In this article, we are going to discuss temporary accounts and all the important aspects related to it.
In accounting, temporary accounts are used to record financial transactions for a particular accounting period. All temporary account balances must be moved to permanent accounts at the end of the time.
What is a Temporary Account?
Temporary accounts are zero-balance accounts that begin the financial year with a zero balance. The balance is apparent in the income statement at the end of the year and is afterward transferred to the permanent account in the form of reserves and surplus.
As a result, income statement accounts are transient and must be closed on a regular basis.
The best way for accountants to gauge a company’s profitability is to use temporary accounts. These temporary accounts can be used for any accounting period, including a quarter. A fiscal year, on the other hand, is the most usual.
The income statement contains the majority of temporary accounts. However, only a few appear on the balance sheet.
Examples of Temporary Accounts
Examine the following examples of temporary accounts, as well as the journal entries required to properly close each account:
The revenue account is used to keep track of all money earned during a given period of time. The revenue account records any money received for goods and services given within the defined accounting period.
Remember that all revenue is recognized when it is earned, not when it is received, according to the revenue recognition principle.
The balance in the revenue account is cancelled out at the end of the accounting period, whether it’s a monthly, quarterly, or yearly term, by moving the balance to your income summary account.
Expense accounts, such as Cost of Sales, Interest, Rent, Delivery, Utilities, and any other expenses, are transitory accounts.
Purchases, Purchase Returns, Purchase Discounts, and Purchase Allowances (all under the periodic inventory system) are all temporary accounts.
If you’re a solo proprietor or your company is a partnership, you’ll need to shift activity from your drawing account for any excises received from the company.
In contrast to the other account types, you do not have to close your drawing account to convert it to an income summary account; instead, you can simply transfer the balance in the drawing account to your capital account.
Temporary Accounts Vs Permanent Accounts: How do Temporary Accounts Differ from Permanent Accounts
A temporary account is one in which the balance is not carried forward at the end of a fiscal year’s accounting. Rather, the balance in these accounts is moved to the relevant permanent account at the end of the time.
The balances of permanent accounts, on the other hand, are carried forward for each accounting cycle.
Liabilities, assets, and equity accounts are all permanent accounts that appear on your balance statement, whereas income and cost accounts appear on your income statement and must be shut at the end of the financial period.
Although the ease of use of accounting software has eliminated the need to manually terminate temporary accounts at the end of each accounting period, you should still grasp the concept of temporary accounts and why they are so crucial in the accounting process.
Accounts that are Temporary
- Include accounts for revenue, expenses, and profit and loss.
- At the end of each period, they are closed.
- At the start of a period, reset the balance to zero.
- Accounts for drawing or withdrawal may be included (e.g., partnerships)
- Assist you in keeping track of your funds from one period to the next.
Accounts that are Permanent
- Include accounts for assets, liabilities, and equity.
- Don’t close your books at the conclusion of the fiscal year.
- They’re on the balance sheet.
- Maintain a cumulative equilibrium
- Keep track of account balances year after year.
FAQs on Temporary Accounts
Is Inventory a Temporary Account?
Inventory is not a Temporary Account. it is essential to proper accounting. The inventory account’s balance is never reset at the conclusion of the accounting month because it is a permanent account.
Is Capital a Temporary Account?
Capital account is a long-term account. By crediting the amount in the latter, the capital account, along with the current and financial accounts, makes up the country’s balance of payments.
Is Cash a Temporary Account?
Cash is not a temporary account. Because this account is permanent, it does not close at the conclusion of a period.
Is Rent Income a Temporary Account?
Rent income is classified as a temporary account. Sales, Service Revenue, Interest Income, Rent Income, Royalty Income, Dividend Income, Gain on Sale of Equipment, and other revenues or income accounts are all transitory accounts.
Is Retained Earning a Temporary Account?
There is no such thing as a temporary account with no retained earnings. Every year, all income statements and dividend accounts are transferred to retained earnings, a permanent account that can be carried forward on the balance sheet. As a result, all income statements and dividend accounts are transitory.
Is Accounts Payable a Temporary Account?
No, Accounts payable isn’t temporary account. It is categorized as a permanent account, alongside Notes Payable, Loans Payable, Interest Payable, Rent Payable, Utilities Payable, and other sorts of payables.
Using temporary accounts will allow you to maintain proper track of your account balances. However, cancelling temporary accounts is just as crucial as opening them.
When you’re using manual accounting systems or spreadsheets, keeping track of and closing temporary accounts takes time, and producing accurate financial statements like an income statement or balance sheet is more difficult.