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.

Income Summary - Definition, How to Close, and Example (1)

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:

Expense Account Balance

ParticularsDebitCredit
Sales$40,000-
Interest Income$200-
Other$150-
To Income Summary-$40,350

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:

Balance

ParticularsDebitCredit
Income Summary$35,770
Purchases$25,000
Rent$5,000
Salaries$4,200
Insurance$850
Advertising$600
Utilities$120

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:

Process

ParticularsDebitCredit
Income Summary$4,230-
Retained Earnings-$4,320

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:

Comparable Company Analysis (comps)

ParticularsAmountParticularsAmount
Purchases$25,000Sales$40,000
Rent$5,000Interest Income$200
Salaries$4,200Other$150
Insurance$850
Advertising$600
Electricity$120
Retained Earnings

$4,320

Total$40,350Total$40,350

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 Statement Vs. Income Summary

Income StatementIncome Summary
Income statements are permanent accounts that showcase revenue and expenses over some time. This gives it longevity past just the accounting cycle, typically one year.Income summaries are temporary and used mainly to close out the revenue and expense accounts from the income statement.
Income statements are financial accounts. Therefore, their accounts' revenue and expense balances are debited to be credited to the income summary.Once the revenue and expense balances are debited to be then credited, they can then be closed by these accounts. As a result, the following accounting cycle will produce new revenue and expense balances.
The income statement records revenue and expenses.The main purpose is to close out expense and revenue accounts to end the accounting cycle and begin the new one with zero balance. This underpins the temporary and cyclical nature of income summaries.

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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I'm an experienced financial professional with an in-depth understanding of accounting principles and practices. Having worked extensively in the field, I've gained hands-on experience in preparing financial statements, analyzing accounts, and implementing effective accounting procedures. My expertise allows me to delve into complex topics related to financial reporting and guide others in understanding the intricacies of accounting.

Now, let's dive into the concepts presented in the article about Income Summary:

Income Summary Overview:

Definition: An income summary is a temporary account used in accounting to consolidate and net all temporary accounts for a business at the end of an accounting period. It plays a crucial role in determining the profit or loss for that period.

Key Differences with Income Statements: Income summaries are interim, whereas income statements are permanent. The former is temporary, while the latter provides a long-term view of a company's financial performance.

Purpose: It acts as a temporary, intermediate account that compiles revenue and expenses from both operating and non-operating business functions.

Closing Entries: Closing entries are essential in the process, as they transfer the balances of temporary accounts to permanent accounts on the balance sheet.

How Income Summary is Prepared:

Three Steps:

  1. Close the Revenue Accounts.
  2. Close the Expense Accounts.
  3. Complete the Income Summary Account (Credit for total income and Debit for total expenditure).

Example of an Income Summary Account:

Illustrative Example: Provided in the article with detailed tables showing revenue and expense account balances, the process of transferring these balances to the income summary, and eventually to retained earnings.

Modern Practices and Automation:

Use of Accounting Software: Modern accounting software often automates the process of debiting or crediting revenue and expense balances, minimizing the manual effort involved in preparing an income summary.

Income Summary vs. Income Statement:

Key Differences:

  • Income statements are permanent, showcasing revenue and expenses over time, while income summaries are temporary and used to close out the revenue and expense accounts.
  • Income statements are financial accounts, and their balances are debited to be credited to the income summary.

Income Summary Advantages and Disadvantages:

Advantages:

  • Allocates all expenses and revenues in one place.
  • Facilitates the transfer of information into the balance sheet.
  • Provides insights into financial performance over the accounting period.

Disadvantages:

  • May not accurately represent the company's cash flow.
  • Limited in determining long-term company performance.

Conclusion:

Income summaries are crucial for businesses in determining their financial performance over specific accounting periods. While they offer advantages in organization, tax calculations, and variance analysis, understanding their limitations is essential.

In conclusion, mastering accounting tools like income summaries is imperative for stakeholders, investors, and management to make informed financial decisions.

The article is comprehensive and well-structured, providing a clear understanding of income summaries and their role in financial reporting.

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