Businesses need to account for income and expenses over certain time frames, called accounting periods. To do this effectively, managers set up income and expense accounts to track individual entries and the balance of the account as of the current day. These accounts must be closed, or cleared at the end of the accounting period, to be ready to receive new entries for the next period. Income and expense accounts are nominal, or temporary accounts, whereas asset, liability and owner's equity accounts are permanent accounts, which keep a running balance throughout the life of the business.
1. Complete the trial balance for the business. This is a listing of all of the general ledger accounts, with two columns for balance entries: a debit column on the left and a credit column on the right. Beside the name of each general ledger account, the balance is listed on the left or right side depending on if the balance is a debit or credit. Total each column. The totals should be equal, or balance. If they do not, correct the error before proceeding.
2. Close the income accounts to the "Income Summary" temporary account. Income accounts usually have a credit balance, increasing their value. Enter a debit in the journal against each income account for the business equal to its balance. The debit and credit cancel each other, with the result being a zero balance in the account. Make a corresponding credit entry into the Income Summary account, increasing its balance, and satisfying the rules of double-entry accounting.
3. Enter a credit amount in the journal for each expense account in an amount equaling the debit balance of the account. Enter an offsetting debit entry to the Income Summary account for each expense account. This results in a zero balance in the expense account and reduces the Income Summary account balance by the amount of expenses for the accounting period. The balance of the Income Summary account should equal the total income for the business during the same period.
4. Debit the Income Summary account for the total of the credit balance of the account, and make an entry under the Owner's Capital account for a sole proprietorship. With a partnership, split the amount into each partner's account according to each person's share in the business. For a corporation, make the entry into the retained earnings account.
5. Make an offsetting credit entry to the owner's draw account for the total balance of the account. The draw account generally has a debit balance and reflects money that the owner has taken from the business for his own use. Make the opposite debit entry to the owner's capital account. This subtracts the amount of the owner's draw from his equity in the business. Each of the temporary accounts now has a zero balance and are ready to receive entries for a new accounting period.
- An income account generally has a credit balance, with a debit balance for expense accounts. Credit entries increase the value of an income account, as well as a liability or owner's equity account, while a debit entry decreases the balance. Debit entries increase the value of an asset account, with a credit balance having the opposite effect.
- If the business has a loss for the month, the income summary account will not end up with a credit balance. Instead, it will have a debit balance and will require a credit entry to close the account and a corresponding debit entry to the owner's capital account. This will reduce the owner's equity to account for the loss.
Items you will need
- general ledger and journal for business
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