Question

What is a temporary account? What is a permanent account? How do they impact the closing process?

Answer 1

Temporary Account

An account which is not supposed to be carried to subsequent year are temporary accounts. They are closed at the end of the year by a transfer to Income summary. Thus a temporary account is general ledger account with zero balance at the beginning of the year, because no balance is brought forward from previous year. All the summary of sales, salaries, rents etc of a year are put into separate leger accounts and final balance is closed by transferring to Income summary at the end of the year.

Even the Income summary account is also a temporary account, because it also closed at the end of the year by transfering its balance to Capital account ( Proprietory business) or Retained earnings account ( Corporations)

Permanent Account

These are the general ledger accounts that carries balances or not closed at the end of the year. Example : Equipment account, Receivables accounts, inventories account etc. These accounts can have a beginning balance and also have an ending balance. These accounts are not closed using the closing entries, instead shown in the balance sheet as assets, liabilities and Equity sections.

Impact on closing process

Temporary accounts which are generally the nominal accounts must be closed by a transfer to income summary account. This a very important aspect since, matching concept, periodicity concept and accrual concepts of GAAP are inherent in this process. That means if a temporary account is not closed or treated as permanent account by ignorance, it will dishonour the Generally agreed accounting principles and Financial statements fails to show the true and fair view.