The Income Summary account is used:
A. To adjust and update asset and liability accounts.
B. To close the revenue and expense accounts.
C. To determine the appropriate withdrawal amount.
D. To replace the income statement under certain circumstances.
E. To replace the capital account in some businesses.
The correct answer and explanation is :
The correct answer is B. To close the revenue and expense accounts.
Explanation:
The Income Summary account plays a crucial role during the closing process of accounting at the end of an accounting period. It serves as a temporary account that facilitates the transfer of balances from the revenue and expense accounts to the owner’s equity (capital) account.
Process:
- Revenue Accounts: All the revenue accounts (such as Sales Revenue, Service Revenue, etc.) are credited to the Income Summary account. The revenue accounts are cleared out (their balances are set to zero) because the business wants to start fresh in the new accounting period.
- Expense Accounts: Similarly, all the expense accounts (such as Rent Expense, Wages Expense, etc.) are debited to the Income Summary account. This again clears out the balances in the expense accounts.
- Transfer to Owner’s Equity: After the revenue and expense balances have been transferred to the Income Summary account, the balance in the Income Summary account will either reflect a net income (if revenues exceed expenses) or a net loss (if expenses exceed revenues).
- If the Income Summary shows a net income, the balance is transferred to the owner’s capital account (in a sole proprietorship) or retained earnings account (in a corporation).
- If the Income Summary shows a net loss, the balance is subtracted from the owner’s capital account or retained earnings account.
Why Income Summary is Important:
- It helps to segregate the income and expenses for a particular period before they are officially transferred to the capital or retained earnings account.
- It prevents the direct alteration of revenue or expense accounts, ensuring that these accounts can be reset for the next period.
Thus, the primary purpose of the Income Summary account is to act as a transitional account for closing revenue and expense accounts (option B), ensuring proper bookkeeping for the subsequent accounting period.