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What is a Temporary Account?

A temporary account is an account that begins each fiscal year with a zero balance. At the end of the year, its ending balance is shifted to a different account, ready to be used again in the next fiscal year to accumulate a new set of transactions. Temporary accounts are used to compile transactions that impact the profit or loss of a business during a year. The balances in these accounts should increase over the course of a fiscal year; they rarely decrease. The balances in temporary accounts are used to create the income statement.

At the end of a fiscal year, the balances in temporary accounts are shifted to the retained earnings account, sometimes by way of the income summary account. The process of shifting balances out of a temporary account is called closing an account. This shifting to the retained earnings account is conducted automatically if an accounting software package is being used to record accounting transactions.

Examples of Temporary Accounts

Examples of temporary accounts are revenue accounts, expense accounts (such as the cost of goods sold, compensation expense, and supplies expense accounts), gain and loss accounts (such as the loss on assets sold account), and the income summary account.

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The Permanent Account

The other main type of account is the permanent account, in which balances are retained on an ongoing basis. These accounts are aggregated into the balance sheet, and include transactions related to assets, liabilities, and equity.

Temporary Account vs. Permanent Account

A temporary account is closed at the end of an accounting period, while a permanent account retains it balance going forward. This results in several differences between these types of accounts, which are as follows:

• Duration. A temporary account is reset to zero after a reporting period ends, while the balance in a permanent account continues beyond the reporting period.

• Closure. A temporary account is closed at the end of a reporting period, while a permanent account remains open.

• Types of accounts used. A permanent account is used for asset, liability, and equity transactions, while a temporary account is used for revenue, expense, gain and loss transactions.

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What Happens if a Temporary Account is Not Closed?

If a temporary account is not closed, its balance will roll over into the next accounting period, combining prior period activity with current period results. This distorts revenue and expense reporting, making it impossible to accurately measure performance for the current period. It can also lead to incorrect retained earnings and misrepresented financial statements.

Terms Similar to Temporary Account

A temporary account is also known as a nominal account.

Related Articles

Clearing Account

Nominal Account

Offset Account

Real Account

Suspense Account

Valuation Account

• Cost definition
• Accrued income definition

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