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Definition of Temporary Account

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What is Temporary Account?

Every business is represented by its Balance Sheet. Once the fiscal year closes, all the accounts representing the transactions of the business for that year are summarized into the Balance sheet. These include various assets, liabilities, owner’s equity, retained earnings, etc. While assets, liabilities & capital directly represents the going concern of the business, they remain in the balance sheet along with the company’s existence. The net profit/loss made by the company is summarized and grouped into reserves & surplus in the balance sheet. The net profit/ loss is the summary of various income & expense accounts.

The temporary accounts can also be referred to as nominal accounts. While the asset, liabilities and retained earnings accounts being permanent accounts relate to the company’s position forever, the temporary account gives us a picture of the financial performance of the company over a certain period of time.

Temporary accounts include revenue accounts, expenses accounts, gain or loss on capital transactions accounts, memorandum accounts & any drawing account. Generally, these accounts are used to prepare the business’s Income statement. At the end of the period, closing entries are recorded to summarize the balance of the temporary accounts which gives us the net profit/loss made by the business for the period. This profit after distribution of dividend or any loss made is shown as part of reserves and surplus / retained earnings in the balance sheet & technically it is part of the owner’s equity. So, these are the accounts that accumulate the transaction information until they’re transferred to the capital account.

Components of Temporary Accounts

Below are the different Components of temporary accounts:

1. Revenue Accounts

These are the accounts in which the transactions of income/revenue earned by the company’s business are recorded. Examples: Sales a/c, Discount received account, etc.

2. Expense Accounts

These are the accounts in which the transaction of all expenses made by the company’s business are recorded. for example, Purchases a/c, salaries a/c, rent a/c, etc.

3. Gain/Loss Accounts

These are the accounts in which the gain or profit made usually on capital transactions are recorded. For example, Gain/loss on the sale of Fixed Assets, etc.

4. Drawings Account

In the above representation, accounts highlighted in green are temporary accounts and orange are permanent accounts.

When the trial balance is prepared at the end of the period, it contains all the accounts both temporary and permanent in it with their balances. Once the closing entries are passed in all the temporary accounts, a post-closing trial balance may be prepared which contains only the summary of the balances in real accounts or permanent accounts. Here the retained earnings account will be properly adjusted with the current year’s profit/loss.

Conclusion

Summarizing with the topic, just to ensure that the financial performance of the company from time to time & also to avoid the mix up between the periods, some accounts are to be closed before preparation of financial statements & balance should be set to zero. These accounts are temporary accounts & upon closing, the balance would be transferred to a profit & loss account or income summary account.