Temporary Account

Updated on April 26, 2024
Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What is A Temporary Account?

Temporary accounts are nominal accounts with zero balance at the beginning of the financial year. At the end of the year, the balance is visible in the income statement and later transferred to the permanent account in the form of reserves and surplus. Thus, accounts that are part of the income statement are temporary and are periodically closed.

What is A Temporary Account

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Temporary accounts are elements in accounting that remain in existence for a short period of time. Usually, they are started at the beginning of the accounting year and record every transaction within the accounting year. Temporary account accounting includes expense accounts, income statements, and withdrawal accounts. They are also referred to as nominal accounts.

Key Takeaways

  • Temporary accounts are accounts with zero balance at the start of the financial period and close at the end to retain accounting operations during the period. 
  • The temporary accounts are revenues and gains, losses and expenses, and drawing or income summary accounts.
  • The main objective of the temporary account is to view the profits or gains of the accounting period.
  • It is crucial to classify an account carefully under a temporary account because if one considers any asset account wrongly, it may erode the entity’s asset base.

Temporary Account Explained

Temporary accounts are accounts that are reset after a fixed period with respect to accounting. After the reset, their balance is zero, and are started afresh. The resetting of these accounts is owing to calculating the gains or losses of the particular accounting period. Therefore, temporary account numbers are independent of the performance of the company in previous financial years.

These are prepared to avoid a mix-up of the balances between two or more accounting periodsAccounting PeriodsAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance.read more. The main objective is to see particular periods’ profits or gains and the accounting activity. It is essential to diligently classify any account under a temporary account because if any asset account is wrongly considered, it will erode the asset base of the entity.

Since these accounts are temporary, the entries are moved to permanent accounts according to relevance for long-term documentation. The long-term accounts or the permanent accounts provide a detailed account of the company and its profitability.

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Types

Let us understand the different types of these accounts and temporary account accounting through the discussion below.

#1 – Revenues and Gains

The entity’s revenue and gains need to be closed at the end of every year. Thus, accounts like sales accounts, service revenue accounts, interest incomeInterest IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. read more account, dividend income account, and profit on the sale of debitDebitDebit represents either an increase in a company’s expenses or a decline in its revenue. read more details of a company’s assets. Examples include short-term Investments, prepaid expenses, supplies, land, equipment, furniture & fixtures, discount income account, etc. are the type of temporary accounts covered under revenue and gains.

#2 – Losses and Expenses

Expenses are the core of all businesses. Hence, as discussed in revenue, expenses must be precise at the end of the year to check the net outflow of the cash for the given period. Thus, accounts like the cost of sales account Cost Of Sales AccountThe costs directly attributable to the production of the goods that are sold in the firm or organization are referred to as the cost of sales.read more, salaries expense account, interest expenseInterest ExpenseInterest expense is the amount of interest payable on any borrowings, such as loans, bonds, or other lines of credit, and the costs associated with it are shown on the income statement as interest expense.read more account, delivery expense account, purchase account, etc., are the type of temporary accounts included under losses and gains.

#3 – Drawing Account or Income Summary Account

The income statement summary is transferred to the capital accountThe Capital AccountThe capital account refers to the general ledger that records the transactions related to owners funds, i.e. their contributions earnings earned by the business till date after reduction of any distributions such as dividends. It is reported in the balance sheet under the equity side as “shareholders’ equity.”read more in sole proprietorship and partnership at the end of the year. The income statement summary is credited to reserves and surplus in a dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more. Without these entries, books cannot be closed. Therefore, entries with such adjustments are considered closing entries and passed into the temporary accounts.

Examples

Below are a few scenarios to help us understand the temporary account numbers. Let us discuss different scenarios through the discussions below.

Example #1

Example #2

How to Close?

It is always mandatory to close all temporary accounts and record the net change to the owner’s capital account. To do this, pass the journal entries and post the same to respective ledgers balancing the same, and then pass closing entries for all temporary accounts. Finally, an income summary account is prepared to show the summary of revenue and expenseExpenseAn expense is a cost incurred in completing any transaction by an organization, leading to either revenue generation creation of the asset, change in liability, or raising capital.read more accounts and discloses the profits and losses of the entity for the given period.

Below are the steps to be followed to close these accounts: –

Steps to close Temporary Account

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Temporary Account Vs Permanent Account

Closure of accountIt gets closed at the end of every year.Permanent Account
Income statement vs. balance sheetAll the income statement accounts are temporary.All the balance sheet accounts are permanent.
Carry forward balancesThe balances of temporary accounts are not carried forward to the following year.The balances of permanent accounts are carried forward to the following year.
Brought forward balancesBalances are not carried forward. Therefore, no credits were brought forward.The permanent account may or may not have brought forward credits.
Also known asThey are also known as nominal accounts.They are also known as permanent accounts.
Post-closing trial balance existenceAfter preparing the trial balance, all such accounts will be zero.As credits are carried forward, there will be only a permanent account, post-closing trial balance.
ExamplesSales account, purchase account, expense account, income account, etc.Asset account, liability account, capital account, etc.

Frequently Asked Questions (FAQs)

Which is not a temporary account?

Revenue, expense, and profit and loss accounts are temporary accounts. In addition, in the case of a sole proprietorship or partnership, one may also have a temporary drawing or withdrawal account.

What is the difference between a permanent and temporary account?

Permanent accounts are different from temporary accounts. Temporary accounts display accomplishments across a specific duration. At the same time, permanent accounts show proceeding business progress.

Which is not a temporary account in accounting?

A drawings account is a corporation’s dividend account where the money is distributed to the owners. As it is not a temporary account, it is transferred to the capital account instead of the income summary through an amount credit.

Why are temporary accounts closed?

A temporary account is closed at the end of every accounting period and begins a new period with a zero balance. It is closed to safeguard the balances from being mixed with the subsequent accounting period balances.

This article is a guide to what is a Temporary Account. Here, we explain its examples, vs permanent accounts, along with how to close it. You can learn more about accounting from the following articles: –

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