In accounting, it’s important to know how to group different types of accounts to keep track of a company’s money and see how well it’s doing. There are two main groups: temporary accounts and permanent accounts.
Temporary accounts show income and expenses for a certain time period, while permanent accounts show a company’s overall financial situation.
In this article, we’ll look at interest income and figure out if it’s a temporary or permanent account.
What Is Interest Income?
Interest income is the money earned from lending money or letting someone else use it. It is the profit made by an investor’s money when they put it into a project or investment. To calculate it, you multiply the initial amount of money by the interest rate and the length of time it is lent.
What Is A Temporary Account?
A temporary account in accounting keeps track of money movements that will be reversed or eliminated at the end of a certain time period. It records things like income, expenses, profits, losses, taking out money, and putting in money during that time.
At the end of the period, these accounts are finalized, with their balances being moved to permanent accounts. This process helps make sure all financial information recorded in an organization’s books is accurate and current.
Temporary accounts are used to keep track of estimated amounts for future transactions that haven’t happened yet. This can give businesses an idea of possible future expenses or income. Having this information can help businesses make better decisions about how to use their resources.
Is Interest Income A Temporary Account?
No, interest income is usually not considered a temporary account. Temporary accounts are used to keep track of income and expenses for a specific time period, like a year, and they are closed at the end of that period.
These accounts include revenue accounts (like sales revenue and interest income) and expense accounts (like salaries expense and rent expense).
However, interest income is a type of income that is often used to keep track of the money earned from interest over a long period of time. It doesn’t get closed at the end of a fiscal year but keeps adding up over time.
It is then mentioned on the company’s income statement as part of its total income. Therefore, interest income is a permanent or nominal account, not a temporary one.
How Do Temporary and Permanent Accounts Differ?
Both temporary and permanent accounts are needed to show how well a business is doing financially, but there are important differences to think about. Here are some important ways that temporary and permanent accounts are different, so you can understand and use each type more easily:
Duration Of Accumulated Amounts
Both short-term and long-term accounts accumulate amounts over periods of time, but the lengths of these periods are different. For short-term accounts, the amount accumulates over a single accounting period. Once the accounting period ends, the money in a short-term account goes back to zero, and its amount is moved to a long-term account.
On the other hand, a permanent account has a balance that continues from one accounting period to another. The balance of a permanent account can become zero, but it is never intentionally set to zero at the end of an accounting period.
Purpose
Temporary and permanent accounts give different types of information about a business’s financial activities, so they have different uses. Temporary accounts keep track of money for a specific time period, while permanent accounts keep track of money over a longer period of time.
After an accounting employee finishes with a temporary account, the business can see the revenues, net income, and expenses for that specific period of time. On the other hand, permanent accounts have ongoing balances, so they are helpful for keeping track of a business’s financial status over the years.
Types Of Related Accounts
You can better understand how a company works and how well it’s doing by knowing which accounts are temporary or permanent. Temporary accounts usually have to do with money coming in or going out. Some examples of temporary accounts are:
- Earned interest
- Gains and losses
- Rent
- Sales discounts
- Sales returns
Utilities
Instead, permanent accounts are for things like money, ownership, and debts. Some specific types of permanent accounts are:
- Accounts payable
- Accounts receivable
- Inventory
- Owner’s equity
- Retained earnings
Examples Of Permanent And Temporary Accounts
Now that you understand the difference between temporary and permanent accounts let’s examine an example of each type.
Temporary Account Example
Let’s say you usually close your accounts at the end of each year. Your company, XYZ Bakery, made $50,000 in sales in 2021. However, you forgot to close one account at the end of 2021, so the remaining balance of $50,000 is carried over to 2022.
In 2022, your business earned $70,000. Since you didn’t calculate your balance at the end of 2021, it seems like you made $120,000 instead of $70,000 in 2022.
To prevent the situation described above, you need to start each year with a balance of zero in your temporary accounts and move any remaining balances to a permanent account. This will allow you to accurately track your sales for 2021 and 2022.
Permanent Account Example
Imagine you have $30,000 in your cash account at the end of 2021. Since it’s a permanent account, you need to keep the same balance of $30,000 for 2022. So, your starting cash account balance for 2022 will also be $30,000.
In 2022, you put an extra $25,000 in your cash account. By the end of the year, your balance will be $55,000, and this amount will be your starting balance for 2023. This process of keeping a permanent account will continue every year until you no longer need them, like when you shut down your business.
Interest income is a type of account in accounting that is used to track and report the income a company makes from its financial assets during a certain period. This includes the interest earned from bank deposits or loans. At the end of the year, the balance in the interest income account is moved to a different account, and a new period of recording begins. It is important to know the difference between temporary and permanent accounts for accurate financial reporting and decision-making in a company.
Thanks for reading. I hope you find it interesting.
