Is Inventory a Permanent or Temporary Account?

In accounting, understanding how different financial records are categorized is fundamental to tracking a business’s financial health. These categories determine how an account’s balance behaves at the close of an accounting period. Clarifying these distinctions helps in accurately preparing financial statements.

What Are Permanent Accounts?

Permanent accounts, also known as real accounts, hold balances that carry forward from one accounting period into the next. Instead, their ending balance becomes the beginning balance for the subsequent period. This continuous nature allows for the ongoing tracking of a business’s cumulative financial position.

Examples of permanent accounts include all asset accounts, such as Cash, Accounts Receivable, and Property, Plant, and Equipment. Liability accounts like Accounts Payable, Notes Payable, and Bonds Payable also fall into this category. Equity accounts, including Owner’s Capital and Retained Earnings, are further examples of permanent records that maintain their balances across periods.

What Are Temporary Accounts?

Temporary accounts, sometimes called nominal accounts, are used to track financial activity for a specific accounting period. At the end of each fiscal period, their balances are closed out, typically to an equity account like Retained Earnings for corporations or Owner’s Capital for sole proprietorships. This process resets their balances to zero.

Revenue accounts, such as Sales Revenue or Service Revenue, are common examples of temporary accounts. All expense accounts, including Rent Expense, Salaries Expense, and Utilities Expense, are also classified as temporary. These accounts summarize a company’s performance over a defined period, which is then reflected in the income statement before being closed.

Why Inventory is a Permanent Account

Inventory is classified as a permanent account because it represents an asset of the business. Specifically, it is a current asset. Its balance does not reset to zero at the end of an accounting period.

Unsold inventory at the close of a fiscal year retains its value and remains on the company’s balance sheet. This ending inventory balance then automatically becomes the beginning inventory for the next accounting period. This continuous flow reflects its nature as a resource held for future economic benefit, directly aligning with the characteristics of a permanent account.

Account Types and the Accounting Cycle

The distinction between permanent and temporary accounts is significant within the accounting cycle. Permanent account balances are ultimately used to prepare the balance sheet, which provides a snapshot of a company’s financial position at a specific point in time. These balances, including inventory, are not subject to the closing process at year-end.

Temporary accounts, conversely, are closed out to prepare the income statement, summarizing financial performance over a period. The closing process ensures that these accounts start fresh, allowing for accurate measurement of profitability for each new period. Permanent accounts, by carrying forward their balances, form the foundation for the next period’s financial reporting.