In accounting, there are multiple types of accounts classified as assets, liabilities, equity, revenues or expenses. Further than that, accounts can be considered a permanent account or a temporary account.
The general rule is that balance sheet accounts are permanent accounts and income statement accounts are temporary accounts. In practice, temporary accounts require a little more attention than permanent accounts.
Accountants use an account called the income summary to close the year for temporary accounts. The purpose of this article is to define the income summary account and look at a helpful overview so that this account becomes less of a mystery.
Income Summary Account (The Definition)
The income summary account is a temporary account. At the end of a financial period, the ending balance from the revenue accounts and expense accounts are transferred to the income summary account.
By doing so, the income summary account displays the net results of the company for a financial period. The income summary account in a credit position means the company has made a profit and the income summary account in a debit position means the company has made a loss.
Essentially, the income summary account summarizes the activities of a company for a financial year.
Why Use the Income Summary Account?
When transferring the balance of all revenue and expense accounts to the income summary account, it ensures that those revenue and expense accounts are closed at year end and their ending balance becomes zero.
In the following financial year, the company starts the new year with adequate temporary accounts that start at zero. The separation of financial periods is a main concept in accounting standards.
This means that recording a transaction in the period in which they occurred is paramount. Being able to show activities for different financial periods is crucial too. Therefore, starting the year with temporary accounts at zero balance is important.
Read More:
Closing Entries Accounting Examples (Beginners: Step by Step)
Income Summary Account: How Does It Work?
The income summary account receives the balance at year end from the revenue and expense accounts. That’s when the revenue and expense accounts are closed. Once that’s completed, the income summary account is closed as well by transferring its balance to a capital account.
This is essentially a 3-steps process:
- Close all revenue accounts.
Revenue accounts are natural credit accounts. This means that in order to close a revenue account at the end of a financial year, a debit entry needs to be created with the balance of the revenue accounts. The other side of the entry (credit) goes to the income summary account.
- Close all expense accounts.
Expense accounts are natural debit accounts. This means in order to close an expense account at the end of a financial year, a credit entry needs to be generated with the balance of the expenses. The other side of the entry (debit) goes to the income summary account.
- Close the income summary account.
To close the income summary account, the balance in the account needs to be transferred to a capital account (generally the retained earnings).
- If the income summary account is at profit (meaning it ends in a credit position), the entry needs to debit the income summary account and credit the capital account.
- If the income summary account is at loss (meaning it ends in a debit position), the entry needs to credit the income summary account and debit the capital account.
Examples of Income Summary Accounting
Let’s take the example of Carl’s Construction Company (“CCC”). On the year end date of 31 December 2022, CCC had the following ending balances in its revenue and expense accounts:
| Revenues | |
| Sales | $150,000 |
| Interest income | $12,000 |
| Gain on sale of equipment | $25,000 |
| Expenses | |
| Cost of goods sold | $50,000 |
| Rent | $30,000 |
| Utilities | $15,000 |
| Salaries | $60,000 |
| Other expenses | $5,000 |
We will use the 3-steps process to close the revenue and expense accounts before closing the income summary account.
Step 1: Journal entry to close the revenue accounts
| Debit | Credit | |
| Sales | $150,000 | |
| Interest income | $12,000 | |
| Gain on sale of equipment | $25,000 | |
| Income summary account | $187,000 |
Step 2: Journal entry to close the expense accounts
| Debit | Credit | |
| Income summary account | $160,000 | |
| Cost of goods sold | $50,000 | |
| Rent | $30,000 | |
| Utilities | $15,000 | |
| Salaries | $60,000 | |
| Other expenses | $5,000 |
Step 3: Journal entry to close the income summary account
From step 1 and 2, we can see that total revenues and expenses are $187,000 and $160,000 respectively. That means CCC has earned a net profit of $27,000 for the year ended 31 December 2022.
The income summary account is at a credit position of $27,000 so that means to close the account, we need to debit the income summary account of that amount with the balancing side going to retained earnings.
| Debit | Credit | |
| Income summary account – net profit | $27,000 | |
| Retained earnings | $27,000 |
For the year ended 31 December 2022, the income summary account looks like the following:
Carl’s Construction Company Income Summary Account for the year ended 31 December 2022
| Account | Debit Amount | Account | Credit Amount |
| Sales | $150,000 | Cost of goods sold | $50,000 |
| Interest income | $12,000 | Rent | $30,000 |
| Gain on sale of equipment | $25,000 | Utilities | $15,000 |
| Salaries | $60,000 | ||
| Other expenses | $5,000 | ||
| Retained earnings | $27,000 | ||
| Total | $187,000 | Total | $187,000 |
Read More:
Average Income for Accountants (Income of a CPA Exposed)
Recapping Income Summary Meaning in Accounting
- Revenues and expenses are transferred to the income summary account at the end of a financial year.
- The income summary account summarizes the activities of a company for a year.
- At the end of a financial period, the income summary account needs to be closed out and the balance moved to a permanent account by using the 3-steps process.
- Using the income summary account properly ensures the clear separation of periods in the process of preparing financial statements.
Income Summary: Final Thoughts
The income summary account is important for any accountant or business owners that are preparing financial statements. It allows for transactions to be reflected correctly in the right financial period as long as it is accurately closed out at the end of every financial period.
This account is a great tool to show the net profit or loss of a company for any financial years.
