Companies must carry over balances from one year to another for the next accounting period. However, they cannot do so directly to revenue and expense accounts. Therefore, companies must use an income summary account.
What is an Income Summary Account?
An income summary account is a temporary account used in the accounting process to aggregate all the revenue and expense account balances at the end of an accounting period. This process helps reset the revenue and expense accounts to zero, preparing them for the next period’s transactions. It allows companies to determine the net profit or loss during a year.
After summarizing the period’s revenues and expenses in the income summary account, the resulting net income or net loss gets transferred to the retained earnings or capital account, depending on the type of business entity. This final transfer closes the income summary account and updates the company’s equity to reflect the financial results of the period.
How does the Income Summary Account work?
The income summary account functions as a temporary holding account during the closing process in accounting, aggregating all the revenue and expense balances at the end of an accounting period. The process begins by transferring the balances of all revenue accounts to the income summary account, which involves debiting the revenue accounts and crediting the income summary account.
Subsequently, all expense accounts are closed by transferring their balances to the income summary account, debiting the income summary account, and crediting the expense accounts. Once the net income or net loss is determined, the income summary account is closed by transferring its balance to the retained earnings or capital account.
If the result is net income, the income summary account is debited, and the retained earnings are credited. Conversely, if there is a net loss, the retained earnings are debited, and the income summary account is credited. This final transfer updates the equity accounts to reflect the period’s financial performance.
Income Summary Account vs Income Statement: What are the differences?
The differences between the income summary account and the income statement come from the following points.
Purpose
The income summary account is a temporary account used during the closing process to consolidate all revenue and expense balances and determine net income or net loss for the period. On the other hand, the income statement is a critical financial report summarizing a company’s revenues, expenses, and profits or losses over a specific reporting period.
Function
The income summary account acts as an intermediary step to reset revenue and expense accounts to zero, preparing them for the next accounting period. In contrast, the income statement informs stakeholders about the company’s financial performance and profitability, aiding in analysis and decision-making.
Duration
The income summary account exists only during the closing process and gets reset once net income or net loss is transferred to retained earnings or capital accounts. However, the income statement is prepared for regular reporting periods (monthly, quarterly, annually) and serves as a permanent record.
Reporting
The income summary account is an internal tool and doesn’t become a part of the financial statements. On the other hand, the income statement is a part of the company’s official financial statements, reported externally by accounting standards.
Conclusion
The income summary account is an internal tool to determine net profit or loss by aggregating all revenue and expense account balances. By doing so, it also resets those balances in the relevant accounts. It is a part of the closing process. The income summary account differs from the income statement in various crucial aspects.
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