What accounts are not closed to the capital account at the end of the year?

As a business owner, you are likely familiar with certain accounting accounts, like your assets or expense accounts. But did you know that each account can also be labeled as a permanent or temporary account?

Read on to learn the difference between temporary vs. permanent accounts, examples of each, and how they impact your small business.

Temporary vs. permanent accounts

Before you can learn more about temporary accounts vs. permanent accounts, brush up on the types of accounts in accounting.

As a brief recap, the five core types of accounts are the following:

• Assets
• Expenses
• Liabilities
• Equity
• Income or revenue

Your accounts help you sort and track your business transactions. Each time you make a purchase or sale, you need to record the transaction using the correct account. Then, you can look at your accounts to get a snapshot of your company’s financial health.

You might also use sub-accounts to record transactions. A few examples of sub-accounts include petty cash, cost of goods sold, accounts payable, and owner’s equity.

Businesses typically list their accounts using a chart of accounts, or COA. Your COA allows you to easily organize your different accounts and track down financial or transaction information.

So, where do permanent and temporary accounts come into play in accounting?

Bookkeeping doesn’t have to be a headache

Whether you’re just starting your business or you’re already well on your way, keeping organized financial records is a must. Download our FREE whitepaper, How to Set up Your Accounting Books for the First Time, for the scoop.

Temporary accounts

What are temporary accounts? Temporary accounts in accounting refer to accounts you close at the end of each period. Temporary accounts are general ledger accounts. All income statement accounts are considered temporary accounts.

You must close temporary accounts to prevent mixing up balances between accounting periods. When you close a temporary account at the end of a period, you start with a zero balance in the next period. And, you transfer any remaining funds to the appropriate permanent account.

Temporary accounts include revenue, expense, and gain and loss accounts. If you have a sole proprietorship or partnership, you might also have a temporary withdrawal or drawing account. Examples of temporary accounts include:

• Earned interest
• Sales discounts
• Sales returns
• Utilities
• Rent
• Other expenses

Unlike permanent accounts, temporary accounts are reset from period to period. The closing process resets the balances for your temporary accounts and prepares them for a new period. Closing temporary accounts at the end of the period lets you see:

• Generated revenues
• Incurred expenses
• Earned net income

How long you maintain a temporary account is up to you. You might decide to close a temporary account at year-end. Or, you might choose to close accounts every quarter. Either way, you must make sure your temporary accounts track funds over the same period of time.

Permanent accounts

What are permanent accounts? Permanent accounts are accounts that you don’t close at the end of your accounting period. Instead of closing entries, you carry over your permanent account balances from period to period. Basically, permanent accounts will maintain a cumulative balance that will carry over each period.

Because you don’t close permanent accounts at the end of a period, permanent account balances transfer over to the following period or year. For example, your year-end inventory balance carries over into the new year and becomes your beginning inventory balance.

Report permanent accounts on your balance sheet. Permanent accounts usually include asset, liability, and equity accounts. Here are a few examples of permanent accounts:

Unlike temporary accounts, you do not need to worry about closing out permanent accounts at the end of the period. Instead, your permanent accounts will track funds for multiple fiscal periods from year to year.

Typically, permanent accounts have no ending period unless you close or sell your business or reorganize your accounts.

Examples of temporary and permanent accounts

Now that you know more about temporary vs. permanent accounts, let’s take a look at an example of each.

Temporary account example

Say you close your temporary accounts at the end of each fiscal year. Your company, XYZ Bakery, made $50,000 in sales in 2021. You forget to close the temporary account at the end of 2021, so the balance of $50,000 carries over into 2022.

In 2022, your business makes $70,000. Because you did not close your balance at the end of 2021, your sales at the end of 2022 would appear to be $120,000 instead of $70,000 for 2022.

To avoid the above scenario, you must reset your temporary account balances at the beginning of the year to zero and transfer any remaining balances to a permanent account. That way, you can accurately measure your 2021 and 2022 sales.

Permanent account example

Let’s say you have a cash account balance of $30,000 at the end of 2021. Because it’s a permanent account, you must carry over your cash account balance of $30,000 to 2022. Your beginning cash account balance for 2022 will be $30,000.

In 2022, you add an additional $25,000 in your cash account. Your year-end balance would then be $55,000 and will carry into 2023 as your beginning balance. This permanent account process will continue year after year until you don’t need the permanent accounts anymore (e.g., when you close your business).

Temporary vs. permanent accounts recap

Temporary vs. permanent accounts can be a lot to digest. To help you further understand each type of account, review the recap of temporary and permanent accounts below.

Temporary accounts:

• Include revenue, expense, and gain and loss accounts
• Are closed at the end of each period
• Reset to a balance of zero at the beginning of a period
• Might include drawing or withdrawal accounts (e.g., partnerships)
• Help you track funds from period to period

Permanent accounts:

• Include asset, liability, and equity accounts
• Don’t close at the end of an accounting period
• Are reported on the balance sheet
• Maintain a cumulative balance
• Track account balances from year to year

Looking for a simple way to track your temporary and permanent account balances? Patriot’s accounting software has you covered. Easily record income and expenses, then get back to your business. What are you waiting for? Start your free trial today!

This article is updated from its original publication date of November 12, 2019.

The capital account, in international macroeconomics, is the part of the balance of payments which records all transactions made between entities in one country with entities in the rest of the world. These transactions consist of imports and exports of goods, services, capital, and as transfer payments such as foreign aid and remittances. The balance of payments is composed of a capital account and a current account—though a narrower definition breaks down the capital account into a financial account and a capital account. The capital account measures the changes in national ownership of assets, whereas the current account measures the country's net income.

In accounting, the capital account shows the net worth of a business at a specific point in time. It is also known as owner's equity for a sole proprietorship or shareholders' equity for a corporation, and it is reported in the bottom section of the balance sheet.

• The capital account, on a national level, represents the balance of payments for a country.
• The capital account keeps track of the net change in a nation's assets and liabilities during a year.
• The capital account's balance will inform economists whether the country is a net importer or net exporter of capital.

Changes in the balance of payments can provide clues about a country’s relative level of economic health and future stability. The capital account indicates whether a country is importing or exporting capital. Big changes in the capital account can indicate how attractive a country is to foreign investors and can have a substantial impact on exchange rates.

Because all the transactions recorded in the balance of payments sum to zero, countries that run large trade deficits (current account deficits), like the United States, must by definition also run large capital account surpluses. This means more capital is flowing into the country than going out, caused by an increase in foreign ownership of domestic assets. A country with a large trade surplus is exporting capital and running a capital account deficit, which means money is flowing out of the country in exchange for increased ownership in foreign assets.

It is important to remember that the U.S. trade deficit is the consequence of foreign investors finding U.S. assets particularly attractive, and driving up the value of the dollar. Should America's relative appeal to foreign investors fade, the dollar would weaken and the trade deficit would shrink.

In recent years, many countries have adopted the narrower meaning of capital account used by the International Monetary Fund (IMF). It splits the capital account into two top-level divisions: the financial account and capital account. The capital and financial accounts measure net flows of financial claims (i.e., changes in asset position). 

An economy's stock of foreign assets versus foreign liabilities is referred to as its net international investment position, or simply net foreign assets, which measures a country's net claims on the rest of the world. If a country’s claims on the rest of the world exceed their claims on it, then it has positive net foreign assets and is said to be a net creditor. If negative, a net debtor. The position changes over time as indicated by the capital and financial account.

The financial account measures increases or decreases in international ownership of assets, whether they be individuals, businesses, governments, or central banks. These assets include foreign direct investments, securities like stocks and bonds, and gold and foreign exchange reserves. The capital account, under this definition, measures financial transactions that do not affect income, production, or savings, such as international transfers of drilling rights, trademarks, and copyrights.

The current and capital accounts represent two halves of a nation's balance of payments. The current account represents a country's net income over a period of time, while the capital account records the net change of assets and liabilities during a particular year.

In economic terms, the current account deals with the receipt and payment in cash as well as non-capital items, while the capital account reflects sources and utilization of capital. The sum of the current account and capital account reflected in the balance of payments will always be zero. Any surplus or deficit in the current account is matched and canceled out by an equal surplus or deficit in the capital account.

The current account deals with a country's short-term transactions or the difference between its savings and investments. These are also referred to as actual transactions (as they have a real impact on income), output, and employment levels through the movement of goods and services in the economy. The current account consists of visible trade (export and import of goods), invisible trade (export and import of services), unilateral transfers, and investment income (income from factors such as land or foreign shares).

The credit and debit of foreign exchange from these transactions are also recorded in the balance of current account. The resulting balance of the current account is approximated as the sum total of balance of trade.

In accounting, a capital account is a general ledger account that is used to record the owners' contributed capital and retained earnings—the cumulative amount of a company's earnings since it was formed, minus the cumulative dividends paid to the shareholders. It is reported at the bottom of the company's balance sheet, in the equity section. In a sole proprietorship, this section would be referred to as owner's equity and in a corporation, shareholder's equity.

In a corporate balance sheet, the equity section is usually broken down into common stock, preferred stock, additional paid-in capital, retained earnings, and treasury stock accounts. All of the accounts have a natural credit balance, except for treasury stock that has a natural debit balance. Common and preferred stock are recorded at the par value of total shares owned by shareholders. Additional paid-in capital is the amount shareholder's have paid into the company in excess of the par value of stock. Retained earnings is the cumulative earnings of the company overtime, minus dividends paid out to shareholders, that have been reinvested in the company's ongoing business operations. The treasury stock account is a contra equity account that records a company's share buybacks.