Although it can lead to confusion, try not to confuse when an account is non-temporary and when it is temporary. An account is not temporary when it is permanent. However, a few things must be kept in mind to refine this definition.
If we were to understand how the temporary account works quickly, we would say that these accounts can be closed at the end of an accounting period. They start in the next accounting period with a zero balance.
This case does not apply to all accounts, hence the difference. Let’s try to understand these issues a little more.
What is a temporary account?
A temporary account is an account that will be closed after a while. In general, it will correspond to the accounting period.
When the temporary account is closed, it has as a measurement element the transactions that will be significant during the accounting cycle they represent. In other words, they will not be used or relevant for the previous or the following accounting cycle.
Therefore, these are accounts recognized in the profit and loss account and used to calculate the expenses and income of the company.
There are exceptions: the giro account is closed after each accounting period. This account should not be included in the income statement and is not considered a temporary account. In this case, it would be a profit and loss account.
Some examples of temporary accounts may include:
- income account
- expense account
- Profit and loss account
It is also possible to have a retirement account for sole proprietorships or partnerships. Inside a temporary account, you can typically find items like:
- sales returns
- discounts on purchases
- rent payment
- Business expenses
One of the reasons why temporary accounts are used is to adjust the results of each accounting period to the reality of a company.
An example commonly used to demonstrate this is as follows: Imagine a company earns a net profit in the first year $160,000, the second year $90,000, and the third year $50,000. If this has not been reported in separate accounting periods in temporary accounts, the average income could be around $100,000 per year in earnings. However, reality does not reflect the downward trend in profits.
Types of temporary accounts
There is no single type of temporary account. In fact, in some cases, they can even be configured in a particular way and combine different concepts. However, these are the three common types that they accept as features:
These are the accounts that reflect the income earned from business activity. Since it is a temporary account, this income will only show up during specific accounting periods.
At the end of each accounting period, this account is closed. When you open it again, the balance will be zero.
Expense accounts, as the name suggests, represent the total expense of the business. It should be noted that the enterprise’s day-to-day (daily) operations are usually recorded as separate expenses.
It’s important to know that not all expense accounts are the same. Depending on the type of business, the account reflects different movements or expenses incurred. Some of the common ones are:
- Income Summary Account
How to close these accounts
The closure of temporary accounts must coincide with the end of the accounting period to which they refer. This isn’t exactly a closure, as the account still exists. What is done is bring the balances to register the corresponding changes, and in the case of income and expense accounts, to zero.
The mechanisms are relatively simple:
- Close the income account. Transfer the money from the income account to the Income Summary account. Balances are transferred
- Close the expense account. It is the same as the previous one, but, in this case, the debits are transferred. In other words, the costs incurred during the accounting period are reflected.
In conclusion, a temporary account is not a good option for long-term savings. Using a temporary account has many disadvantages, including limited investment options, low-interest rates, and the inability to access your funds if you need them urgently. Whether you’re using a traditional bank or brokerage account, make sure it’s a long-term solution for your finances.
Does this item meet your immediate needs? If yes, then kindly share it with your friends. Also, do well to share your thoughts in the comments section below.