Closing the December income summary account: the Guitar Lessons Corporation's December 31 adjusted trial balance reports income summary of $0. The two previous revenues and expenses closing journal entries changed this balance to a $920 credit balance ($3,395 revenues - $2,475 expenses). This $920 credit balance represents the Guitar Lessons Corporation's net income for December. At this point, the use of the name income summary seems quite logical: as a result of closing revenues and expenses to income summary, the income summary account summarizes the company's net income.

As stated several times in this and previous chapters, owners (stockholders) have a right to resources generated by management. In other words, owners have a right to a company's net income. Retained earnings is the stockholders' equity account in which owners' rights to net income are reported. Remember retained earnings reports the dollar amounts of resources generated by management and kept in the company. The accounting process by which net income is put into the retained earnings account is the closing of the income summary account.

The Guitar Lessons Corporation's income summary account would be closed at the end of December through the following journal entry.

Date 

Description 

Post. 
Ref. 

Debits 

Credits 

Dec. 31 

Income Summary

399 

920

 

 

     Retained Earnings

313 

 

920

 

Close income summary account 

 

 

 

 

The dollar amounts in the above journal entry were obtained directly from the company's December 31 general ledger, not from its adjusted trial balance. Remember, the adjusted trial balance was prepared before revenues and expenses were closed to income summary. Therefore, the income summary account balance was $0 on the December 31 adjusted trial balance but was a $920 credit balance after revenues and expenses were closed. Since the income summary account had a credit balance on December 31, it would be closed by a debit. The offsetting credit required so that total debits equals total credits was to the retained earnings account. Again, retained earnings reports the dollar amounts of resources generated by management and kept in the company.

 

After the journal entry to close the income summary account is posted to the company's general ledger, the accounts will appear as follows.

 

Retained Earnings

 

Income Summary

 

$4,250

 

$2,575

$3,395

 

$920

 

$920

 $0

 

$5,170

 

 

 

 

As the above general ledger accounts show, once the proper income summary closing entry is prepared and posted, the December 31 general ledger balance in the income summary account is $0. Net income has been transferred from revenue and expense accounts to the income summary account and, finally, to retained earnings. Thus, the results of management's efforts to generate resources in December are reflected in stockholders' equity. Furthermore, by closing revenues and expenses to income summary first and then closing income summary to retained earnings, the results of management's efforts appear as one item ($920) in retained earnings. If the income summary account had not been used but, instead, revenues and expenses were closed directly to income summary, the results of management's efforts would be more difficult to identify in retained earnings because several amounts (all revenues and expenses) would have had to be considered.

 

Since the effect of the income summary closing entry was simply to transfer dollar amounts between stockholders' equity accounts, the company's total resources and sources of resources remained unchanged, as shown below.

 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

$14,920

=

$2,900

+

$7,000

+

$5,020

 

 

 

 

 

 

- $920
income summary

+ $920
retained earnings

$14,920

=

$2,900

+

$7,000

+

$5,020

As a final note on the closing of income summary to retained earnings, remember the Guitar Lessons Corporation's statement of retained earnings presented in Chapter 4 and shown below. Note how December's net income was added to the December 1 retained earnings balance. In the accounting system, the $920 journal entry to close income summary to retained earnings accomplished the same purpose as adding net income to retained earnings on the statement of retained earnings. In both cases, retained earnings increased by the company's net income. Owners have a right to management-generated resources (net income) and owners' rights to management-generated resources are shown in retained earnings.

Guitar Lessons Corporation 
Statement of Retained Earnings 
For the Month Ended December 31

Balance, December 1

$4,250

Plus: Net Income for December

920

Subtotal

$5,170

Less: Dividends in December

150

Balance, December 31

$5,020

 

Closing the December dividends account: the Guitar Lessons Corporation's December 31 adjusted trial balance reports dividends of $150. This indicates that the company distributed to owners $150 of resources generated by the company's management.

 

To keep the results of December's distribution of resources from being reported again in January, the balance in the dividends account is eliminated, or closed, at the end of December through the following journal entry.

 

Date 

Description 

Post.
Ref.

Debits 

Credits 

Dec. 31 

Retained Earnings

313 

150

 

 

    Dividends

312 

 

150

 

Close dividends account 

 

 

 

The dollar amounts in the above journal entry were obtained directly from the company's December 31 adjusted trial balance. Since the dividends account had a debit balance on December 31, its balance was eliminated by a credit. The offsetting debit required so that total debits equals total credits was to the retained earnings account. Retained earnings reports the dollar amounts of resources generated by management and kept in the company. Since dividends are management-generated resources flowing out of the company to owners, dividends result in fewer management-generated resources being kept, or retained, in the company. Thus, dividends reduce retained earnings.

After the journal entry to close the dividends account is posted to the company's general ledger, the accounts will appear as follows.

Retained Earnings

 

Dividends

 

$4,250

 

$150

$150

$150

$920

 

$0

 

 

$5,020

 

 

 

 

Since the effect of the dividends closing entry was simply to transfer dollar amounts between stockholders' equity accounts, the company's total resources and sources of resources remained unchanged, as shown below.

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

$14,920

=

$2,900

+

$7,000

+

$5,020

 

 

 

 

 

 

- $150
retained earnings

+ $150
dividends

$14,920

=

$2,900

+

$7,000

+

$5,020


As a final note on the closing of dividends to retained earnings, remember the Guitar Lessons Corporation's statement of retained earnings presented in Chapter 4 and shown again below. Note how December's dividends were deducted from retained earnings. In the accounting system, the $150 journal entry to close dividends to retained earnings accomplished the same purpose as deducting dividends from retained earnings on the statement of retained earnings. In both cases, retained earnings decreased by the company's dividends.

 

Guitar Lessons Corporation 
Statement of Retained Earnings 
For the Month Ended December 31

Balance, December 1

$4,250

Plus: Net Income for December

920

Subtotal

$5,170

Less: Dividends in December

150

Balance, December 31

$5,020

 

** You now have the background to do text exercises 5.3, 5.4, and 5.5.
 

Practice Exercise

On September 30, the Christopher Corporation's adjusted trial balance appeared as follows.

Christopher Corporation
Adjusted Trial Balance 
September 30

Acct. No.

Account

Debits

Credits

111 

Cash

$8,000

 

113

Accounts Receivable

2,000

 

115 

Supplies

1,000

 

211

Accounts Payable

 

$2,500

215 

Income Taxes Payable

 

500

311 

Common Stock

 

4,000

313 

Retained Earnings

 

3,000

315 

Dividends

300

 

411 

Fees Revenue

 

6,000

511 

Supplies Expense

600

 

517 

Wages Expense

3,400

 

523 

Income Taxes Expense

700

 

 

Totals

$16,000

$16,000


1. Determine the company's retained balance on September 30 after all closing entries were prepared and posted to the general ledger.

The Christopher Corporation's retained earnings on its September 30 adjusted trial balance was $3,000. The company's net income for September was $1,300 ($6,000 fees revenue - $600 supplies expense - $3,400 wages expense - $700 income taxes expense). The company's September dividends were $300. After all closing entries were prepared and posted to the general ledger, the company's September 30 retained earnings balance is $4,000, which was calculated as follows.

Balance, September 1

$3,000

Plus: Net Income for September

1,300

Subtotal

$4,300

Less: Dividends in September

300

Balance, September 31

$4,000

 

2. Calculate the balance in the company's income summary account after all closing entries were prepared and posted to the general ledger.

 

The balance in the company's income summary account after the revenue and expense closing entries were prepared and posted to the general ledger was a credit balance of $1,300. The income summary balance was then closed to retained earnings, bringing the income summary balance to $0.

 

3. Calculate the balance in the company's dividends account after all closing entries were prepared and posted to the general ledger.

 

The balance in the company's dividends account on its adjusted trial balance was a debit balance of $300. The dividends balance was then closed to retained earnings, bringing the dividends balance to $0.

 

 

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