A little help with understanding these steps in preparing an income statement

[bunyonb]

Why do they transfer the balance of the sales account to the trading account? How does this close the sales account? And why do they credit the trading account? How does debitting the sales account closes it?

Why do they transfer the balance of the purchases account to the trading account? Why do they say you must debit the trading account and credit the purchases account(thus closing it)? What's the rule that says you must do that? Why do they draw up a trading account seperate from the one that makes up the income statement/trading profit and loss account

 

[kirby]

When you say "trading account" do you mean the "income summary"? But the income summary process is only done to start a new accounting year. So - please clarify thanks

 

[ColinCPA]

I do not understand what you mean by "trading account", but let me see if I can teach some Accounting 101 and clear up some obvious misconceptions.

There are two kinds of accounts. Temporary (income statement accounts) and permanent (balance sheet accounts). The "sales" and "purchases (cost of goods sold)" accounts are temporary accounts to be reported on the income statement. This is because they report the sales and inventory expensing activity over the reporting period. At the end of the period, they are "closed" into the real accounts on the balance sheet (capital/retained earnings) so that the next reporting period can start anew.

When it comes time to close the accounts, you would obviously need to "zero out" the balances of those accounts to close them. The sales account(s) will have a credit balance, therefore the closing entry will include a debit to zero it out. The other side of the entry must be a credit, so it hits the balance sheet (capital/retained earnings account). Correspondingly, the purchases (or cost of goods sold) account(s) have a debit balance, so obviously they follow the opposite logic to close out, with a debit hitting the balance sheet.

The result is that your income statement is zeroed out for the next period and your balance sheet reflects the accumulation of income (or loss) from the period.

That's about it.