That’s exactly what we will be answering in this guide –  along with the basics of properly creating closing entries for your small business accounting. 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 income statement profit of $27,000 for the year ended 31 December 2022.

Everything to Run Your Business

Rather than closing the revenue and expense accounts directly to Retained Earnings and possibly missing something by accident, we use an account called Income Summary to close these accounts. Income Summary allows us to ensure that all revenue and expense accounts have been closed. The Income Summary is very temporary since it has a zero balance throughout the year until the year-end closing entries are made. Next, the balance resulting from the closing entries will be moved to Retained Earnings (if a corporation) or the owner’s capital account (if a sole proprietorship). HighRadius offers a cloud-based Record to Report solution that helps accounting professionals streamline and automate the financial close process for businesses. We have helped accounting teams from around the globe with month-end closing, reconciliations, journal entry management, intercompany accounting, and financial reporting.

Importance of Income Summary Account for Your Business

Expense accounts have a debit balance, so you’ll have to credit their respective balances and debit income summary in order to close them. Accounts are considered “temporary” when they only accumulate transactions over one single accounting period. Temporary accounts are closed or zero-ed out so that their balances don’t get mixed up with those of the next year. 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. After these two entries, the revenue and expense accounts have zero balances.

Step #4: Close Dividends

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. It summarizes income and expenses arising from operating and non-operating activities. Closing entries are journal entries made at the end of an accounting period, that transfer temporary account balances into a permanent 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. When doing closing entries, try to remember why you are doing them and connect them to the financial statements.

• Instead of sending a single account balance, it summarizes all the ledger balances in one value.
• All drawing accounts are closed to the respective capital accounts at the end of the accounting period.
• Assets, liabilities and most equity accounts are permanent accounts.
• In other words, they represent the long-standing finances of your business.
• Closing journal entries are made at the end of an accounting period to prepare the accounting records for the next period.
• If the credit balance is more than the debit balance, it indicates the profit; if the debit balance is more than the credit balance, it shows the loss.

In this case, the income summary account has a net credit balance which means that the company has a net income of $5 million. An income summary account is effectively a T-account of the income statement. Since it is a temporary ledger account, it does not appear on any financial statement.

income summary account

The income summary account is an intermediate point at which revenue and expense totals are accumulated what type of account is income summary before the resulting profit or loss passes through to the retained earnings account. However, it can provide a useful audit trail, showing how these aggregate amounts were passed through to retained earnings. At the end of a period, all the income and expense accounts transfer their balances to the income summary account. The income summary account holds these balances until final closing entries are made. Then the income summary account is zeroed out and transfers its balance to the retained earnings (for corporations) or capital accounts (for partnerships).

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. If the income summary account has a net credit balance i.e. when the sum of the credit side is greater than the sum of the debit side, the company has a net income for the period.

After closing, its balance is reflected in the retained earnings on the balance sheet. When making closing entries, the revenue, expense, and dividend account balances are moved to the retained earnings permanent account. If you own a sole proprietorship, you have to close temporary accounts to the owner’s equity instead of retained earnings. At the end of each accounting period, all of the temporary accounts are closed. This way each accounting period starts with a zero balance in all the temporary accounts, so revenues and expenses are only recorded for current years.