your income statement. Then, you transfer a summary of the statement into a temporary account.

However, it can provide a useful audit trail, showing how these aggregate amounts were passed through to retained earnings. The income summary account is a temporary account used in the closing stage of the accounting cycle to collect the balances of the revenue and expense accounts, which are then closed. The purpose of the income summary account is to facilitate the process of closing temporary accounts and transfer their balances into the retained earnings account. An income summary account is a temporary account used at the end of an accounting period to collect all revenue and expense account balances. Once the revenues and expenses are transferred to the income summary account, the resulting net balance, whether a profit or a loss, is then moved to the retained earnings account.

It allows users to extract and ingest data automatically, and use formulas on the data to process and transform it. Kristin is a Certified Public Accountant with 15 years of experience working with small business owners in all aspects of business building. In 2006, she obtained her MS in Accounting and Taxation and was diagnosed with Hodgkin’s Lymphoma two months later. Instead of focusing on the fear and anger, she started her accounting and consulting firm. In the last 10 years, she has worked with clients all over the country and now sees her diagnosis as an opportunity that opened doors to a fulfilling life.