What is an Income Summary Account and How to Calculate It?

Introduction

An income summary account is a temporary account used by businesses at the end of the year to organize their finances. Businesses earn money (revenue) and incur expenses throughout the year. At the end of the year, businesses gather all revenue and expenses and place them into an income summary account.

Once everything is in the account, businesses can easily determine if they made a profit or a loss. After this analysis, they move the total profit or loss into their main savings account, also called retained earnings, and the income summary account is emptied and ready to be used again next year. This serves as an excellent way for businesses to keep their financial records organized and start fresh each year.

In this blog, we will discuss the income summary account in detail and understand how to calculate it with some real-world examples.

What is an Income Summary Account?

An income summary account is a temporary account used at the end of an accounting period to collect all revenue and expense account balances. Once the revenues and expenses are transferred to the income summary account, the resulting net balance, whether a profit or a loss, is then moved to the retained earnings account.

The income summary account process ensures the generation of accurate financial statements and ensures that the revenues and expenses for the accounting period are accurately closed for that period.

How to Calculate an Income Summary Account?

Calculating an income summary account involves a few steps typically performed during the closing process at the end of an accounting period:

• Close revenue accounts

  To close a revenue account, first total the balances from all revenue accounts, such as sales and service income, to determine the total revenue for the period. Then, make a journal entry by debiting each revenue account and crediting the income summary account with the total revenue. This consolidates all earnings into the income summary account for further analysis.

• Close expense accounts

  Closing expense accounts involves summing the balances of all expense accounts, including costs such as salaries, rent, and utilities, to calculate the total expenses for the period. After determining the total, make a journal entry by crediting each expense account for its balance and debiting the income summary account with the total expense amount. This consolidates all expenses into the income summary account, preparing it for the final calculation of net income or net loss.

• Determine net profit or net loss

  After transferring all revenue and expense balances to the income summary account, assess the final balance to determine the net profit or net loss. If the total revenue (credited) exceeds the total expenses (debited), the income summary account will show a credit balance, indicating net profit. Conversely, if total expenses exceed total revenue, the account will show a debit balance, representing a net loss. This balance reflects the financial outcome for the period and provides the basis for adjusting retained earnings.

• Close the income summary account

  To close the income summary account, transfer its final balance to the retained earnings account. If the income summary account shows a credit balance due to net income, debit the income summary account and credit the retained earnings account by the same amount. If there is a debit balance due to a net loss, credit the income summary account and debit the retained earnings account. This final step clears the income summary account to zero and updates the retained earnings to reflect the net result of the period, ensuring the accounts are set for the new accounting period.

Example of an Income Summary Account

To understand how an income summary account works, let’s take a look at ABC company with the following financial information:

• Sales revenue: $100,000
• Service revenue: $20,000
• Salaries expense: $30,000
• Rent expense: $10,000
• Utility expense: $5,000

Step 1: Close revenue accounts

The journal entry to close the revenue will be:

Step 2: Close expense accounts

The journal entry to close the expense account will be:

Step 3: Determine net profit or net loss

• The balance in the income summary account after the above entries is a credit balance of $75,000 ($120,000 – $45,000), indicating net profit.

Step 4: Transfer net profit to retained earnings

The journal entry to transfer the net profit to retained earnings will be:

Step 5: Reset the income summary account

• After these entries, the income summary account balance is zero, ready for the next accounting period.

Importance of Income Summary Account for Your Business

The income summary account holds significant importance for a business due to several key reasons:

• Financial consolidation

  The income summary account aggregates all revenue and expense accounts for a specific period, providing a comprehensive view of the company’s net profit or net loss. This consolidation is essential for understanding overall financial performance, as it allows businesses to see the total revenues earned and expenses incurred in one place before making the final transfer to retained earnings.

• Streamlined closing process

  By serving as an intermediary, the income summary account simplifies the financial closing process. It ensures that revenue and expense accounts are reset to zero at the end of each period, preparing them for the next accounting cycle. This reduces the risk of errors and maintains accurate and organized financial records.

• Enhanced clarity

  Using an income summary account helps organize financial data into a single account before closing the books. This provides clarity, making it easier to review and verify financial information, which is beneficial for understanding the business’s financial health and ensuring accurate record-keeping.

• Facilitates decision-making

  The income summary account offers the stakeholders a clear summary of the financial performance for a period. This clear overview is crucial for making informed strategic decisions, as accurate financial data is foundational for effective planning, budgeting, and forecasting.

How Can HighRadius Help Streamline and Enhance the Management of Income Summary Accounts?

HighRadius offers a cloud-based Record to Report solution that helps accounting professionals streamline and automate the financial close process for businesses. We have helped accounting teams from around the globe with month-end closing, reconciliations, journal entry management, intercompany accounting, and financial reporting.

Our Financial Close Software is designed to create detailed month-end close plans with specific close tasks that can be assigned to various accounting professionals, reducing the month-end close time by 30%.The workspace is connected and allows users to assign and track tasks for each close task category for input, review, and approval with the stakeholders. It allows users to extract and ingest data automatically, and use formulas on the data to process and transform it.

Our Account Reconciliation Software provides an out-of-the-box formula set that can configure matching rules and match line-level transactions from multiple data sources and create templates to automate various transaction processing required for month-end close. Our solution has the ability to prepare and post journal entries, which will be automatically posted into the ERP, automating 70% of your account reconciliation process.

Our AI-powered Anomaly Management Software helps accounting professionals identify and rectify potential ‘Errors and Omissions’ throughout the financial period so that teams can avoid the month-end rush. The AI algorithm continuously learns through a feedback loop which, in turn, reduces false anomalies. We empower accounting teams to work more efficiently, accurately, and collaboratively, enabling them to add greater value to their organizations’ accounting processes.

FAQs

1) How to close a revenue account?

To close a revenue account, debit the revenue account for its balance and credit the income summary account with the same amount, consolidating the revenue for the period. This step ensures that the revenue is accurately transferred and the account is reset for the next period.

2) Is income summary a temporary account?

Yes, the income summary is a temporary account used to summarize revenues and expenses for a specific period before transferring the net income or net loss to the retained earnings account. It is reset to zero at the end of each accounting period and does not carry a balance forward.

3) How to close the income summary to retained earnings?

To close the income summary to retained earnings, debit the income summary account for its balance and credit the retained earnings account with the same amount, reflecting the net income or net loss for the period. This process updates retained earnings and resets the income summary account to zero.

4) On which financial statement will the income summary be shown?

The income summary account does not appear on any financial statement. It is a temporary account used to summarize revenues and expenses before transferring the net income or net loss to the retained earnings account on the balance sheet. After closing, its balance is reflected in the retained earnings on the balance sheet.

5) Does the income summary have a normal balance?

The income summary account does not have a normal balance because it is a temporary account used to summarize revenues and expenses. It can have either a credit balance (indicating net income) or a debit balance (indicating net loss), depending on the period’s financial results.

6) Income Summary vs. Income Statement

The income summary is a temporary account used to summarize revenues and expenses for the specific purpose of closing out accounts at the end of a financial period. In contrast, the income statement is a detailed financial statement that reports a company’s total revenues, expenses, and net income or loss over a specific period.