Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. He is the sole author of all the materials on AccountingCoach.com.
The next day, January 1, 2019, you get ready for work, but before you go to the office, you decide to review your financials for 2019. What are your total expenses for rent, electricity, cable and internet, gas, and food for the current year? You have also not incurred any expenses yet for rent, electricity, cable, internet, gas or food. This means that the current balance of these accounts is zero, because they were closed on December 31, 2018, to complete the annual accounting period. You can either close these accounts straight to the retained profits account or close them to the income summary account.
What is an Income Summary Account?
The balance in the Income Summary account equals the net income or loss for the period. This balance is then transferred to the Retained Earnings account. The accounts that need to start with a clean or $0 balance going into the next accounting period are revenue, income, and any dividends from January 2019. To determine the income (profit or loss) from the month of January, the store needs to close the income statement information from January 2019. The income summary account has a balance equal to Sam’s Guitar Shop’s net income for the year after Sam’s Guitar Shop prepares its closing entries. In a journal entry like this, the balance is transferred to the retained earnings account.
Transfer of Earnings
Closing entries prepare a company for the next accounting period by clearing any outstanding balances in certain accounts that should not transfer over to the next period. Closing, or clearing the balances, means returning the account to a zero balance. Having a zero balance in these accounts is important so a company can compare performance across periods, particularly with income. It also helps the company keep thorough records of account balances affecting retained earnings. Revenue, expense, and dividend accounts affect retained earnings and are closed so they can accumulate new balances in the next period, which is an application of the time period assumption. 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.
Once all the temporary accounts are compiled, the value of each account is then debited from the temporary accounts and credited as a single value to the income summary. You record the income define the income summary account summary amount by adding the total expenses and total income and then transferring them to the balance sheet. If the Income Summary has a debit balance, the amount is the company’s net loss.