What it means
Imagine running a marathon and resetting your stopwatch at every mile marker. That is essentially what temporary accounts do for your business finances.
They track activity for a specific timeframe, usually one financial year, allowing you to measure performance over that exact period. These accounts include all revenue categories, expense categories, and the owner's drawings.
At the end of the financial year, these temporary balances must be cleared out. This process is known as closing the books.
Accountants transfer the net profit or loss from these temporary accounts into retained earnings, which lives on the balance sheet. By zeroing out the temporary accounts, the business prepares to measure performance accurately for the upcoming year without mixing past results with new ones.
Why does this matter for non-finance managers? Because it ensures that your profit and loss statement reflects only what happened during the current period.
If temporary accounts were not reset, your sales and costs would accumulate indefinitely, making it impossible to tell if your business is growing, shrinking, or holding steady this year compared to last year. In day-to-day operations, you interact with temporary accounts every time you record a sale, pay an electricity bill, or buy office supplies.
While your balance sheet items like cash and loans roll over continuously, your income statement items rely entirely on these temporary setups to keep score for the current financial cycle.
In practice
Real-world examples.
Example
A freelance graphic designer earns 4,000 pounds in client fees and spends 500 pounds on software in December. On 31 December, these income and software expense totals are cleared to zero.
Example
A local cafe records 15,000 pounds in coffee sales and 11,000 pounds in ingredient costs for the month. At month-end, these temporary totals are processed, leaving a clean slate for the next month.
Example
A small consultancy firm tracks 8,000 pounds in staff travel costs over the summer. When the financial year ends in September, this travel cost account is reset to zero for the new fiscal year.
Think of it
“Temporary accounts are like the daily trip odometer in a car. You reset it to zero before a specific journey to track that single trip, while the main odometer keeps running up the total lifetime mileage.
Formula
Calculation
Net Income = Total Revenues - Total Expenses
Example:
Total Revenues = 50,000 pounds
Total Expenses = 35,000 pounds
Net Income = 50,000 pounds - 35,000 pounds = 15,000 pounds
This 15,000 pounds is then transferred out of the temporary revenue and expense accounts, resetting them to zero, and moved into permanent retained earnings.Case study
Seen in the real world.
Bright Spark Lighting, a small retail shop, reached the end of its financial year on 31 March. Throughout the year, the manager carefully tracked sales and costs using temporary accounts. The books showed total sales revenue of 120,000 pounds and operating expenses of 85,000 pounds, leaving a net profit of 35,000 pounds.
To prepare for the new financial year starting on 1 April, the accountant performed the year-end closing process. The accountant debited all revenue accounts and credited all expense accounts until their balances hit zero. The net difference of 35,000 pounds was moved into the company's retained earnings account on the balance sheet.
When the team arrived at work on 1 April, all sales and expense tracking started fresh from zero. This allowed Bright Spark Lighting to measure its new performance accurately without interference from the previous year's figures.
Watch out
Common mistakes.
- Failing to reset temporary accounts at the end of the accounting period, which distorts the next period's results.
- Confusing temporary accounts with permanent accounts like bank balances or long-term loans.
- Forgetting to transfer the final net balance into the permanent equity or retained earnings section.
Questions
People also ask.
What happens if I forget to close temporary accounts?
Your next year's income statement will include revenues and expenses from the previous year, making your financial reports inaccurate.
Are asset accounts temporary?
No. Assets, liabilities, and equity accounts are permanent accounts because their balances roll over into the next financial period.
Do temporary accounts only reset annually?
While usually reset annually, some businesses choose to close their temporary accounts monthly or quarterly for internal reporting.
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