At the end of each fiscal year all temporary accounts must be cleared. This is done so that company can track those accounts as they pertain to a new fiscal year.
Temporary accounts consist of revenue and expense accounts.
The balances from those accounts are moved to retained earnings.
Example:
Company XYZ has the following entries for its temporary accounts at the end of 2021:
Revenue Cr. $300,000
Payroll Expense Dr. $190,000
Material Expense Dr. $120,000
As the company moves from 2021 into 2022, it does not make sense to keep adding new revenue and expenses to existing balances because they do not pertain to 2020.
Company XYZ must clear temporary accounts. To do that, a Summary Account is used.
The following entries will be made to the summary account:
Revenue Dr. $300,000
Summary Account Dr. $10,000
Payroll Expense Cr. $190,000
Material Expense Cr. $120,000
The entries will wipe temporary accounts and set them to $0 balance. Summary account now has a balance of Cr. $10,000.
A summary account now needs to be cleared itself as it never appears on financial statements. To clear this account we must debit (credit) retained earnings:
Summary Account Dr. $10,000
Retained earnings: Cr. $10,000