Income Summary - Definition, How to Close, and Example (2024)

What is Income Summary?

An income summary is an account that is temporary and nets all the temporary accounts for a business upon closing them at the end of the given accounting period.

Though sometimes confused with income statements, the key difference between the two is that those income summaries are interim, whereas income statements are permanent.

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.

The result is a balance that shows either a profit or loss. For example, if a company's credit is more prominent than its debit on the final temporary account, it means they have made a profit. Conversely, if a company's debt is more prominent than its credit, they have sustained a loss.

It can also be called the revenue and expense summary since it compiles the revenue and expenses that stem from the operating and non-operating business functions.

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.

Closing entries play a significant role in producing the accounts as they move the temporary account balances to permanent accounts on the balance sheet.

Suppose the balance on the final account is a profit (credit balance). In that case, companies will debit the temporary account for the amount in profit and credit it to the retained earnings (a crucial part of the balance sheet).

If the balance on the final account is a loss (debit balance), companies have to credit the lost amount to the retained earnings. However, each temporary account can be reset thanks to closing entries and begin the next accounting period with a zero balance.

How is an Income Summary Prepared?

There are three steps to preparing this form, all relatively simple. These steps revolve around the revenue and expenses of the company. All companies have revenue and expense accounts, which need to be transferred into the company's summary.

Step 1: Close the Revenue Accounts

The first step in preparing it is to close all the revenue accounts. This is because revenue accounts are always gains. Thus, they always have credit balances.

When the accounting period ends, all the revenue accounts are closed when the credit balance is properly transferred. This involves debiting the revenue accounts to reset them with zero balance and crediting the final temporary account.

Step 2: Close the Expense Accounts

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.

When the accounting period ends, all the expense accounts are closed when the debit balance transfers into the income statement. Then, inversely to revenue accounts, the expense accounts are credited to reset them with zero balance and debiting the final account.

Step 3: Complete the Income Summary Account

To complete the income summary account, the last step to preparing it must be one column for credit and another for debit. The credit side will be the company's total income, and the debit side is the company's total expenditure.

When comparing the two columns, it is essential to look at their totals. If the credit balance exceeds the debit balance, it indicates a profit. On the other hand, if the debit balance is greater than the credit balance, it indicates a loss.

Once a company determines whether it has sustained a loss or earned a profit, the results from the final account are typically transferred into retained earnings on the balance sheet. However, it is sometimes transferred into a capital account. This concludes the process of producing an income summary.

Example of an Income Summary Account

To gain a better understanding of what these temporary accounts are, take a look at the following example.

This company is creating it for the end of the year, which is also the end of the accounting period. The closing of the revenue account balance on December 31st is:

• Sales - $40,000
• Interest Income - $200
• Other - $150

The closing balance of the expense account on December 31st is:

• Purchases - $25,000
• Rent - $5,000
• Salaries - $4,200
• Insurance - $850
• Advertising - $600
• Electricity - $120

Revenue account balance:

Looking at the revenue account balance, all the revenue-generating sources, whether operating or non-operating business functions are included in the process. Once all the revenue streams have been compiled, businesses credit them to transfer to the summary.

Expense account balance:

Transferring the expense account to the account is similar to the revenue account process. However, rather than credit the expense balance to transfer it, businesses must debit it, given that expenses are already credited.

Process of transferring income summary to retained earnings:

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.

This indicates that a profit was made because a credit balance must be debited to the income summary.

Prepared income summary account:

As the tables show, this business made a profit during the accounting period. As a result, the business credited its revenue account more than it debited its expenses account, leading to a credit balance.

While this example highlights exactly what preparing the account looks like, there are times when companies never actually have to go through the process of producing it.

Modern-day accounting software typically does the process of automatically debiting or crediting revenue and expense balances once the accounting period ends.

In many cases, the computer never even shows the income summary or has a record. The chart of accounts may not even show it either.

Income Summary vs. Income Statement

Often confused with income statements, the two are very different and should not be interpreted as being the other. The key similarity is that they both report total nets and losses.

They also have very similar names. The differences should, however, be noted.

Income Summary Advantages and Disadvantages

There are many advantages for businesses when they use income summaries. However, like every accounting tool, it must be used correctly and in coordination with other accounting tools to operate smoothly and provide value.

Below are the key advantages income summaries provide to businesses and companies during the accounting period:

• The most important benefit of using income summaries is that it allocates all expenses and revenues in one place. This makes it easy to transfer the information into the balance sheet.
• Compiling the revenue and expense accounts also helps determine financial performance over a set time, that being the accounting period.
• Companies that use these accounts can take note of their performance over the accounting cycle, allowing them to analyze thehealth of their company.
• Income summaries also provide significant tax advantages. All the information necessary for taxes is consolidated in a summary. The two-column format also simplifies calculating cash profit by adding or deducting the accrual balances.
• Income summaries help make budget vs. actual variance analysis simple. Variance analysis can provide businesses insight into their sales revenue and cost of sales. Making variance analysis simple provides significant benefits for companies.

While income summaries can provide significant benefits to companies that use them for accounting purposes, there are also some disadvantages to keep in mind. Many of these come in the form of understanding what each section of the document means and interpreting it.

Below are the key disadvantages income summaries provide to businesses and companies during the accounting period:

• One of the significant disadvantages of income summaries is that they are compiled using operating and non-operating functions. Doing this makes it so they do not provide an accurate financial picture of the company's cash flow.
• Regarding cash flow, income summaries do not give you any data on their situation. So, while they certainly highlight profitability, they can easily overlook whether or not the company's cash outflows are more significant than its inflows.
• Additionally, income summaries of one year are not enough to determine a company's performance. While comparing revenues and expenses over the year can undoubtedly underline some problems or strengths, company performance can only be determined after ten years.

Conclusion

Income summaries are temporary accounts that net all the revenue and expenses accounts to determine whether there was a credit balance (profit) or debit balance (loss). They make it easier for businesses to transition revenues and expenses into the balance sheet.

Without these accounts, accounting errors from transitioning the revenue and expense balances would be significantly more frequent. Additionally, all the information is condensed into one location, making it a fantastic tax tool.

Its use as an organizational skill is underlined by how it summarizes all the necessary ledger balances in one value instead of a single account balance. In addition, it summarizes all the business functions, especially the operating and non-operating activities.

Transferring it to a balance sheet gives more meaningful output to stakeholders, investors, and management. Therefore, learning about income summaries and other accounting tools in business is imperative.

WSO provides its members with an Accounting Foundations course to master the necessary accounting skills.

Researched and authored by Adrian de Vernou | LinkedIn

Reviewed and Edited by Raghav Dharmarajan

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