As we mentioned, the income summary is a temporary account in itself. You will start by clearing out the income accounts from the income statement (revenue) and crediting the income summary. Once all of the required entries have been made, you can run your post-closing trial balance, as well as other reports such as an income statement or statement of retained earnings.
Closing entry for revenues
For instance, a company with a $5,000 credit in the income summary account must debit income summary for $5,000. This entry takes the income summary account balance off the company’s books. Write the date when the company transfers the income summary balance to the retained earnings account. Draft the day and month when the company closes the income summary account. Credit expenses for the amount contained in the company’s expense account. If a company has $5,000 in its expense account, the company must credit expense for $5,000.
Step 3: Closing the income summary account
- The income statement reflects your net income for the month of December.
- For the rest of the year, the income summary account maintains a zero balance.
- Write the date when the company transfers the income summary balance to the retained earnings account.
- A company often employs a variety of accounting tools to keep track of its profits or losses and expenses.
- They’d record declarations by debiting Dividends Payable and crediting Dividends.
If the resulting 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. Then you are going to create a journal entry to transfer the balance of each temporary account to the appropriate permanent account. For example, the balance of a revenue account will go to the income summary. After this closing entry has been posted, each of these revenue accounts has a zero balance, whereas the Income Summary has a credit balance of $7,400. The company can make the income summary journal entry by debiting the income summary account and crediting the retained earnings if the company makes a net income.
Types of Accounts
To determine the income (profit or loss) from the month of January, the store needs to close the income statement information from January 2019. We need to complete entries to financial engineer update the balance in Retained Earnings so it reflects the balance on the Statement of Retained Earnings. We know the change in the balance includes net income and dividends.
How to Prepare Your Closing Entries
The credit to income summary should equal the total revenue from the income statement. It is a temporary, intermediate account, which means that the revenue and expenses balance is transferred to permanent accounts at the end of the accounting period through closing entries. The purpose of closing entries is to prepare the temporary accounts for the next accounting period.
8: Closing Entries
Whether you’re posting entries manually or using accounting software, all revenue and expenses for each accounting period are stored in temporary accounts such as revenue and expenses. Likewise, after transferring all revenues and expenses to the income summary account, the company can make the journal entry to close net income to retained earnings. The income summary is a temporary account that its balance is zero throughout the accounting period. The company only uses this account at the end of the period to clear all accounts in the income statement. Likewise, after transferring the balances of all accounts in the income statement to the balance sheet, the income summary balance will become zero again.
Step 1 – Close Revenue to the Income Summary
And so, the amounts in one accounting period should be closed so that they won’t get mixed with those in the next period. Now for this step, we need to get the balance of the Income Summary account. In step 1, we credited it for $9,850 and debited it in step 2 for $8,790. If it all seems a bit complex or maybe you are a small business owner who takes on their own accounting, you may wonder if you really need to know closing entries in practice.
Debit the company’s revenue account for the balance in the revenue account. For instance, a company with a $10,000 balance in revenue must debit revenue for $10,000. This entry takes the amount contained in the company’s revenue account off the books.
” Could we just close out revenues and expenses directly into retained earnings and not have this extra temporary account? We could do this, but by having the Income Summary account, you get a balance for net income a second time. This gives you the balance to compare to the income statement, and allows you to double check that all income statement accounts are closed and have correct amounts. If you put the revenues and expenses directly into retained earnings, you will not see that check figure. No matter which way you choose to close, the same final balance is in retained earnings. The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts.
In other words, the income and expense accounts are “restarted”. The income summary account is an account that receives all the temporary accounts of a business upon closing them at the end of every accounting period. This means that the value of each account in the income statement https://www.business-accounting.net/ is debited from the temporary accounts and then credited as one value to the income summary account. Lastly, prepare a post-closing trial balance to verify that the balances of the permanent accounts are correct and that the temporary accounts have been reset to zero.
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. Though sometimes confused with income statements, the key difference between the two is that those income summaries are interim, whereas income statements are permanent. 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).
All companies have revenue and expense accounts, which need to be transferred into the company’s summary. If you paid out dividends during the accounting period, you must close your dividend account. Now that the income summary account is closed, you can close your dividend account directly with your retained earnings account.
At the end of a period, the balances of all income and expense accounts are transferred to the income summary account. This retains these balances until final closing entries are made. Afterward, its balance is transferred to the retained earnings (for corporations) or capital accounts (for partnerships).
Note that by doing this, it is already deducted from Retained Earnings (a capital account), hence will not require a closing entry. Finally, you are ready to close the income summary account and transfer the funds to the retained earnings account. Communicate the day and month of the closing entry in the general journal. You record the income summary amount by adding the total expenses and total income and then transferring them to the balance sheet. The income and spending accounts are, as you can see, transferred to the income summary account. Now that we have closed income and expenses, we need to move the balances from the income summary to retained earnings.
You follow the same transfer-and-close process with the Income Summary account as with the first two temporary accounts. Debit the $7,000, transfer the total to your Retained Earnings or Owner’s Capital account, and then close Income Summary. Alternatively, you can take the income and expense figures from your income statement and record the total in Retained Earnings without setting up an intermediate Income Summary account.
To further clarify this concept, balances are closed to assure all revenues and expenses are recorded in the proper period and then start over the following period. The revenue and expense accounts should start at zero each period, because we are measuring how much revenue is earned and expenses incurred during the period. However, the cash balances, as well as the other balance sheet accounts, are carried over from the end of a current period to the beginning of the next period. Transferring funds from temporary to permanent accounts also updates your small business retained earnings account. You can report retained earnings either on your balance sheet or income statement. Without transferring funds, your financial statements will be inaccurate.
Therefore, we need to transfer the balances in revenue, expenses and dividends (the temporary accounts) into Retained Earnings to update the balance. After closing the revenue accounts, the next step in compiling the document is to close all the expense accounts. Expense accounts are always losses or costs, meaning they have debit balances.
