Most business owners are familiar with 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 categorized and managed as a temporary or permanent account.
Below, we explore how temporary accounts differ from permanent accounts, offer examples of temporary accounts and examples of permanent accounts, 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 timeframe. At the end of predetermined fiscal periods, businesses close these accounts and transfer the remaining balances. There is no single standard timeframe for temporary accounts, but many companies choose to zero them out on a quarterly basis.
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.
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 need to carefully review transactions within them 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 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:
- Revenue accounts
Tracking the amount of money received for goods and services provided, revenue accounts include interest income and sales accounts.
- Expense accounts
Expense accounts track funds spent to keep an organization up and running. These costs can include rent, utilities, and wages.
- 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 timeframe.
- Drawing or dividend accounts
With a drawing account, a business owner can withdraw money for personal use. Sole proprietorships, partnerships, or S-corps typically use drawing accounts. Corporations, in contrast, usually return shareholder capital and company profits through dividend accounts.
Examples of Permanent Accounts
Accounts that are typically permanent include:
- Asset accounts
Asset accounts track everything a business owns, including physical items (e.g., inventory) and less tangible property (e.g., stocks).
- Liability accounts
Organizations use liability accounts to record and manage debts owed, including expenses, loans, and mortgages.
- Equity accounts
An equity account is a financial representation of business ownership accrued through payments to a company or through residual earnings generated by an organization.
Primary Differences between Temporary Accounts and 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 can be found on a company’s balance sheet, which provides a snapshot of what the company owns and owes at a specific point in time, and a temporary account can be found on a company’s income statement, which assesses profit and loss over a stretch of time.
Why It Matters
Understanding the distinction between temporary accounts and permanent accounts and managing them accordingly is crucial. A single error will 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 redistributed at the end of the quarter. Otherwise, these funds will create a discrepancy in the general ledger, resulting in miscalculations across other accounts.
How Accounts Receivable Automation Can Help
When businesses rely on spreadsheets or manual accounting systems, tracking and closing temporary accounts can be a time-consuming process—and one that’s prone to error. With a fully automated accounts receivable operation, you don’t have to worry about oversights that will derail your company’s financials.
To find out what tools and techniques are most effective in modernizing and streamlining your accounting practice, read The Ultimate Guide to Automating the Accounts Receivable Process.
Or schedule a live demo of the Invoiced Accounts Receivable Cloud to see what an automated cloud-native accounting platform can do for your business.
