Is Cost of Goods Sold a Temporary Account?

Cost of Goods Sold (COGS) represents the direct costs attributable to the production of the goods a company sells. These costs typically include the direct materials, direct labor, and manufacturing overhead incurred to create the products. Cost of Goods Sold is categorized as a temporary account, a fundamental classification in financial reporting. This classification ensures accurate measurement of a business’s performance over specific periods.

Understanding Account Classifications

In accounting, accounts are broadly classified into two categories: temporary (or nominal) and permanent (or real). Temporary accounts track financial activity for a specific accounting period, such as a fiscal year or quarter. Their balances are reset to zero at the end of each period and do not carry forward. Examples include revenues, expenses, and dividends, which measure a company’s periodic financial performance.

Permanent accounts, conversely, maintain their balances from one accounting period to the next. They provide a cumulative view of a company’s financial standing. Common examples include assets like cash, accounts receivable, and inventory, as well as liabilities such as accounts payable and loans payable, and equity accounts like common stock and retained earnings. These accounts are reported on the balance sheet, reflecting the entity’s financial position.

Cost of Goods Sold as a Temporary Account

Cost of Goods Sold is classified as a temporary account because it is an expense directly tied to revenue generation within a specific accounting period. Like other expenses, COGS measures the cost incurred to produce goods sold during that period. This relationship allows for the accurate calculation of gross profit and net income for the defined timeframe.

As an expense, COGS’s balance must be reset to zero at the close of each accounting period. If not reset, costs would accumulate across multiple periods, making it impossible to determine profitability for any single period. Resetting COGS ensures financial performance accurately reflects costs and revenues pertinent to that period, preventing distortion in financial reporting.

The Closing Process

The closing process is a procedural step performed at the end of an accounting period to prepare the financial records for the next. Its primary objective is to transfer temporary account balances to a permanent equity account, typically Retained Earnings, effectively zeroing out temporary accounts. This ensures each new accounting period begins with a clean slate for revenue, expense, and dividend accounts.

For Cost of Goods Sold, the closing process involves crediting the COGS account to bring its balance to zero. This amount, along with the balances from other temporary accounts, is often transferred to an Income Summary account. The Income Summary account, itself a temporary account, serves as a clearing account to aggregate all revenues and expenses for the period. Finally, the net balance from the Income Summary account is transferred to the Retained Earnings account, which is a permanent equity account on the balance sheet. After these closing entries are posted, the COGS account starts the new accounting period with a zero balance, ready to accumulate new costs for the goods sold in that period.