Overview
People often like to start the new year from scratch. If you are a for-profit organization, this is not just something you can decide to do. This is what you have to do. There are a lot of rules and requirements every company has to adhere to when maintaining accounting records. So, once the year is over, the bookkeeping records go through a closing process. This is when a bookkeeper uses an account with the title Income Summary to get bookkeeping records ready for the new transactions. How exactly does it work?
The Income summary is a little helper bookkeepers turn to ensure that they move gains or losses and other temporary items to the Balance sheet without any errors. This bookkeeping account is created only for this purpose. Given that, it falls into the category of temporary bookkeeping accounts.
The word temporary does not mean that the bookkeeper crosses out the accounts altogether after some time. Actually, just the balances of each account are getting removed, which is typically the end of the calendar year for most companies. In other words, they will begin the new year with a blank slate. You will see these accounts on every business’s reports, which is obviously the accounts that reflect revenue sources, all the various expenses, and money paid to the shareholders.
Closing process
Closing of bookkeeping accounts that are set up as temporary happens when the reporting year comes to an end since the balances identified on them relate to the previous reporting period. In the new reporting year, each account is opened by recording the first business transaction on them.
To obtain information about the net amount of money received for the reporting year, all accounts that reflect business expenses are recorded as the debit to the Income summary, and revenue totals are recorded as the credit. The accounts related to the changes in equity are also closed.
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. Other accounts that record changes in equity for the reporting year are also closed.
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. In this case, the program or bookkeeper will take the balances of all the temporary general ledger accounts and add them directly to the appropriate Balance sheet accounts. You will make a credit entry when transferring revenue to the Retained earnings, for instance, and debit it when transferring all the expenses.
Example
To help you better grasp the concept, below you can see an example of the closing process.
Date
Account Name
DR
CR
December 31
Income Summary
$9,750
Cost of Goods Sold
$5,000
Depreciation
$800
Utilities
$450
Rent
$1,500
Payroll
$2,000
Date
Account Name
DR
CR
December 31
Revenue
$16,400
Income Summary
$16,400
Date
Account Name
DR
CR
December 31
Income Summary
$6,650
Retained Earnings
$6,650