Temporary Account
An acccount that closes at the end of each accounting period and has no balance when a new period begins.
What is a Temporary Account?
A temporary account closes at the end of each accounting period and has no balance when a new period begins.
The accounts are closed to keep their balances separate from those of the subsequent accounting period. The goal is to display the revenue earned and the accounting activities for various time periods.
At the end of the year, its ending amount is transferred from one account to another after the fiscal year so that it can be utilized once more to accrue new transactions in the next financial year.
These accounts compile transactions that affect a business's annual profit or loss. Over the course of a financial year, the balances in these accounts should rise; rarely do they fall.
The income statement is produced using the balances in temporary accounts.
The balance in this account is occasionally transferred to the retained profits account through the income summary account at the end of a financial year. When balances are transferred from a temporary account, it's called closing an account.
If an accounting software package is being utilized to record accounting transactions, this shifting to the retained earnings account will take place automatically.
Key Takeaways
- Temporary accounts, also known as nominal accounts, are used to record revenues, expenses, gains, and losses during a specific accounting period.
- These accounts are closed at the end of each period, transferring their balances to permanent accounts, such as retained earnings.
- The primary purpose of temporary accounts is to track financial activity within a given accounting period. By closing these accounts at the end of the period, a company can start fresh in the next period.
- Temporary accounts affect the income statement, where revenues and expenses are reported to determine the net income for the period.
Examples of Temporary Accounts
Some examples can be broadly categorized into three categories:
- Revenue account, expenses account (such as cost of products sold, salaries and benefits, and supplies).
- Gains and losses (such as the loss on asset sales account).
- Income summary account.
Revenue
A company's overall earnings are referred to as revenue, and the account must be closed out after the financial year. The accountant prepares a debit entry for the total balance of the revenue account to close it.
For instance, a debit entry of $50,000 should be made in the revenue account if the total income recorded is $50,000. A corresponding credit of $50,000 is then made in the income summary account to keep the entries in balance.
Expenses
Any business needs expenses because they keep the operation running. The expense accounts are temporary accounts that reflect every expenditure the business makes on running its business, including, among other things, costs for supplies and advertising.
For instance, a $16,450 total spending amount was recorded after the accounting year. The money is moved from the expense account to the income summary by crediting it, which zeroes out the balance.
An equal amount is then recorded as a debit to the income summary account.
Income Summary
The company's temporary account, in which the revenues and expenses were transferred, is called the income summary. The net income is reflected when the other two accounts are closed.
In the example above, the income summary shows a net income of $33,550 from total revenues of $50,000 minus total expenses of $16,450.
The income summary must be transferred to the capital account because it is a temporary account by debiting the income summary for 33,550 and crediting the capital account for that value.
Drawings Account
Owners of businesses can take money from a drawing account for their use. This is a payment of business profits to the owner of the company.
Drawing accounts are frequently used by sole proprietorships, partnerships, or S-Corps companies. C-Corporations, in contrast, will distribute dividends from firm profits and shareholder cash.
At the end of an accounting period, your program will transfer its balance to the owner's equity or capital account.
For instance, the drawing account has $5,000 in it. So the accountant's next step is to deduct $5,000 from the drawing account and credit the same amount to the capital account.
Temporary Account Vs. Permanent Account
A temporary account must be shut down when an accounting period concludes. It seeks to display the actual earnings and expenses incurred by a company over a specific time.
Temporary accounts are short-term accounts that open with a zero balance at the beginning of each accounting period and close at the conclusion to keep track of the accounting activity that took place during that time.
They consist of spending accounts, income statements, and income summary accounts.
On the other hand, a permanent account has the following qualities:
- It may remain open for the company's existence and is only sometimes closed at the end of an accounting period.
- These accounts, also known as real accounts, fall under equity, liabilities, and assets.
- The balances of permanent accounts are carried over into the subsequent accounting period. Therefore, the following period begins at the close of the preceding one.
The accounts with continued balances across time are known as permanent accounts. Permanent accounts include the asset, liability, and equity accounts, which are all combined into the balance sheet.
The asset, liability, and net asset accounts are the permanent accounts in a nonprofit organization.
How to Close a Temporary Account
All these accounts must always be closed, and the owner's capital account must be updated with the net change.
To accomplish this, pass the journal entries, post them to the appropriate ledgers, and ensure that they balance, after which you pass the closing entries for all temporary accounts.
Preparing an income summary account, which shows the entity's earnings and losses for the specified period, comes to a close with a summary of revenue and expense accounts.
A temporary account closure entails closing all accounts falling into that category, using the above examples, and closing it.
1. A revenue account should be closed. To do this, the revenue account's balance must be moved to the income summary.
Particulars | Debit | Credit |
---|---|---|
Revenue A/c | $50,000 | |
Income Summary A/c | $50,000 |
2. An expense account should be closed. The identical procedure is followed when moving money from the cost accounts to the income summary.
Particulars | Debit | Credit |
---|---|---|
Income Summary A/c | $16,450 | |
Expense A/c | $16,450 |
3. An income summary should be closed. The sum of the revenue and expenses from the income summary is moved to the capital account.
Particulars | Debit | Credit |
---|---|---|
Income Summary A/c | $33,550 | |
Capital/Retained Earnings A/c | $33,550 |
4. A drawing account should be closed. The capital or retained earnings account receives the funds previously in the draw's account.
Particulars | Debit | Credit |
---|---|---|
Income Summary A/c | $10,000 | |
Capital A/c | $10,000 |
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