A permanent account is an ongoing source of information for an entity. It reflects the carrying balance of a particular account on the balance sheet of an entity at any time.
Once created, a permanent account is maintained throughout the life of a business. Its current balance is reconciled periodically to reflect the accumulated balances at the end of each accounting period.
Let us discuss what is a permanent account and how it works with its different types.
What is a Permanent Account?
A permanent account refers to a type of account that does not require a closing entry at the end of each accounting cycle. Instead, its ending balance is carried forward to the next accounting period.
As the name suggests, these types of accounts are permanent in nature. It means they are not created or deleted at the end of an accounting period.
The financial statements of a business can have either permanent or temporary accounts. Broadly categorizing, balance sheet accounts are permanent and income statement accounts are temporary.
Some common examples of permanent accounts include:
- Accounts receivable and payable
- Retained Earnings
- Share Capital/Owner’s Equity
- Notes receivable and payable
A permanent account is also called a general ledger account or a real account. It may not contain any balance at all or even a negative balance in some cases.
Permanent accounts contain accumulated balances. Therefore, businesses and auditors perform strict compliance and auditing practices to ensure their integrity.
How Does a Permanent Account Work?
As mentioned above, permanent accounts are typically balance sheet accounts. These accounts are created once and remain as long as the balance sheet remains intact.
A ledger or balance sheet account is a summary of different accounting transactions over a specified period. Businesses report these transactions and summarize them into different account categories.
At the end of an accounting cycle, either the account balance is carried forward to another account or it is accumulated.
Permanent accounts will include the net positive or negative balance from its ledger accounts at the end of each accounting period. Thus, the accumulated balance will show whether the permanent account balance increased or decreased over the accounting period.
For instance, a cash account will show the net positive or negative cash flow on the balance sheet at the end of each accounting period cumulatively for the whole business.
Similarly, any permanent account will be adjusted and the ending balance of the account will become the opening balance for the next period and so on.
Types of Permanent Account
As mentioned above, permanent accounts are mostly balance sheet accounts. We can broadly categorize them into their asset classes as well.
Asset accounts represent the sources of a business with economic values. They can be tangible or intangible.
Asset accounts are permanent accounts on the balance sheet of a business. They represent accumulated value at any given time.
At the end of each accounting cycle, any gains or losses on these assets are adjusted to their respective accounts.
Liabilities represent the money owed by a business to its different stakeholders. Liabilities also represent accumulated value at any time.
Changes to all liability accounts are reflected through increased or decreased balances from their respective sub-accounts.
An equity account is also a permanent account that reflects accumulated worth earned by a business over the life of the business.
Issuing new shares or buying back old ones will change the equity account balance. This balance will be adjusted at the end of each accounting cycle.
A net asset account is a difference between the assets and liabilities of an entity. It is commonly used by not-for-profit entities. Essentially, it is the same as the equity account.
Permanent accounts are reconciled periodically. Even if there is no change to any of these accounts during an accounting period, their ending balance remains on the balance sheet.
Examples of Permanent Accounts
Suppose a company ABC Co. Shows a cash balance of $15 million at the end of 2020. The company recovers from the previous year’s slump and shows increased sales for 2021.
The management decides to keep the additional cash inflow for working capital needs. After paying all expenses for the year, the company has a net inflow of $3 million.
The cash balance for ABC Co. At the end of the year, 2021 will now be $18 million.
Suppose ABC company has current assets worth $50 million and fixed assets of $100 million. Its total assets are $150 million (and therefore Equity + liabilities of $150 million).
The management of ABC company decides to dispose of one of its properties worth $15 million to settle its bank loan worth $12 million.
After paying for its bank loan, the company will reflect a net decrease in its liabilities by $12 million, a decrease of $15 million in fixed assets, and an increase of $3 million in current assets (cash).
So, the current assets of ABC company will now be $53 million, fixed assets $85 million, and total assets $138 million. Its total liabilities + equity will now be $138 million.
Key Features of a Permanent Account
Permanent accounts come with certain features or characteristics. We can identify them by evaluating these key features.
Permanent accounts accrue balance over the length of an accounting cycle. Assets accumulate these balances net of any changes during this period.
These net changes in each permanent account balance are adjusted at the end of each accounting period. Therefore, these balances reflect the accrued values at any given time.
Length of Accounting Cycle
Permanent accounts show accrued balances at any given time. However, their accounting balances change from one period to the next.
Unlike temporary accounts, there is no carried forward balance for permanent accounts though. Therefore, the length of the accounting period only matters to evaluate changes in the ending balance of permanent accounts.
The primary purpose of permanent accounts is to provide useful information to the stakeholders of a business. As they reflect the balances since inception, they provide valuable information to key stakeholders.
Permanent accounts are useful for tracking yearly and quarterly changes in different business segments as well.
Permanent accounts on the balance sheet can further be classified into sub-accounts as well. In practice, balance sheet accounts reflect the summary balances of these sub-accounts.
Common examples of permanent sub-accounts include cash, inventory, accounts receivable, share capital, share premium, bank loan, and retained earnings.
How Do Closing Entries work with Permanent Accounts?
The closing process is usually linked to temporary accounts. However, permanent accounts go through similar phases to close out at the end of each accounting period.
- The first step is to identify and recognize an accounting transaction.
- The second step is to record the transaction in the general ledger under the right account type.
- In the next step, accountants prepare unadjusted or trial balances for all ledger accounts.
- Then, the ledger book is adjusted through reconciliation and all accounts are checked for accuracy. This step prepares adjusted trial balances.
- The next important step is to summarize ledger accounts and take the balances to the financial statement accounts.
- Finally, temporary account balances are reconciled and moved to permanent accounts as well.
The process shows that the permanent accounts reflect the summary of ledger accounts as well as temporary accounts.
Can Permanent Accounts Have Zero Balance?
Yes, permanent accounts can show zero or negative balances as well. Different types of permanent accounts can show zero balance for any accounting period.
For example, if a company created an inventory account once for a significant amount, it may change over time. If the company fully utilized its inventory during an accounting period and newer stocks did not arrive in time, the account will show zero inventory.
Similarly, a permanent asset or liability account may show a negative balance at a given time as well. Although it happens rarely as accounting adjustments take place during the period and before the end of the accounting cycle.