At any given time, your business’s inventory account tells you the current value of the inventory you have on hand. When you report your end-of-year income, you’ll calculate the profits you made by selling that inventory.
But what if you want to know if you made a profit on the inventory you sold last quarter? Just looking at your total inventory balance can’t tell you that.
Instead, you’ll need to use temporary accounts. They help you track your performance in a given accounting cycle and determine whether or not you’re meeting your short-term business goals.
Let’s dive deeper into how they work.
What Are Temporary Accounts?
Temporary accounts (or nominal accounts) are accounts that you close at the end of an accounting period. This means you don’t carry their balances over to the start of the next period.
Instead, when the next accounting cycle begins, all of your temporary accounts reset to zero.
For example, if you wanted to know your revenue for 2022—that would be a temporary account—and in 2023, the balance would go back to $0.
This helps you assess a certain metric (like revenue) for a given period of time.
Is Inventory a Temporary Account?
No, inventory is not a temporary account. That’s because it shows you how much goods you have at the moment, instead of over a certain month, year, a few years, or any other specific amount of time.
That’s a good thing since you’ll always want to know how much stock you have on hand.
So if inventory is not a temporary account, then what is it? Inventory is considered a permanent account.
What Are Permanent Accounts?
Permanent accounts (or real accounts) stay open from one accounting period to the next. Their cumulative balances carry over. That way, you can track the real value of an account.
For example, let’s say you have $10,000 worth of inventory at the end of the year. When the new year begins, you still have $10,000 worth of inventory—it doesn’t reset to zero.
So, your real accounts reflect that by carrying over the value.
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What’s the Difference Between Temporary and Permanent Accounts?
Temporary accounts show your balances for a given period, like a quarter or a fiscal year, while
permanent accounts tell you exactly what you own or owe right now.
You can use your temporary accounts to see if you’re on track to meet your short-term goals, and you can use permanent accounts to better grasp where you stand at any given time.
Here’s more on the main differences between temporary and permanent accounts:
Balance Reset vs. Carryover
With a temporary account, the balance gets reset each time you start a new accounting period. In contrast, permanent account balances carry over, meaning the ending balance of a permanent account becomes the starting balance for the next period.
While this might sound like a small difference, it changes how you interpret the balance for each account type.
Let’s see how this works by comparing two types of accounts: revenue from sales (temporary account) and accounts receivable (permanent asset account).
For this example, we’ll say that you use a one-year accounting period, and at the end of the accounting period, your accounts have the following:
|Revenue from sales
Your revenue account tells you you’ve earned $500,000 this year, and your accounts receivable says you still need to collect $15,000 from your customers.
At the start of the next accounting period, the two accounts will look like this:
|Revenue from sales
The zero balance in the revenue account tells you that you haven’t generated any sales revenue yet in this new year, while the $15,000 in accounts receivable tells you that you still need to collect that amount from your customers. After all, your unpaid customer invoices don’t reset just because you started a new accounting year.
Because of this difference, temporary accounts help you track your business’s progress over a specific period of time, such as one quarter or one year.
Balances for permanent accounts are recorded on your balance sheet, showing the company’s finances at that moment.
For example, the cash account is an asset account on the balance sheet. If you look at your cash account on any given day, it tells you the actual cash your business has at that time.
Likewise, the accounts payable balance shows the balance of your unpaid expenses. It does not show how much you’ve spent over the last quarter or year.
To find information such as expenses or revenue for a given period, you’ll use income statement accounts, which are temporary. The income statement shows a report of your business’s performance for a specific period, such as one year.
Types of Temporary Accounts
The four types of temporary accounts are revenue, expenses, gain and/or loss accounts, and drawing or dividend accounts:
Here’s a closer look at each type:
- Revenue: Financial accounts that record income earned through sales, rent, or interest.
- Expenses: Financial accounts that track the cost of your expenses, such as utilities, rent, or promotions.
- Gain and/or loss: Financial accounts that record a gain or loss on the sale of assets, like investments, property, or machinery.
- Drawing/dividend: Financial records showing owners taking money out of the business. Drawing accounts show owner’s draws and are used by sole proprietors, partnerships, and S-corps. Dividend accounts are used by corporations to track profits that get redistributed to shareholders.
As you can see, each type of temporary general ledger account is quite broad. Therefore, you may find it useful to create accounts within each category to track a specific metric.
For example, you may want to create several accounts in the expense category: one for tracking wages, one for rent, and one for advertising costs. So when you track rent-related costs in your ledger, you’ll use the rent expense account.
You may also choose to create a temporary income summary account, which helps with the end-of-the-year closing process. It’s where you combine all the other accounts and calculate net profit (or loss)—and transfer those funds to the right permanent accounts.
While this account isn’t completely necessary, it can help you keep a record of what money got transferred in case you undergo an audit.
Examples of Temporary Accounts
You or your accountant ultimately decide what temporary accounts to create, depending on what you want to track. But here are some examples of commonly used temporary accounts to help you get started.
- Sales income
- Interest income
- Cost of goods sold
- Purchase discounts
- Purchase allowances
- Purchase returns
- Payroll taxes
- Gain (or loss) from the sale of an asset
- Gain (or loss) from the sale of an investment
- Owner’s draw
Types of Permanent Accounts
Permanent accounts typically fall into one of three categories.
- Asset: Asset accounts keep track of all the things of value that your business owns. Assets can be tangible (equipment, vehicles) or intangible (patents, stocks).
- Liability: Liability accounts track everything your business owes, including expenses and debt, such as loans or mortgages.
- Equity: Equity accounts track business ownership based on the money that owners have invested.
Examples of Permanent Accounts
Examples of permanent (or non-temporary) accounts include:
- Cash and cash equivalents
- Accounts receivable
- Accounts payable
- Interest payable
- Wages payable
- Taxes payable
- Retained earnings
- Owner’s equity
Making Sense of Your Business Accounts
Whether you run a small business or a large corporation, it’s helpful to understand the different types of accounts used in the accounting process.
That way, you can make sense of your bookkeeping and check on your business goals. For example, did you make as much profit as you wanted over the last quarter? Or do you have enough cash flow to pay out bonuses?
Temporary accounts track your company’s performance over a given period and get reset when the next period begins. Permanent accounts keep track of your business’s overall progress because they are cumulative.
So now you know all there is to know about permanent and temporary accounts, all that’s left to do? Get that spreadsheet out and start crunching numbers!