What Is The Nominal Account?
Nominal Accounts are accounts related to 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.
It is thus a portion of the accounting general ledger which the company need to close at the end of every accounting year. It is sometimes called a temporary account. This type of account includes all expenses, revenues, losses, and gains that are incurred within the financial year.
Table of contents
- A nominal account is a crucial type of account used to meticulously record various financial transactions, such as expenses, revenues, gains, or losses in a company’s comprehensive financial records.
- Nominal accounts are considered temporary and closed at the end of each accounting period. Their balances are systematically transferred to the company’s retained earnings or profit and loss account.
- Common examples of nominal accounts encompass pivotal financial elements such as sales revenue, cost of goods sold, rent expense, and interest expense.
- These accounts play a fundamental role in accurately reflecting a company’s financial performance and maintaining meticulous financial records.
Nominal Account Explained
A nominal account is a general ledger requiring a closure at the end of every accounting period. All financial transactions done during any year is accumulated and stored in it and transferred to the permanent account later at the end of the fiscal year.
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.
The balances of this nominal account list are never carried forward to the coming accounting period, which is typically done in the case of any permanent account. This above process leads to resetting the account and making it ready for recording transactions for the next accounting period. The balance transfer process facilitates the calculation of profit or loss for the particular accounting period.
In case of recording of financial transactions there are typically three kinds of nominal account used by a business. The nominal account list are as follows:
- Revenue account – This type of account records all the financial transactions that are related to receipts or cash inflow for the business. This account is displayed in the profit and loss statement and helps in evaluating the financial position of the company. If the balance of the revenue account is high, the business is financially strong and showing a good performance overall.
- Expense account – These records all the expenses of transactions that lead to cash outflow for the business or all expenditures incurred for the same. The transaction recording for this is either monthly, quarterly or yearly.
- Gains and losses Account – This account provides a summary of all the gains and losses that the business incurs during a particular fiscal year. The management, shareholders and other stakeholders take or use this kind of information to make important business and investment decisions, because it helps in understanding the financial health of the company and its future potential regarding growth and expansion.
Thus, the above are the various types of nominal account that the companies maintain in their books so as to keep a clear and transparent record of all the transactions that take place. The nominal account in accounting helps in proper financial planning as well as decision making. Such an accounting procedure is very useful during audit which is an essential requirement in order to provide a true and fair view to all its stakeholders.
Let us try to understand the nominal account in accounting concept with the help of a suitable example.
Consider a temporary account like a sales account that is opened for recording the sale of goods and services during the year. The total sales are transferred to the revenue statement account at the end of the financial year. Similarly, expenses are recorded in the expense accountExpense AccountExpense accounting is the accounting of business costs incurred to generate revenue. Accounting is done against the vouchers created at the time the expenses are incurred. and, again at the end of the year, are transferred to the revenue statement account. Finally, the positive/ negative changes (Revenue- expenses) are transferred to a permanent account on 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 over multiple years to calculate asset value as a present value of future cash flow.
- A Liability is a long-term outflow of a fund that extends beyond the financial year.
|Types of Account
|Long Term Inflow
|Long Term Outflow
|Short Term Inflow
|Short Term Outflow
Video Explanation 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 a Nominal account with the help of an example:
Suppose a good is purchased for Rs.15,000 in a cash transaction. We are affecting two accounts to record this transaction, i.e., purchase and cash.
|Nominal Account – Debit all Expense
|To Cash Account
|Real Account – Credit what goes out
The amount will be Rs. 15,000 in both debitDebitDebit represents either an increase in a company’s expenses or a decline in its revenue. and credit.
Transferring Fund From Nominal Account To Real Account
The following journal entries of nominal account format show how the balances in nominal ac are shifted through an income summary account to the retained earnings account-Retained Earnings Account-Retained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.
#1 – Shift all Rs. 10,000 of revenuesRevenuesRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions. 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 recordkeepingRecordkeepingRecordkeeping is a basic accounting stage that teaches us how to keep track of monetary business transactions with the goal of keeping a permanent record of all transactions, knowing the correct picture of assets-liabilities, profits and losses, etc., keeping control of expenses with the goal of minimizing expenses, and having important information for legal and tax purposes. to the next fiscal year.
Nominal Account Vs 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.
- This nominal account format starts with zero balance and ends with zero balance, so only this account is called a temporary account. Whereas the balance in a real account does not reset to zero at the end of fiscal yearEnd Of Fiscal YearFiscal Year (FY) is referred to as a period lasting for twelve months and is used for budgeting, account keeping and all the other financial reporting for industries. Some of the most commonly used Fiscal Years by businesses all over the world are: 1st January to 31st December, 1st April to 31st March, 1st July to 30th June and 1st October to 30th September, last year’s balances get carried 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 sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company. account, i.e., accounts for recording assets, liabilities, and owner’s equity.
- At the end of every fiscal year, the balances in the nominal (temporary accountTemporary AccountTemporary accounts are nominal accounts that start with zero balance at the beginning of the financial year. The balance is visible in the income statement at the year-end and then transferred to the permanent as reserves and surplus.) account are transferred to a real account (temporary account) for the net change during the accounting year. The nominal account rule is reset to zero, and the balance is carried forward to a real account.
- Entries in the nominal account are recorded as per the journal entries concerning time and date.
Thus, the above are some important differences between the two types of accounts. It is necessary to have a clear idea about the same so that it is easy to understand the financial statements with a proper clarity and use them to get information required for financial decision making.
Frequently Asked Questions (FAQs)
There are two types of nominal accounts: revenue accounts, which record income earned by a business through sales, services, or other sources, and expense accounts, which record costs incurred by a business for operating expenses, salaries, utilities, and other expenditures necessary for business operations. These accounts are closed at the end of an accounting period to transfer their balances to the owner’s equity or retained earnings account.
Yes, a realization account is a nominal account used to record the gains or losses made while settling the accounts of a partnership firm when it is dissolved or when a partner retires or dies.
No, outstanding expenses are not considered nominal accounts. Instead, they are considered personal accounts because they represent the amount the business owes to external parties and are recorded as liabilities on the balance sheet.
This article has been a guide to what is Nominal Accounts. We explain it with example, types, differences with real account along with rules. Also, we discuss the Nominal account vs. Real Account. Here are the other articles in accounting that you may like –