What Is a Temporary Credit & How Does It Work?
Understand the nature of temporary credits: conditional financial adjustments that are not permanent and how they conclude.
A credit is a financial adjustment that reduces an amount owed or increases an account balance. It can represent a decrease in liabilities or an increase in assets or equity on a balance sheet. While many credits are permanent, some are temporary.
A temporary credit is not intended to remain indefinitely on an account or record. These credits are conditional, often time-bound, or tied to a specific event that leads to their removal or reclassification.
Understanding the Temporary Aspect
The fundamental characteristic of a temporary credit is its impermanence; it is not a lasting entry. These credits have a defined lifespan, tied to a specific date, the fulfillment of a condition, or a future financial event. Their provisional nature means they are subject to change, reversal, or expiration.
A temporary credit may be provisional, pending further verification or approval. For example, a financial institution might grant a credit contingent on an investigation’s outcome. Alternatively, a temporary credit can serve a short-term purpose, such as bridging a gap until a final transaction is processed or a specific condition is met.
These credits are designed to expire after a certain period or upon a particular event. This built-in obsolescence distinguishes them from permanent ledger entries.
Temporary Credits in Accounting Records
In financial accounting, several entries are temporary credits, designed to be reversed or closed out within a specific accounting period. Revenue accounts, such as sales or service revenue, track income earned and are temporary. Expense accounts, which record costs like rent or utilities, are also temporary and reset to zero at the end of each period.
Accruals involve recognizing expenses incurred or revenues earned before cash changes hands. An accrued expense might involve a credit to a liability account, like “Accrued Expenses Payable,” until payment is made. At that point, the liability is debited and cash is credited, reversing the temporary credit.
Deferred revenue, also known as unearned revenue, is another example. This occurs when a business receives payment for goods or services before they are delivered. The cash received is debited, and an unearned revenue liability account is credited. As goods are delivered or services rendered, the unearned revenue account is debited, and a revenue account is credited, reducing the temporary liability.
Suspense or clearing accounts frequently utilize temporary credits. These accounts act as holding places for transactions where the final classification is not yet determined. A credit might be temporarily posted to a suspense account until the proper destination account is identified. Once known, the suspense account is debited, and the appropriate permanent account is credited, moving the entry and clearing the temporary credit.
For sole proprietorships and partnerships, drawing accounts function as temporary equity accounts. These accounts are credited when owners withdraw funds for personal use during an accounting period. At the end of the period, the drawing account is closed out to the owner’s capital account, reversing the temporary credit and reflecting the reduction in owner’s equity.
Temporary Credits in Consumer Transactions
Consumers encounter temporary credits in their daily banking and credit activities, often without realizing their provisional nature. Provisional credits issued by banks or credit card companies for disputed transactions are common. If a consumer reports an unauthorized charge or error, the financial institution may issue a temporary credit to their account while investigating the claim.
This credit is temporary because it is subject to reversal if the investigation concludes the dispute is invalid or the transaction was legitimate. For example, if a fraud claim is denied, the provisional credit will be debited back from the consumer’s account.
Promotional credits or offers also represent temporary adjustments to consumer accounts. These include credits for signing up for a new service, meeting a spending threshold on a credit card, or participating in a loyalty program. These credits often have an expiration date or specific conditions for their use, such as requiring use within a certain timeframe or for particular purchases.
Similarly, a bank might temporarily increase a credit limit for a specific period or place a temporary credit hold on funds. These adjustments are not permanent and are expected to revert to their original state or be released once the underlying condition, such as a large purchase or a pending transaction, is resolved.
How Temporary Credits Conclude
The conclusion of a temporary credit is an intrinsic part of its design. These credits cease to exist through one of two mechanisms: expiration or active reversal/adjustment. Expiration occurs when the credit reaches a pre-defined end date or time limit, as seen with many promotional offers.
Alternatively, a temporary credit can be concluded through a reversal or adjustment. This involves an active financial entry, typically a debit, that offsets or removes the initial temporary credit. For instance, a provisional credit for a disputed transaction is debited back if the dispute is resolved against the consumer. In accounting, accrued expenses are reversed when paid, and deferred revenue is reduced as services are rendered.
The process ensures financial records and consumer accounts accurately reflect the final financial position after the temporary condition is met or the defined period ends.