What Is Considered a Temporary Account?

Businesses use various financial accounts to track their economic activities and present their financial health. While all accounts serve to categorize financial information, not all are treated identically at the close of an accounting period. Understanding these different classifications is important for accurate financial reporting and analysis.

Defining Temporary Accounts

Temporary accounts, also known as nominal accounts, record financial activities within a specific accounting period. Their primary purpose is to track financial performance, such as revenues and expenses, over a defined timeframe.

These accounts begin each new accounting period with a zero balance, accumulating transactions throughout the period. At the end of the period, their balances are transferred out, resetting to zero for the next period. This characteristic allows businesses to measure their profitability and operational efficiency for a distinct period, whether it is a month, quarter, or a full fiscal year.

Distinction from Permanent Accounts

The distinction between temporary and permanent accounts lies in how their balances are handled at the end of an accounting period. Permanent accounts, also known as real accounts, represent balances that continue from one accounting period to the next, providing a cumulative view of a business’s financial standing.

These accounts include assets (what a business owns, such as cash or equipment), liabilities (what a business owes, like accounts payable or loans), and equity (the owners’ claim on the business’s assets). Unlike temporary accounts, permanent accounts are not closed out; their ending balance in one period becomes the beginning balance for the subsequent period.

Temporary accounts reflect a company’s performance over a specific duration, typically appearing on the income statement. Permanent accounts, conversely, show a company’s financial position at a particular moment in time, as presented on the balance sheet. This separation allows financial statement users to assess both operational results and overall financial health independently. Correctly managing these accounts ensures accurate financial records and reliable financial statements.

The Closing Process

The closing process is the accounting procedure that defines the temporary nature of certain accounts. At the end of each accounting period, typically monthly, quarterly, or annually, the balances of all temporary accounts are transferred to a permanent equity account. This resets temporary accounts to zero, preparing them for new transactions in the upcoming period.

This reset ensures each accounting period’s financial performance can be measured independently, without commingling with previous periods’ activities. The process generally involves transferring revenue and expense account balances to an intermediate account, often called “Income Summary.”

The Income Summary balance, representing net income or loss, is then transferred to a permanent equity account. For corporations, this is typically Retained Earnings; for sole proprietorships and partnerships, it is often the owner’s capital account. Owner’s draw or dividend accounts are also closed directly to the relevant equity account.

Common Examples of Temporary Accounts

Temporary accounts track financial flows and activities within a specific period. Revenue accounts are a primary example, recording all income generated from sales of goods or services, such as Sales Revenue or Service Revenue.

Expense accounts also fall into this category, tracking all costs incurred to generate revenue during the period. Common examples include Rent Expense, Salaries Expense, Utilities Expense, and Advertising Expense. Gain and loss accounts, which record non-operational transactions like a gain or loss on the sale of an asset, are also temporary.

Accounts related to distributions to owners, such as Dividends for corporations or Owner’s Draw for sole proprietorships and partnerships, are temporary as they reflect withdrawals of equity for a specific period. These accounts help determine a business’s profitability and how earnings are distributed within a given accounting cycle.