Temporary account is in simple words are such accounts that are maintained only until the end of particular accounting period (which can of any length of time i.e. a week, a month, two months, a quarter, semi annual or annual). And when such accounting period lapses, these accounts are closed and nothing of such accounts is carried forward to next accounting period.
These accounts represent incomes earned or expenses incurred in particular accounting period and as incomes or expenses of one period must be reported in the same and not in previous or subsequent periods therefore, every transaction of such accounts stays in the same period. Once the relevant accounting period ends any balance in such accounts is transferred to income statement or statement of other incomes as the case may be. Such transfer is made by making special type of accounting entries called closing entries. As closure of account is intended i.e. closing accounts in same period to which they relate and due to this fact entries are named closing entries.
All kinds of incomes and expenses are the examples of temporary accounts. For example sales account, purchases account, rent account, interest on investments account etc.
A point to remember is that results or balances from temporary accounts are reported in income statement and not in the balance sheet. Balance sheet is prepared at the end of accounting period and contains only those accounts which are carried forward to the next accounting period.
One of the reason for closing down such accounts is not to mix up results of one period with another period. For example sales accounting pertaining to year 2011 will be closed in the income statement of year 2011 and for year 2012 a new sales account with zero balance will be opened to record sales of year 2012. This way sales of 2011 and 2012 will be kept separate and users will not be confused about earnings made by selling goods in one period and the other.
One of the characteristics of temporary accounts is that they represent only numbers and the item to which they relate does not exist in reality. For example salary account is a temporary account and only provides information regarding amount of salary expense. That is why they are also called nominal accounts where nominal means number.
However, there are few exceptions to temporary accounts which are not reported in income statement even though they are in nature temporary accounts and one of them is Drawings account. Drawing account is reported as a deduction from owners’ capital in the balance sheet or statement of financial position. Similarly any account which holds the transactions about appropriation of profits is also a temporary account.
One interesting fact however is that all the temporary accounts ultimately end up in entity’s capital or retained earning (or losses). Just like profit after tax (or net profit) calculated at the conclusion of income statement is transferred to equity in the end. And process of closing down temporary accounts completes when the net profit or net loss is transferred to equity in the balance sheet from income statement or statement of comprehensive income.