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What is the Nominal Account?
Nominal Accounts are accounts related and associated with losses, expenses, income, or gains. Examples include a purchase account, sales account, salary A/C, commission A/C, etc. The outcome of a nominal account is either profit or loss, which is then ultimately transferred to the capital account.
- The nominal account is an income statement account (expenses, income, loss, profit). It is also known as a temporary account, unlike the balance sheet account ( Asset, Liability, owner’s equity), which are permanent accounts.
- So nominal accounting starts with a zero balance at the start of every accounting year. Then during the period, it accumulates all the gains and losses and returns to zero balance at the end of every accounting year by transferring/paying the amount/ balances to a permanent account.
Nominal Account Example
Consider a temporary account like a sales account that is opened for recording the sale of goods and services during the year. At the end of the financial year, the total sales are transferred to the revenue statement account. Similarly, expenses are recorded in the expense account and which again at the end of the year are transferred to the revenue statement account. In the end, the positive/ negative changes (Revenue- expenses) are transferred to a permanent account in the balance sheet.
Based on the periodicity of the flow of funds, the Account is divided as below.
- An Income is a short-term inflow of funds during the fiscal year.
- Expenses are the short-term outflow of the fund during the fiscal year.
- An asset is the long-term inflow of funds whose time horizon can be spread to multiple years, so assets value can be calculated as a present value of future cash flow.
- A Liability is a long-term outflow of a fund that is extending beyond the financial year.
The Rules of Nominal Account
The golden rules to record any transaction under nominal accounts are:
1.) Debit all the expenses and losses.
2.) Credit all the income and gains.
Let us understand the rules of Nominal account with the help of an example:
Suppose a good is purchased for Rs.15,000 in a cash transaction. To record this transaction, we are affecting two accounts i.e., purchase account and cash account.
The amount will be Rs. 15,000 in both debit and credit.
Transferring Fund from Nominal Account to Real Account
The following journal entries show how the balances in nominal ac are shifted through an income summary account to the retained earnings account-
#1 – Shift all Rs. 10,000 of revenues generated during the month to the income summary account
#2 – Shift all Rs. 9,000 of expenses generated during the month to the income summary account (there is assumed to be just one expense account)
#3 – Shift the Rs. 1,000 net profit balance in the income summary account to the retained earnings account
The preceding entries can be completed manually. However, an accounting software package will handle the transfer tasks automatically, once an authorized user sets the rollover flag in the software to close the old reporting year and shift recordkeeping to the next fiscal year.
Difference Between a Nominal Account and a Real Account-
When we differentiate these two accounts, the main parameter we consider is the balances in these accounts at the end of the fiscal year.
- As we know, this account starts with zero balance and ends with zero balance, so only this account is called a temporary account. Whereas balance in a real account does not reset to zero at the end of fiscal year, and last year balances get to carry forward to the next fiscal year.
- These are income statement accounts i.e., accounts for recording income, expenses, profit, and losses. In contrast, a real account is linked with a balance sheet account i.e., accounts for recording assets, liabilities, owner’s equity.
- At the end of every fiscal year, the balances in nominal (temporary account) account are transferred to a real account (temporary account) for the net change during the accounting year. In other terms, the nominal account rule is reset to zero, and the balance is carry forwarded to a real account.
- Entries in the nominal account are recorded as per the journal entries concerning time and date.
Nominal Account Video
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