What is Temporary Account?
Temporary accounts (nominal accounts) are reset at the end of each accounting period. Learn how temporary accounts work, which accounts are temporary, and why they get closed at year-end.
What Is a Temporary Account?
A temporary account (also called a nominal account) is a general ledger account used to track financial activity during a specific accounting period—one fiscal year, quarter, or month. At the end of that period, the account is "closed" and its balance is transferred to a permanent account, resetting it to zero for the next period. The word "temporary" reflects the account's purpose: it captures a snapshot of performance for a defined window of time, then gets cleared out so the next period can start fresh. Think of temporary accounts as scorecards that get wiped clean at the end of each game—allowing you to track each season's results independently rather than accumulating an ever-growing total. Temporary accounts are the backbone of period-based financial reporting. Without them, you'd have no way to answer the question: How did we perform this quarter versus last quarter? All revenues, expenses, and distributions would simply accumulate in a single running total, making it impossible to isolate any given period's performance.
Temporary vs. Permanent Accounts
The accounting world divides all accounts into two categories: | | Temporary (Nominal) Accounts | Permanent (Real) Accounts | |---|---|---| | Also called | Nominal accounts | Real accounts | | Purpose | Track a single period's activity | Carry balances across periods | | Reset at year-end? | Yes — closed and zeroed | No — balance carries forward | | Appears on | Income statement | Balance sheet | | Examples | Revenue, Expenses, Gains, Losses, Drawing | Assets, Liabilities, Equity | This distinction is critical because it determines what shows up on each financial statement. Income statement = temporary accounts (the performance of THIS period). Balance sheet = permanent accounts (the cumulative financial position as of TODAY). Understanding this distinction helps you read both statements correctly. When you look at your income statement, every line is a temporary account that was active only during that reporting period. When you look at your balance sheet, every line is a permanent account that carries the cumulative history of the business.
The Complete List of Temporary Accounts
Revenue Accounts All income accounts are temporary—they reset at year-end: - Service Revenue - Sales Revenue - Consulting Revenue - Interest Revenue - Rental Income - Subscription Revenue - Royalty Income - Any other income account Expense Accounts All cost and expense accounts are temporary: - Salaries Expense - Rent Expense - Utilities Expense - Office Supplies Expense - Professional Fees - Marketing Expense - Depreciation Expense (the expense itself is temporary; accumulated depreciation is permanent) - Bad Debt Expense - Insurance Expense - Software Subscriptions - Interest Expense - Any other expense account Gain and Loss Accounts - Gain on Sale of Equipment - Loss on Sale of Investments - Unrealized Gain/Loss on Securities (depending on accounting treatment) - Loss on disposal of fixed assets Owner's Drawing / Dividends - Owner's Drawing (sole proprietorship/partnership) — the distributions an owner takes from the business - Dividends (corporation) — returns of capital to shareholders Note: Income Summary is technically a temporary account used during the closing process to consolidate revenue and expense accounts before transferring to retained earnings. It has a zero balance both before and after the closing process.
The Closing Process — 4 Steps
At the end of each accounting period, accountants perform closing entries to reset temporary accounts. Here's the four-step process: Step 1: Close Revenue Accounts to Income Summary All revenue account balances are transferred to Income Summary: `` Income Summary (Dr.) $XXX Revenue Account (Cr.) $XXX ` This zeroes out all revenue accounts, ready for the next period. Step 2: Close Expense Accounts to Income Summary All expense account balances are transferred to Income Summary: ` Expense Account (Dr.) $XXX Income Summary (Cr.) $XXX ` After Steps 1 and 2, the Income Summary account balance equals net income (credit balance) or net loss (debit balance). Step 3: Close Income Summary to Retained Earnings (or Owner's Capital) If Income Summary has a credit balance (profit): ` Income Summary (Dr.) $XXX Retained Earnings (Cr.) $XXX ` If Income Summary has a debit balance (loss): ` Retained Earnings (Dr.) $XXX Income Summary (Cr.) $XXX ` Step 4: Close the Drawing/Dividends Account to Owner's Capital ` Owner's Capital (Dr.) $XXX Drawing (Cr.) $XXX `` After all four steps, every temporary account has a zero balance and is ready for the new period. The permanent equity accounts (retained earnings or owner's capital) have absorbed the period's net result.
Temporary Accounts in Action — Example
Sole proprietor freelancer (Jan's Design Studio) for Year 1: Income Statement Accounts (Temporary): | Account | Debit | Credit | |---|---|---| | Design Revenue | — | $120,000 | | Project Expenses | $45,000 | — | | Software & Tools | $8,000 | — | | Office Supplies | $2,000 | — | | Professional Fees | $5,000 | — | | Net Income | $60,000 | | Closing Entries: 1. Close Revenue: `` Income Summary (Dr.) $120,000 Design Revenue (Cr.) $120,000 ` 2. Close Expenses: ` Income Summary (Cr.) $60,000 Project Expenses (Dr.) $45,000 Software & Tools (Dr.) $8,000 Office Supplies (Dr.) $2,000 Professional Fees (Dr.) $5,000 ` 3. Close Income Summary to Owner's Capital: ` Income Summary (Dr.) $60,000 Jan's Capital (Cr.) $60,000 ` 4. Close Drawing (assume owner withdrew $24,000 during the year): ` Jan's Capital (Dr.) $24,000 Jan's Drawing (Cr.) $24,000 `` Result: Jan's Capital account increases by $36,000 ($60,000 profit − $24,000 drawings), accurately reflecting the net increase in her equity for the year. All temporary accounts now show $0 and are ready for Year 2.
Why the Closing Process Matters
1. Clean Slate Each Period Closing entries ensure that each accounting period starts with zero balances in revenue and expense accounts. This allows accurate period-by-period comparison. If you didn't close accounts, your Year 2 revenue would include Year 1 revenue—making your income statement a cumulative total rather than a period-specific performance report. 2. Preserves Audit Trail Proper closing entries maintain a clear record of how retained earnings changed during the period—separating what came in (revenue), what went out (expenses), and what was distributed to the owner (drawings). Auditors can trace every dollar from the income statement to the equity section of the balance sheet. 3. Reduces Errors Across Periods Resetting temporary accounts eliminates the risk of double-counting revenues or expenses across periods. Without closing entries, a miscategorized expense in Year 1 might contaminate Year 2 figures as well. 4. Required for Accurate Tax Reporting The IRS requires businesses to report income and expenses on an annual basis (or on their fiscal year basis). The closing process creates clean, period-specific financial statements that support tax filings. Without it, there would be no clear delineation of what income and expenses belong to which tax year.
Common Misconceptions About Temporary Accounts
Misconception 1: "I don't need to close my books if I use cash basis accounting." Cash basis businesses still need to close accounts if they track receivables, payables, or any income statement activity. The closing process affects all accounts with revenue and expense activity, regardless of whether the business uses cash or accrual basis. Misconception 2: "Closing entries change my actual business performance." No—closing entries are purely reclassification entries. They move balances from temporary accounts to permanent accounts; they don't create or destroy value. Your net income remains the same before and after closing entries. Misconception 3: "Only corporations need to close accounts." Every business entity type—sole proprietorships, partnerships, LLCs, and corporations—performs the closing process. The only difference is which equity account receives the transfer: retained earnings (corporations), owner's capital (sole proprietors), or partner capital accounts (partnerships). Misconception 4: "Depreciation Expense is permanent because Accumulated Depreciation is." Depreciation Expense is a temporary account that closes each year. Accumulated Depreciation (the contra asset) is permanent and carries forward. They're different accounts—one on the income statement (temporary), one on the balance sheet (permanent).
Does Your Accounting Software Handle This Automatically?
For most modern small-business accounting software (QuickBooks, Xero, FreshBooks, Wave, Eonebill), the closing entries process is automated. At year-end, the software generates closing entries with a single click—or handles the process automatically when you open a new accounting period. What this means practically: while you should understand the mechanics of closing entries, you likely won't need to manually post them. However, understanding what's happening under the hood helps you catch errors, interpret year-end reports correctly, and understand why your income statement balances don't carry forward to the next year.
Temporary Accounts and Your Annual Tax Filing
From a tax perspective, temporary accounts define your taxable year. All the revenue accounts and expense accounts that close at December 31 (or your fiscal year-end) determine what income and deductions appear on your tax return for that year. This is why timing matters: a payment received on December 31 hits your current year's temporary revenue account; the same payment received on January 1 goes to next year's account. For freelancers managing their tax liability, understanding when revenue and expenses flow through temporary accounts can inform timing decisions—accelerating deductions into the current year or deferring income to the next.
The Bottom Line
Temporary accounts are the heartbeat of period-based accounting. They capture a discrete reporting period's revenues, expenses, and distributions so you can accurately measure performance for that specific window of time. At each year-end, they get closed—reset to zero—and their net balance transfers to retained earnings (or owner's capital), preserving the complete history of how your business equity changed. Understanding temporary accounts helps you read your income statement correctly and appreciate why year-end accounting is a distinct exercise from day-to-day bookkeeping. It also clarifies the fundamental logic of double-entry accounting: the income statement (temporary accounts) feeds into the balance sheet (permanent accounts) through the closing process. Key Takeaways: 1. Temporary accounts track a single period's activity and are closed to zero at year-end 2. Examples: all revenue, expense, gain, loss, and drawing accounts 3. Closing entries transfer temporary account balances to retained earnings or owner's capital 4. Permanent accounts (assets, liabilities, equity) are never closed—they carry forward indefinitely 5. Modern accounting software automates the closing process, but understanding the mechanics helps you interpret your financials correctly Want clean, organized financial records for easy year-end close? Try Eonebill Free View Pricing → | Glossary Home → | Home →