Since dividend and withdrawal accounts are not income statement accounts, they do not typically use the income summary account. These accounts are closed directly to retained earnings by recording a credit to the dividend account and a debit to retained earnings. The income summary is used to transfer the balances of temporary accounts to retained earnings, which is a permanent account on the balance sheet.
Permanent Accounts
The closing entries are dated in the journal as of the last day of the accounting period. Your closing journal entries serve as a way to zero out temporary accounts such as revenue and expenses, ensuring that you begin each new accounting period properly. Now that all the temporary accounts are closed, the income summary account should have a balance equal to the net income shown on Paul’s income statement. Now Paul must close the income summary account to retained earnings in the next step of the closing entries. A sole proprietor or partnership often uses a separate drawings account to record withdrawals of cash by the owners.
Balance Sheet
Here are MacroAuto’s accounting records simplified, using positive numbers for increases and negative numbers for decreases instead of debits and credits in order to save room and to get a higher-level view. The process of using of the income summary account is shown in the diagram below. For sole proprietorships and partnerships, you’ll close your drawing account to your capital account, because you will need to reduce your capital account by the draws taken for the month. If your expenses for December had exceeded your revenue, you would have a net loss.
The expense accounts have debit balances so to get rid of their balances we will do the opposite or credit the accounts. Just like in step 1, we will use Income Summary as the offset account but this time we will debit income summary. The total debit to income summary should match total expenses from the income statement. Remember the income statement is like a moving picture of a business, reporting revenues and expenses for a period of time (usually a year). We want income statements to start every year from zero, but for accounts like equipment, debt, and cash accounts—reported on the balance sheet—we want to keep a running balance from the beginning of the business.
While these accounts remain on the books, their balance is reset to zero each month, which is done using closing entries. Closing entries are the journal entries used at the end of an accounting period. Remember that all revenue, sales, income, and gain accounts are closed in this entry. Whether you’re processing closing entries manually, or letting your accounting software do the work, closing entries are perhaps the most important part of the accounting cycle.
All temporary accounts must be reset to zero at the end of the accounting period. To do this, their balances are emptied into the income summary account. The income summary account then transfers the net balance of all the temporary accounts to retained earnings, which is a permanent account on the balance sheet. If a temporary account has a debit balance it is credited to bring it to zero, and the retained earnings account is credited to balance the closing entry. Likewise, if a temporary account has a credit balance, it is debited to bring it to zero and the retained earnings account is credited.
Step 3: Close Income Summary account
The balance in dividends, revenues and expenses would all be zero leaving only the permanent accounts for a post closing trial balance. The trial balance shows the ending balances of all asset, liability and equity accounts remaining. The main change from an adjusted trial balance is revenues, expenses, and dividends are all zero and their balances have been rolled into retained earnings.
In this example we will close Paul’s Guitar Shop, Inc.’s temporary accounts using the income summary account method from his financial statements in the previous example. Temporary accounts are income statement accounts that are used to track accounting activity during an accounting period. For example, the revenues account records the amount of revenues earned during an accounting period—not during the life of the company. We don’t want the 2015 revenue account to show 2014 revenue numbers. Income summary is a holding account used to aggregate all income accounts except for dividend expenses.
Step 1: Close Revenue accounts
All temporary accounts eventually get closed to retained earnings and are presented on the balance sheet. Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step. There is no need to close temporary accounts to another temporary account (income summary account) in order to then close that again. Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow.
You begin the closing process by transferring revenue and expense account balances to the income summary account, a temporary account used specifically to transfer revenue and expense account balances. As mentioned, temporary accounts in the general ledger consist of income statement accounts such as sales or expense accounts. When the income statement is published at the end of the year, the balances of these accounts are transferred to the income summary, which is also a temporary account. The permanent accounts in which balances are transferred depend upon the nature what services will you offer of business of the entity.
- Closing entries are mainly used to determine the financial position of a company at the end of a specific accounting period.
- As a corresponding entry, you will credit the income summary account, which we mentioned earlier.
- ‘Retained earnings‘ account is credited to record the closing entry for income summary.
- They are special entries posted at the end of an accounting period.
- Notice how only the balance in retained earnings has changed and it now matches what was reported as ending retained earnings in the statement of retained earnings and the balance sheet.
- For example, in the case of a company permanent accounts are retained earnings account, and in case of a firm or a sole proprietorship, owner’s capital account absorbs the balances of temporary accounts.
We will debit the revenue accounts and credit the Income Summary account. The credit to income summary should equal the total revenue from the income statement. On the statement of retained earnings, we reported the ending balance of retained earnings to be $15,190. We need to do the closing entries to make them match and zero out the temporary accounts. All expense accounts are then closed to the income summary account by crediting the expense accounts and debiting income summary.
Notice how only the balance in retained earnings has changed and it now matches what was reported as ending retained earnings in the statement of retained earnings and the balance sheet. Because you paid dividends, you will need to reduce your retained earnings account, which is what this entry accomplishes. Since we credited income summary in Step 1 for $5,300 and debited income summary for $5,050 in Step 2, the balance in the income summary account is now a credit of $250. Let’s move on to learn bookkeeper in tennessee about how to record closing those temporary accounts. Clear the balance of the revenue account by debiting revenue and crediting income summary. These accounts are be zeroed and their balance should be transferred to permanent accounts.
Closing entries are mainly made to update the Retained Earnings to reflect the results of operations and to eliminate the balances in the revenue and expense accounts, enabling them to be used again in a subsequent period. A net loss would decrease owner’s capital, so we would do the opposite in this journal entry by debiting the capital account and crediting Income Summary. Temporary accounts are accounts in the general ledger that are used to accumulate transactions over a single accounting period.
The income statement reflects your net income for the month of December. Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs. Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career. Net income is the portion of gross income that’s left over after all expenses have been met. Retained earnings are defined as a portion of a business’s profits that isn’t paid out to shareholders but is rather reserved to meet ongoing expenses of operation.
There are various journals for example cash journal, sales journal, purchase journal etc., which allow users to record transactions and find out what caused changes in the existing balances. Closing entries are mainly used to determine the financial position of a company at the end of a specific accounting period. In order to produce more timely information some businesses issue financial statements for periods shorter than a full fiscal or calendar year. Such periods are referred to as interim periods and the accounts produced as interim financial statements. Any account listed on the balance sheet is a permanent account, barring paid dividends.