All too often, bookkeeping and accounting present a confusing morass of math concepts and complicated rules for small business owners. Two accounting concepts that are often confused with each other are the income summary and the income statement. While both are designed to report your company’s net profits and losses, the similarities end there. The income statement is a detailed account of a business' income and expenses. It’s a permanent part of the accounting record. In contrast, the purpose of an income summary is to simply close entries for a specific amount of time and then report those figures to the statement of retained earnings.
An income statement is a permanent account that tracks a business' income and expenses. An income summary is a temporary account designed to close out entries for an accounting period and then report those figures to retained earnings.
One of the major differences between the income summary and the income statement has to do with permanence. In small business accounting, accounts may be either permanent or temporary. Permanent accounts are essentially those accounts that are not closed when the accounting period ends. As a result, they’re cumulatively measured as a group. Permanent accounts are those that are included in the balance sheet, or the asset, liability and capital accounts. Permanent accounts would not include temporary accounts, such as the income summary, which is designed to help clean up and close revenues and expenses for a specific period of time.
The income summary is a transitional account that an accountant uses to close revenues and expenses at the end of an accounting period. Those figures come from the income statement. Once they’re copied from the income statement to the income summary, the next step is to subtract expenses from revenues. The resulting figure will either be a positive number, in which case it is called the net profit, or a negative number, in which case the company is said to show a loss for that particular period.
After the net profit or loss is calculated, it’s moved to, and reported on, the retained earnings sheet, which helps the business to determine the journal entry to close revenues. If the company reported a net profit, it's debited from the income summary and credited to the retained earnings. If the company reported a net loss, the income summary is credited and the retained earnings debited. The income summary then shows zero and the account is closed.
By way of contrast, the income statement is a permanent account. It’s not used solely for the purpose of holding specific figures only for a specific period of time, but rather, it’s used to report a company’s revenues, expenses, profits and losses for an accounting period. The income statement relates to the income summary, however. Specifically, the revenue and expense figures that income summaries are based on come straight from the income statement. However, income statements are much more detailed than the summaries.
Companies of different sizes and degrees of complexity can use income statements that are likewise simple or complex. Regardless of which approach the company takes, the basic formula is the same. The first section of the statement lists, and then adds together, all the company's sales revenues. Next, the statement lists the costs of the goods which were sold and adds together those costs. That figure is then subtracted from the total sales revenue to calculate gross profit. From gross profit, the statement deducts operational expenses from gross profit to calculate the income from operations.
After that, the statement then adds together nonoperating items, such as gains or losses. If the result is a positive number, it's added to the income from operations. If the result is a negative number, it's deducted. The resulting figure represents income before taxes. Finally, the statement adds together taxes and subtracts that figure from the before-tax income. The result is the company's net income.
The income statement and income summary have very different purposes. The primary purpose of an income summary is to close entries at the end of an accounting cycle. It’s a useful accounting tool, but it’s one that’s designed to be temporary in nature. On the other hand, an income statement is designed to calculate and compile income and expenses on a single sheet, in order to make it easier to determine the company’s overall financial health. The net income figure reported on the income statement will show whether the company is profitable or not, and also point out areas that need improvement.