Temporary accounts refer to accounts that are closed at the end of every accounting period. These accounts include revenue, expense, and withdrawal accounts. They are closed to prevent their balances from being mixed with those of the next period.
Also known as: Nominal accounts, Income statement accounts
Temporary accounts include all revenue accounts, expense accounts, and in the case of sole proprietorships and partnerships, drawing or withdrawal accounts.
1. Revenue accounts - all revenue or income accounts are temporary accounts. These accounts include Sales, Service Revenue, Interest Income, Rent Income, Royalty Income, Dividend Income, Gain on Sale of Equipment, etc. Contra-revenue accounts such as Sales Discounts, and Sales Returns and Allowances, are also temporary accounts.
2. Expense accounts - expense accounts such as Cost of Sales, Salaries Expense, Rent Expense, Interest Expense, Delivery Expense, Utilities Expense, and all other expenses are temporary accounts. Purchases, Purchase Discounts, and Purchase Returns and Allowances (under periodic inventory method) are also temporary accounts.
3. Drawing or withdrawal accounts of the owner/s in sole proprietorships and partnerships
Temporary accounts are closed at the end of every accounting period. The closing process aims to reset the balances of revenue, expense, and withdrawal accounts and prepare them for the next period. Unlike permanent accounts, temporary accounts are measured from period to period only.
For example, ABC company was able to make $500,000 sales in 2019. If the sales account was not closed, it will be carried over to the next accounting period. Say in 2020, the company makes $600,000. If the 2019 account was not closed, the balance that would appear at the end of 2020 would be $1,100,000. But we want to measure what occurred in 2020 only, hence the need to close the the previous period's balance. The same theory applies for expenses and withdrawals.
This enables users to know how much revenues were generated, how much expenses were incurred, and how much net income the company made in different accounting periods -- 2018, 2019, 2020, etc.
Temporary accounts are closed to the appropriate capital account. In sole proprietorships, they are closed to the owner's capital account. In partnerships, they are distributed to the partners' capital accounts using an appropriate allocation method. In corporations, they are closed to retained earnings or accumulated profits. Ultimately, after the closing process, temporary accounts are incorporated and become part of a "permanent" capital account.