Examples of temporary accounts are Supplies and Prepaid Expenses, which are in the ledger for just a short time before they expire.
The correct answer and explanation is:
The statement provided refers to temporary accounts, but there is a slight mix-up. Supplies and prepaid expenses are actually classified as asset accounts and are not typically considered temporary accounts.
Temporary accounts are those that are used to track financial transactions over a specific period, such as a month or a year, and are closed at the end of the accounting period. These accounts track revenues, expenses, gains, and losses. Once the period concludes, the balances in these accounts are transferred to permanent accounts, such as the retained earnings account.
Examples of temporary accounts include:
- Revenue accounts: These track the money earned from the sale of goods and services during a specific period. For example, Sales Revenue or Service Revenue are temporary accounts.
- Expense accounts: These represent the costs incurred to earn the revenue in a specific period, such as Rent Expense, Utilities Expense, or Salaries Expense.
- Income summary: This temporary account is used to summarize the revenue and expense accounts at the end of an accounting period before transferring the balance to retained earnings.
- Gain and loss accounts: These track specific gains or losses resulting from business activities, such as Gain on Sale of Assets or Loss on Investments.
Prepaid expenses and supplies are asset accounts, but they are part of the balance sheet and fall under the category of current assets. They represent amounts paid in advance for services or goods that will be used or consumed in the future, and their balances are adjusted over time. For instance, a prepaid insurance expense would be recorded as an asset until the insurance is used up. Similarly, supplies are considered assets until they are consumed in the course of doing business.
The key difference is that temporary accounts are cleared out at the end of each accounting period, while asset accounts like prepaid expenses and supplies are carried over into the next period.