What Is an Example of a Temporary Account?

Temporary accounts track a business’s financial activities over a specific period. These accounts provide a snapshot of performance for a defined accounting period, such as a month, quarter, or fiscal year. Unlike permanent accounts, which carry their balances forward indefinitely, temporary accounts are closed at the end of each period. This periodic reset allows businesses to measure their profitability and operational results for that period, providing insights into financial performance.

Characteristics of Temporary Accounts

Temporary accounts’ balances are reset to zero at the beginning of every new accounting period. This resetting mechanism ensures each period’s financial performance is measured independently, preventing the accumulation of revenue and expense figures across multiple periods. This aligns with the concept of periodicity, which segments a business’s life into consistent time intervals for reporting.

These accounts directly relate to a business’s income statement, reporting revenues earned and expenses incurred during a specific period. Revenue accounts track income from sales or services, while expense accounts record operational costs. Temporary accounts also include equity adjustments like dividends or owner’s drawings, which represent distributions to owners during the period. Resetting these balances at period-end prepares the accounts to accumulate new data for the subsequent period, ensuring accurate performance measurement.

Common Examples of Temporary Accounts

Revenue accounts represent the income a business generates from its primary operations, such as selling goods or providing services. For example, a consulting firm uses a “Service Revenue” account to track fees earned from client engagements. A retail store records sales in a “Sales Revenue” account. These accounts are temporary because their balances are cleared at year-end, allowing new revenue to be tracked from zero in the next period.

Expense accounts reflect the costs a business incurs to generate its revenues during an accounting period. Examples include “Rent Expense” for office space, “Utilities Expense” for electricity and water, and “Salaries Expense” for employee compensation. These accounts are temporary because they track costs for a specific period. At the close of the period, each expense account is zeroed out, preparing it to record new expenses for the upcoming period.

Dividend or drawing accounts are also temporary, representing amounts distributed to owners from the business’s profits. For a corporation, “Dividends Declared” tracks payments to shareholders, while for a sole proprietorship, an “Owner’s Drawings” account records owner withdrawals. These distributions reduce the owner’s equity for that period and are reset to zero at the period’s end. This ensures the equity account reflects only the current period’s retained earnings or capital balance.

The Closing Process

The closing process is an accounting procedure performed at the end of each accounting period to prepare the books for the next. During this process, the balances of all temporary accounts are transferred to a permanent equity account. For corporations, this account is “Retained Earnings,” while for sole proprietorships and partnerships, it is a “Capital” account.

The transfer consolidates all revenues and expenses for the period into a single net income or net loss figure. An intermediate account, “Income Summary,” can facilitate this consolidation before the final transfer to Retained Earnings or Capital. Once balances are transferred, each temporary account has a zero balance, ready to accumulate new financial data for the subsequent accounting period.

This systematic transfer links the performance reported on the income statement to the financial position shown on the balance sheet. The net effect of all temporary accounts (net income or net loss, plus or minus dividends/drawings) ultimately adjusts the Retained Earnings or Capital account on the balance sheet. This process ensures that financial statements accurately reflect a business’s performance for a given period and its cumulative financial position.