What Kind of Account Is Income Summary?
Unpack the Income Summary account's purpose and process within financial accounting, linking revenues, expenses, and equity.
An Income Summary account plays a specific role in the accounting process, particularly at the end of a financial period. It acts as a temporary holding place for certain financial figures before they are moved to a permanent record. This account simplifies the transfer of financial performance results into a company’s long-term equity.
Nature and Role of the Income Summary Account
The Income Summary account is classified as a temporary, or nominal, account. Unlike permanent accounts, which carry their balances forward from one accounting period to the next, temporary accounts are closed out at the end of each period. This reset ensures that revenue and expense figures accurately reflect only the activities of the current period, preventing them from accumulating indefinitely.
This account is specifically used during the “closing entries” phase of the accounting cycle. Closing entries are journal entries made at the end of an accounting period to transfer the balances of temporary accounts to permanent accounts. The Income Summary account serves as an intermediary, accumulating the balances of revenue and expense accounts. Its primary purpose is to act as a clearing account, facilitating the calculation of net income or loss before that figure is transferred to an equity account. While not strictly necessary in some modern computerized accounting systems, it provides a valuable audit trail by showing how aggregate revenue and expense amounts lead to the final profit or loss.
Accounts Summarized by Income Summary
The Income Summary account gathers balances from all revenue and expense accounts. Revenue accounts, which typically have credit balances, are debited to reduce their balances to zero. This debit effectively transfers the revenue amounts into the Income Summary account, where they are recorded as credits.
Similarly, expense accounts, which typically have debit balances, are credited to bring their balances to zero. These credited expense amounts are then transferred as debits to the Income Summary account. This process ensures that all revenue and expense accounts begin the next accounting period with a zero balance, ready to record new transactions.
Final Disposition of the Income Summary Balance
After all revenue and expense accounts have been closed into it, the Income Summary account holds a balance representing the company’s net income or net loss for the period. If the total credits (from revenues) exceed the total debits (from expenses), the Income Summary account will have a credit balance, indicating net income. Conversely, if the total debits exceed the total credits, it will have a debit balance, signaling a net loss. This balance should align with the net income or loss reported on the income statement.
The final step in the closing process involves transferring this net balance out of the Income Summary account. For corporations, this balance is transferred to the Retained Earnings account, which is a permanent equity account. If the Income Summary has a credit balance (net income), the Income Summary account is debited to zero it out, and Retained Earnings is credited to increase equity. If there is a debit balance (net loss), the Income Summary account is credited, and Retained Earnings is debited, thereby decreasing equity. This final transfer zeroes out the Income Summary account, completing its temporary role and updating the company’s long-term equity.