What Is a Temporary Account in Accounting?

Accounting accounts are fundamental tools for systematically recording and classifying all financial transactions within an organization. They help businesses maintain an organized record of financial activities, providing a clear picture of money’s flow. By categorizing financial events, accounts allow for comprehensive tracking and analysis of a company’s financial performance. This structured approach ensures financial information is available for internal management and external stakeholders.

Defining Temporary Accounts

Temporary accounts track financial activities for a defined period, such as a month, quarter, or year. Their balances are reset to zero at the conclusion of each accounting period, preparing them for the next cycle. This distinguishes them from permanent accounts, which continuously carry balances forward.

The primary objective of temporary accounts is to measure a business’s financial performance and profitability during a specific timeframe. These accounts capture revenues earned and expenses incurred, allowing for the calculation of net income or loss. The closing process ensures each new accounting period begins with a fresh slate for income and expense tracking, providing clarity and allowing consistent performance comparison across different periods.

Common Types of Temporary Accounts

Several types of accounts are categorized as temporary, each tracking a different aspect of periodic financial activity. Revenue accounts record income generated from primary operations, such as sales of goods or services, accumulating all earnings. Expense accounts track all costs incurred to generate revenue, including salaries, rent, and utilities.

Dividend accounts (or drawing accounts for sole proprietorships and partnerships) track profit distributions to owners, which reduce business equity. The Income Summary account is an intermediary used exclusively during the closing process. It temporarily holds the net effect of all revenue and expense accounts before transfer to a permanent equity account.

The Role of Temporary Accounts in the Accounting Cycle

Temporary accounts play a specific role within the accounting cycle, particularly during the “closing process” at the end of each period. This process prepares temporary accounts for the next period and transfers their net financial impact to a permanent equity account, such as Retained Earnings. Closing ensures a period’s financial performance is finalized and reflected in the business’s long-term financial position.

During closing, balances from all revenue accounts are transferred to the Income Summary account. Subsequently, balances from all expense accounts are also transferred to the Income Summary account. The resulting net balance in the Income Summary, representing the period’s net income or loss, is then transferred to a permanent equity account. Finally, any dividend or drawing account balances are transferred directly to a permanent equity account. This systematic transfer provides data for preparing the income statement, which reports a company’s financial performance for that specific period.