Whether you’re a small business owner or a senior accountant at a large company, temporary accounts can help you track your economic activity, manage your company’s finances, and maintain a clear record of how much profit and loss the business is generating. Let’s look at what temporary accounts are, how they work, and the types of temporary accounts you can use.
Definition and Example of Temporary Accounts
Temporary accounts are short-term accounts that start each accounting period with zero balance and close at the end to maintain a record of accounting activity during that period. They include the income statements, expense accounts, and income summary accounts.
Alternative name: Nominal accounts
Temporary accounts are reset to zero by transferring their balances to permanent accounts. Starting an accounting period with a zero balance enables businesses to monitor activity for a specific accounting period without mixing up data from two different time periods. For example, if company XYZ generates $40,000 in revenue in one accounting period, the amount can be recorded for that period in a temporary account. Then the temporary account will begin the next accounting period with no revenue.
How Temporary Accounts Works
Using temporary accounts can help maintain accurate records of the economic activity during each accounting period. For instance, say a company makes $40,000 in revenue during Year 1 and $50,000 in revenue during Year 2. Now, if the temporary account isn’t closed during Year 1, the revenue will be carried over to Year 2 and be recorded as $90,000. This data can lead to false conclusions about how the company performed that year, which can lead to poor decision making or potential problems with taxation. To avoid mixing up this data and for an accurate picture of transactions taking place during a fixed time period, temporary accounts can be quite helpful. They can create concrete boundaries to separate economic activity for better tracking and more efficient financial management. Temporary accounts can be maintained year-to-year, quarterly or monthly, depending on your accounting period. Since temporary accounts are short-term accounts, their data entries are moved to relevant permanent accounts to close them and maintain long-term financial records. These permanent accounts maintain a cumulative balance and offer a bigger picture of a company’s ongoing transactions.
Types of Temporary Accounts
Types of temporary accounts may include revenue accounts, expenses accounts, and income summaries. Let’s explore each of these examples in more detail.
Revenue accounts
Revenue accounts are used to track the amount of money earned during a particular period of time. Money received for goods and services sold during the accounting period is recorded in these statements. The specific types of revenue accounts include sales accounts, profit statements, interest income accounts, and more.
Expense accounts
Expense accounts are used to track the amount of money spent on keeping the business running. This can include costs related to rent, utilities, staff wages, and other functional expenses. The specific types of expenses accounts include cost of sales account, salaries expense account, buying account, and more.
Income summary accounts
At the end of an accounting period, entries from all revenue and expense accounts are transferred into the income summary account. This data reflects the net profit or loss that the business incurred during a particular accounting period or another specified time period.
