Most business owners know the five core accounts for tracking and managing transactions: asset, equity, expense, liability, and revenue. But what’s less widely understood is that each type can be further categorized and managed as a temporary or permanent account.
Below, we explore how temporary accounts differ from permanent accounts, offer some examples of each account type, and discuss why understanding the distinction is crucial for your accounting operations.
What Are Temporary Accounts?
Temporary — or “nominal” — accounts are short-term accounts for tracking financial activity during a certain time frame. Businesses close temporary accounts and transfer the remaining balances at the end of predetermined fiscal periods.
There is no standard time frame for temporary accounts, but many companies choose to zero them out quarterly.
For small and large businesses alike, temporary accounts help accounting professionals track economic activity, manage company finances, and establish a clear record of profit and loss.
Examples of Temporary Accounts
Companies have flexibility in determining which accounts will be permanent and which will be temporary, but business accounts that are often temporary include:
1. Revenue accounts
Tracking the amount of money received for goods and services provided, revenue accounts include interest income and sales accounts.
2. Expense accounts
Expense accounts track funds spent to keep an organization up and running. These costs can include rent, utilities, and wages.
3. Income summary accounts
An income summary account contains all revenue and expense entries from a designated accounting period and reflects net profit or loss within that time frame.
4. Drawing or dividend accounts
A business owner can withdraw money for personal use with a drawing account. Sole proprietorships, partnerships, or S-corps typically use drawing accounts. Corporations, in contrast, usually return shareholder capital and company profits through dividend accounts.
What Are Permanent Accounts?
Permanent — or “real” — accounts typically remain open until a business closes or reorganizes its operations. A balance for a permanent account carries over from period to period and represents worth at a specific point in time.
Although permanent accounts are not closed at year-end, businesses must carefully review transactions annually, ensuring that only the proper items are recorded. Plus, since having too many permanent accounts can increase and complicate accounting workloads, it can be helpful for companies to assess whether some of these accounts can be combined.
Examples of Permanent Accounts
1. Asset accounts
Asset accounts track everything a business owns, including physical items (e.g., inventory) and less tangible property (e.g., stocks). Accounts receivable is an asset account.
2. Liability accounts
Organizations use liability accounts to record and manage debts owed, including expenses, loans, and mortgages. Accounts payable is a liability account.
3. Equity accounts
An equity account is a financial representation of business ownership accrued through company payments or residual earnings generated by an organization.
How Do Temporary Accounts Differ From Permanent Accounts?
A rolling balance vs. a balance reset
A company continues rolling the balance of a permanent account forward across fiscal periods, maintaining one cumulative balance. With a temporary account, an organization redistributes any funds remaining at the end of a specific timeframe, creating a zero balance.
An indicator of ongoing progress vs. an indicator for a discrete time period
While a permanent account indicates ongoing progress for a business, a temporary account indicates activity within a designated fiscal period.
Balance sheet vs. income statement
A permanent account is recorded on a company’s balance sheet, which provides a snapshot of what the company owns and owes at a specific point in time. Temporary accounts are recorded on a company’s income statement, which assesses profit and loss over a stretch of time.
Why understanding the difference between permanent and temporary accounts matters
Understanding the distinction between temporary accounts and permanent accounts and managing them accordingly is crucial to accurate accounting processes. A single error can throw off the rest of a company’s financial tracking.
For example, if a business sets a certain percentage of earnings aside in a temporary account for quarterly taxes, funds in that account must be applied to taxes, and any remaining balance must be redistributed at the end of the quarter. Otherwise, these funds will create a discrepancy in the general ledger, resulting in miscalculations across other accounts.
Let’s see if you can answer some of these temporary vs. permanent account FAQs:
Is retained earnings a permanent account?
Answer: Yes. The balance for retained earnings at the end of its given period carries over to the next period, making it a permanent account.
Is rent a permanent account?
Answer: No. Rent is an expense paid out and “reset” to $0 at the end of each given period, typically a month.
How are temporary and permanent account transactions recorded?
Answer: Permanent accounts are on a balance sheet; temporary accounts are on an income statement.
Invoiced: Helping Businesses Manage Both Temporary and Permanent Accounts
Monitoring permanent and temporary accounts can be a time-consuming, error-prone process, especially when your business relies on spreadsheets and manual accounting systems.
With fully automated accounts receivable and accounts payable operations, you don’t have to worry about oversights that will derail your company’s financials. Invoiced offers accounts receivable automation software and accounts payable automation software. Streamline invoice management, get custom performance reports, and integrate with your other systems, all online and in one place.
To see our software in action, schedule a live demo today!
New to automation? To find out what tools and techniques are most effective in modernizing and streamlining your accounting practice, you can check out our guides on how to automate accounts receivable and how to automate accounts payable.
