The entry to close Cost of goods sold results in a debit to Income summary
To understand why the entry to close Cost of Goods Sold (COGS) results in a debit to Income Summary, let's break it down:
1. Income Summary: Income Summary is a temporary account used during the closing process to summarize all revenue and expense accounts. It serves as a clearing account to calculate the net income or loss for the period.
2. Cost of Goods Sold (COGS): COGS represents the direct costs associated with producing goods or services sold by a company. It includes the cost of materials and labor directly used in production.
3. Closing Process: The closing process is a series of steps at the end of an accounting period to transfer the balances of temporary accounts (revenue and expense accounts) to a permanent account (retained earnings). This process resets the temporary accounts for the new period.
Now, let's see how the entry to close COGS results in a debit to Income Summary:
1. Opening Entry: Throughout the accounting period, expenses such as COGS are recorded with debit entries. This increases the expense accounts and reduces income.
2. Closing Entry: At the end of the accounting period, all revenue and expense accounts, including COGS, are closed. Closing entries are made to transfer their balances to Income Summary.
To close COGS, we credit the COGS account and debit the Income Summary account:
Dr. Income Summary
Cr. COGS
By debiting Income Summary, we are reducing its balance and transferring the cost of goods sold to this temporary account. This debit entry effectively reduces the company's net income for the period.
Finally, during the next closing cycle, the balance in the Income Summary account will be transferred to the Retained Earnings account, which is a permanent account on the balance sheet.