Is Service Revenue a Temporary Account?

A common question arises regarding service revenue and its classification within the accounting system. This article will clarify whether service revenue is considered a temporary account and explain the significance of this distinction in financial practice.

What is Service Revenue

Service revenue represents the income a business earns from providing services to its customers. This differs from sales revenue, which comes from selling physical goods.

For example, consulting firms earn service revenue by offering strategic advice, law offices generate income through legal services, and repair shops receive payments for fixing items. This revenue is recognized when the service is performed, regardless of when the cash is received, especially under the accrual accounting method.

Understanding Temporary Accounts

Temporary accounts, also known as nominal accounts, track financial activities for a specific accounting period. These accounts include revenues, expenses, and dividends or owner’s drawings. Their purpose is to measure a business’s performance, such as its net profit or loss, over a defined period, like a month, quarter, or year.

A defining characteristic of temporary accounts is that their balances are reset to zero at the end of each accounting period. In contrast, permanent accounts (or real accounts), such as assets, liabilities, and equity, maintain their balances from one period to the next, reflecting a business’s cumulative financial position.

Service Revenue as a Temporary Account

Service revenue is indeed classified as a temporary account. This classification stems from its role in measuring a business’s financial performance over a specific period, typically a fiscal year.

The periodic nature of service revenue is crucial for determining a business’s profitability for that specific period. For instance, the service revenue earned in one year does not relate to the revenue earned in the next year. Therefore, at the close of an accounting period, the balance in the service revenue account must be reset to zero. This zeroing out allows the business to accurately begin tracking revenue for the subsequent period, preventing the mixing of income from different operational cycles.

Closing Temporary Accounts

At the end of an accounting period, businesses perform a crucial process called “closing the books” or making closing entries. This process involves transferring the balances of all temporary accounts, including service revenue, to permanent equity accounts. The primary goal is to reset the temporary accounts to a zero balance, preparing them to accumulate new transactions for the upcoming period.

For service revenue, its credit balance is transferred to an intermediate account called Income Summary. The Income Summary account then consolidates all revenues and expenses for the period, revealing the net income or loss. Finally, the balance from the Income Summary account is transferred to a permanent equity account, such as Retained Earnings for corporations or Owner’s Capital for sole proprietorships and partnerships. This final transfer ensures that the period’s profitability is reflected in the business’s overall equity, allowing for a fresh start in the new accounting cycle.