What Accounts Are Temporary Accounts?

Financial accounts serve as the organizational backbone for businesses, providing a structured way to record and summarize financial transactions. These accounts are essential for tracking a company’s economic activities and presenting its financial health and performance to stakeholders. The classification and management of these accounts are fundamental to accurate financial reporting.

Understanding Temporary Accounts

Temporary accounts, also known as nominal accounts, are accounting records used to track financial activities that relate to a specific accounting period. These accounts include revenues, expenses, and dividends or owner’s drawings. Their purpose is to measure a company’s performance over a defined timeframe, such as a fiscal quarter or year. At the beginning of each new accounting period, temporary accounts start with a zero balance, reflecting that they track activity only for the current period and ensuring financial results are not mixed.

Temporary Accounts Versus Permanent Accounts

The distinction between temporary and permanent accounts lies in their longevity and how their balances are treated at the end of an accounting period. Permanent accounts, also referred to as real accounts, are balance sheet accounts, encompassing assets, liabilities, and equity. Their balances are carried forward from one accounting period to the next, maintaining a cumulative record of the business’s financial position. For example, the cash balance at the end of one year becomes the starting cash balance for the next.

In contrast, temporary accounts are income statement accounts and owner’s drawing/dividend accounts, which are closed out at the end of each period. This means their balances are reset to zero for the new period. Temporary accounts measure performance over a period, while permanent accounts reflect the financial position at a specific point in time. The closing process ensures that revenues and expenses are properly matched to the period in which they occurred.

The Closing Process

At the conclusion of an accounting period, temporary accounts undergo a procedure known as the closing process. This process zeroes out the balances of all temporary accounts. The balances from revenue and expense accounts are transferred to an intermediate account, often called Income Summary, which is itself a temporary account. The net balance in the Income Summary account, representing the period’s net income or loss, is then transferred to a permanent equity account.

For corporations, this permanent account is Retained Earnings, while for sole proprietorships and partnerships, it is the Owner’s Capital account. Any balances in dividend or owner’s drawing accounts are transferred directly to the appropriate equity account. This updates the equity account to reflect the period’s profitability and any distributions made.

Common Examples of Temporary Accounts

Temporary accounts fall into categories. Revenue accounts track all income generated from a business’s primary operations and other sources. Examples include Sales Revenue from goods or services, Interest Revenue earned on investments, and Rent Revenue from property. These accounts accumulate the total earnings for the period.

Expense accounts record all costs incurred to operate the business and generate revenue. Examples are Rent Expense for office space, Utilities Expense for services like electricity and water, Salaries Expense for employee compensation, and Depreciation Expense for the usage of assets. The Cost of Goods Sold, representing the direct costs of products sold, is also an expense account.

Dividend and drawing accounts reflect distributions of profits to owners. A Dividends account is used by corporations to record payments made to shareholders. For sole proprietorships and partnerships, an Owner’s Drawing account tracks funds or assets withdrawn by the owner for personal use. Both types of accounts reduce the owner’s equity and are closed at the end of the period.