What is the Nominal Account?
Nominal Accounts are accounts related and associated to losses, expenses, income or gains. Examples include purchase account, sales account, salary A/C, commission A/C etc. The final outcome of nominal account is either profit or loss which is then ultimately transferred to the capital account.
- The nominal account is income statement account (expenses, income, loss, profit) and is also known as temporary account unlike balance sheet account ( Asset, Liability, owner’s equity) which are permanent account.
- So nominal accounting starts with a zero balance at the start of every accounting year and 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 permanent account.
Nominal Account Example
Consider a temporary account like sales account which is opened for recording sale of goods and services during the year and at the end of the financial year the total sales are transferred to the revenue statement account similarly expenses are recorded in expense account and which again at the end of year are transferred to revenue statement account and at the end the positive/ negative changes (Revenue- expenses) are transferred to permanent account in balance sheet.
Based on the periodicity of flow of fund the Account is divided as below
- An Income is a short-term inflow of funds during fiscal year
- An Expenses are the short-term outflow of the fund during fiscal year
- An asset is the long-term inflow of funds whose time horizon can be spread to multiple years so as assets value can be calculated as a present value of future cash flow.
- A Liability is a long-term outflow of a fund which 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 this 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 under book 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 record keeping 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 next fiscal year.
- These are income statement accounts i.e. accounts for recording income, expenses, profit and losses whereas real account is linked with 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 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 real account.
- Entries in the nominal account are recorded as per the journal entries with respect to time and date.
This has been a guide to what is Nominal Accounts. Here we discuss the golden rules to record any transaction with examples. Als,o we discuss Nominal account vs Real Account. Here are the other articles in accounting that you may like –