Which of the following are temporary accounts that are closed at the end of the year

What is a Temporary Account?

Temporary accounts are nominal accounts with zero balance at the beginning of the financial year. At the end of the year, the balance is visible in the income statement and later transferred to the permanent account in the form of reserves and surplus. Thus, accounts that are part of the income statement are temporary and are periodically closed.

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• What is a Temporary Account?
• Types of Temporary Accounts
• Temporary Account Examples
• Difference Between Temporary Account and Permanent Account
• How to Close the Temporary Account?
• Recommended Articles
• What are the 4 temporary accounts?
• Which of the following are all temporary accounts that are closed at the end of the accounting period and will have a balance of zero at the end of the closing process?
• What are the 3 temporary accounts?
• What accounts are closed at the end of the period?
• Which of the following accounts are temporary accounts?

Types of Temporary Accounts

The following are their types: –

#1 – Revenues and Gains

The entity’s revenue and gains need to be closed at the end of every year. Thus, accounts like sales accounts, service revenue accounts, interest incomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. read more account, dividend income account, and profit on the sale of debitDebit represents either an increase in a company’s expenses or a decline in its revenue. read more details of a company’s assets. Examples include short-term Investments, prepaid expenses, supplies, land, equipment, furniture & fixtures, discount income account, etc. are the type of temporary accounts covered under revenue and gains.

#2 – Losses and Expenses

Expenses are the core of all businesses. Hence, as discussed in revenue, expenses must be precise at the end of the year to check the net outflow of the cash for the given period. Thus, accounts like the cost of sales accountThe costs directly attributable to the production of the goods that are sold in the firm or organization are referred to as the cost of sales.read more, salaries expense account, interest expenseInterest expense is the amount of interest payable on any borrowings, such as loans, bonds, or other lines of credit, and the costs associated with it are shown on the income statement as interest expense.read more account, delivery expense account, purchase account, etc., are the type of temporary accounts included under losses and gains.

#3 – Drawing Account or Income Summary Account

The income statement summary is transferred to the capital accountThe capital account refers to the general ledger that records the transactions related to owners funds, i.e. their contributions earnings earned by the business till date after reduction of any distributions such as dividends. It is reported in the balance sheet under the equity side as “shareholders’ equity.”read more in sole proprietorship and partnership at the end of the year. The income statement summary is credited to reserves and surplus in a dividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more. Without these entries, books cannot be closed. Therefore, entries with such adjustments are considered closing entries and passed into the temporary accounts.

Temporary Account Examples

Example #1

• ABC Ltd. recorded revenues of $600,000 for the financial year 2017. In 2018, it recorded $400,000 worth of gains, and $800,000 in 2019.
• The company will use a temporary account to represent the revenue annually to display in financial statementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more. If the record were not closed, the total earnings Earnings are usually defined as the net income of the company obtained after reducing the cost of sales, operating expenses, interest, and taxes from all the sales revenue for a specific time period. In the case of an individual, it comprises wages or salaries or other payments.read more would be $1800,000.
• The company can be visible as profitable due to total turnover. Therefore, that cannot always be good because three years’ worth of revenues cannot be clubbed to measure the business’s solvencySolvency of a company means its ability to meet the long term financial commitments, continue its operation in the foreseeable future and achieve long term growth. It indicates that the entity will conduct its business with ease.read more. For the proper computation of any year’s profit and expenses, the temporary account must be created and closed adequately at the end of the year.

Example #2

• Let us take the example of retained earningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more. Retained earnings show the company’s accumulated gains or losses over time. Every year, at the end of the year, the balances of income and expense accounts are transferred to the income statementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more and then squared off against the income summary account, bypassing the closing entriesClosing Entries in Accounting are the journal entries made at the end of an accounting period to nullify the balances of temporary accounts by transferring the amount to the permanent accounts. read more.
• Once the accounting process is completed, books are closed by transferring the surplus/losses to the retained earning account. Ledger reserves and surplusReserves and Surplus is the amount kept aside from the profits that are to be used either for the business or for the shareholders to pay out dividends. Reserves and surplus is reflected under shareholders funds in the balance sheet.read more will not be closed at the end of a period as the exact nature is permanent. Instead, it contains a balance that carries forward to the next year and later discloses its past incomes and losses.

Difference Between Temporary Account and Permanent Account

How to Close the Temporary Account?

It is always mandatory to close all temporary accounts and record the net change to the owner’s capital account. To do this, pass the journal entries and post the same to respective ledgers balancing the same, and then pass closing entries for all temporary accounts. Finally, an income summary account is prepared to show the summary of revenue and expenseAn expense is a cost incurred in completing any transaction by an organization, leading to either revenue generation creation of the asset, change in liability, or raising capital.read more accounts and discloses the profits and losses of the entity for the given period.

Below are the steps to be followed to close these accounts: –

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For eg:
Source: Temporary Account (wallstreetmojo.com)

• Revenue and gains account – Step one is to square off this account. It includes transferring the amount of the revenue accountRevenue accounts are those that report the business's income and thus have credit balances. Revenue from sales, revenue from rental income, revenue from interest income, are it's common examples.read more to the income summary account on the debit side.
• Expenses and losses account – Step two is to square off the expenses and losses. It includes transferring the amount of the cost account to the income summary account on the credit side.
• Income summary account – Step three is to square off the income summary. The amount of the income summary is expenses and revenue transferred to the capital account.
• Drawings account – The last step is to square off the drawings account. The amount in the drawings account is transferred to the capital account or the retained earningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more account.

Conclusion

These are prepared to avoid a mix-up of the balances between two or more accounting periodsAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance.read more. The main objective is to see particular periods’ profits or gains and the accounting activity. It is essential to diligently classify any account under a temporary account because if any asset account is wrongly considered, it will erode the asset base of the entity.

Recommended Articles

This article is a guide to a Temporary Account and its definition. Here, we discuss temporary account examples, types, and how to close them, including the differences between temporary and permanent accounts. You can learn more about accounting from the following articles: –

• Escrow Account
• Clearing Account
• Public-Private Partnership
• Examples of T-Account