Afterward, its balance is transferred to the retained earnings (for corporations) or capital accounts (for partnerships). This moves income or loss from an income statement account to a balance sheet account. When the accounting period ends, https://www.kelleysbookkeeping.com/how-to-account-for-cash-receipts/ 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.
Types of Accounts
Temporary (nominal) accounts are accounts that are closed at the end of each accounting period, and include income statement, dividends, and income summary accounts. The new account, Income Summary, will be discussed shortly. These accounts are temporary because https://www.kelleysbookkeeping.com/ they keep their balances during the current accounting period and are set back to zero when the period ends. Revenue and expense accounts are closed to Income Summary, and Income Summary and Dividends are closed to the permanent account, Retained Earnings.
#1. Close Revenue Accounts
- The income summary account is an intermediate point at which revenue and expense totals are accumulated before the resulting profit or loss passes through to the retained earnings account.
- While revenues and expenses in accounting records are reset to zero at the conclusion of a period, they are reported in the income statement to reflect profitability for the time.
- Retained Earnings is the only account that appears in the closing entries that does not close.
- After the financial statements are finalized and you are 100 percent sure that all the adjustments are posted and everything is in balance, you create and post the closing entries.
- They’d record declarations by debiting Dividends Payable and crediting Dividends.
All of the revenue accounts balance in the credit side column as the organization’s total income. Also, all of the expense accounts balance in the debit side column as the organization’s total spending. If the credit balance is greater than the debit balance, the profit is indicated.
Permanent versus Temporary Accounts
We know that all revenue and expense accounts have been closed. If we had not used the Income Summary account, we would not have this figure to check, ensuring that we are on the right path. 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. The first step in preparing it is to close all the revenue accounts. Suppose the balance on the final account is a profit (credit balance).
Step 3: Close Income Summary account
This is no different from what will happen to a company at the end of an accounting period. A company will see its revenue and expense accounts set back to zero, but its assets and liabilities will maintain a balance. Stockholders’ equity accounts will also maintain their balances. In summary, the accountant resets the temporary accounts to zero by transferring the balances to permanent accounts. 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.
You will notice that we do not cover step 10, reversing entries. This is an optional step in the accounting cycle that you will learn about in future courses. Steps 1 through 4 were covered in Analyzing and Recording Transactions and Steps 5 through 7 were covered in The Adjustment Process. Because you paid dividends, you will need to reduce your retained earnings account, which is what this entry accomplishes. 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. Below are the T accounts with the journal entries already posted.
We could do this, but by having the Income Summary account, you get a balance for net income a second time. This gives you the balance to compare to the income statement, and allows you to double check that all income statement accounts are closed and have correct amounts. If you put the revenues and expenses directly into retained earnings, quality of design and quality of conformance you will not see that check figure. No matter which way you choose to close, the same final balance is in retained earnings. Likewise, shifting expenses out of the income statement requires you to credit all of the expense accounts for the total amount of expenses recorded in the period, and debit the income summary account.