Balance Sheet, Owner's Equity Statement and Income Statement: Temporary vs Permanent Accounts

by Kei
(Charleston, South Carolina)

Q: The three primary financial statements that we have seen so far are the Balance Sheet, Statement of Owner’s Equity, and the Income Statement. Please describe which account categories belong on which statement and identify them as temporary or permanent.


Temporary vs Permanent Accounts

First of all, let me clarify the difference between "temporary" and "permanent" accounts.

Temporary accounts are accounts that start with a balance of zero at the beginning of each year and are used to calculate other figures at the end of the year (namely, the profit or loss for the year).

When these end-of-year calculations are done, the account is cancelled out or started again from zero. Thus "temporary."

salaries expense temporary T-Account closed profit and loss


Permanent accounts
, on the other hand, start with a balance of zero only when the business has just begun. Thereafter, year after year after year, they continue with their balance and are never cancelled out or reduced back to zero. Their balance is carried through from the end of one year to the beginning of the next.

Asset Permanent T-Account


Now let's look at the different statements and the types of accounts (temporary or permanent) that are shown in each one...

The Income Statement

sample basic income statement net profit figure

The income statement shows incomes and expenses . Incomes and expenses are all temporary accounts used to calculate profit (or loss) each year.

The balances of incomes and expenses are cancelled out at the end of each year and started again from zero at the beginning of each year. That is why they are known as "temporary" accounts.

Services rendered income T-Account closed off



The Statement of Changes in Equity

sample basic statement of owner's equity closing balance

This contains the profit account, capital and drawings (or "dividends" in a company).

The
profit and loss account is temporary as it starts from zero each year. Profit belongs to the owner/s and is used to calculate the new balance of the owner's equity account at the end of each year.

Profit and Loss T Account


Owner's equity (sometimes called "Capital") is a permanent account as its balance is carried on from one year to the next.

Owner's Equity T-Account


Drawings (or "dividends" for a company) is a temporary account as its balance starts from zero and is calculated newly each year. Just like the profit account, drawings is used to calculate the new balance of the owner's equity account at the end of each year.

Drawings T Account closed profit and loss


The Balance Sheet
(or Statement of Financial Position)

sample basic simple balance sheet

The balance sheet contains assets, liabilities and owner's equity accounts . All three of these accounts are permanent accounts , meaning their balances are not cancelled out or reduced to zero at the end of each year. Instead, their balances are carried through from the end of one year to the beginning of the next.

The subject of cancelling out temporary accounts (known as "closing entries") is only covered in my
basic accounting books (not available for free on this website). You are welcome to check them out if you need more info on closing entries.

Hope that makes sense!

Best,
Michael Celender
Founder of Accounting Basics for Students


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Comments for Balance Sheet, Owner's Equity Statement and Income Statement: Temporary vs Permanent Accounts

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student
by: khadar dirie

Thank your effort. Please continue this lesson.

Profit/loss on balance sheet
by: Anonymous

I understand that the temporary accounts get closed out at the end of the accounting cycle.
My question is what does the balance sheet look like in the middle of your accounting cycle?

Profit/loss shows up in your income summary account which is closed out to Retained Earnings on the Balance Sheet.

My accounting period is a calendar year Jan-Dec.

I check my Balance Sheet on March 1st, 20__.
I made a profit of $2000.00 in February.
Will my Balance Sheet reflect my profit in the Capital account or will it not show up until I close accounts? (pretend I am hand writing all my journal entries, adjusting entries, etc. A computer program is not performing these functions for me)

Is the Retained Earnings account ever closed out? Or does it accumulate totals?

Here's my opinion... In the middle of the cycle, assuming a totally manual accounting system (no computer program), the balance sheet may or may not exist - because basically it's up to you if you want to close out the accounts and when you want to do so. Balance sheets are normally only drawn up at the end of the period (at the end of the year). However they could be drawn up more often for management purposes (for example at the end of each quarter or month).

In other words, even in this manual accounting system, like a computerized system, the profit could still be closed out at the end of each month. Or at other intervals.

The retained earnings account is a permanent (owner's equity) account and is thus never closed out. There is no need to do so. It just accumulates totals. It remains as a permanent record of the accumulated profits - which belong to the owners of the business.

Hope that helps!

Best,
Michael Celender

Feedback
by: Process Street

Hey this is very enlightening! I can’t thank you enough for sharing this post about balance sheet, statement of owner's equity and income statement now I have basic knowledge about this area.

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