Accounting deals with many different types of accounts. One account you may stumble across in your accounting journey for your business is a nominal account. But, what are nominal accounts?
We’re here to help you understand just that. This article goes over:
- Nominal account definition
- Types of nominal accounts
- Nominal account examples
Nominal account definition
A nominal account is a general ledger account that you close at the end of each accounting year. Basically, you store accounting transactions in a nominal account for one fiscal year. At the end of the fiscal year, you transfer the balances in the account to a permanent account. After the closing process, each nominal account starts the next accounting year with a balance of zero.
Nominal accounts include all of your company’s income statement accounts. You can use nominal accounts to collect accounting transaction information for:
Some types of nominal account transactions may include revenue from the sale of services, cost of goods sold, and loss on a sale of an asset. You may also deal with sales accounts or purchase accounts.
Because a nominal account holds transactions until the end of a fiscal year, nominal accounts are also called temporary accounts.
Nominal account vs. real account
Remember those permanent accounts we mentioned earlier? Those are also called real accounts. And when you deal with nominal accounts, you also handle real accounts.
A real account does not close at the end of a period or at the end of the accounting year. Instead of closing after a certain time period like nominal accounts, real accounts stay open, accumulate balances, and carry over into other accounting periods.
Real accounts are essentially the opposite of nominal accounts. They deal with the balance sheet as well as assets, liabilities, and equity.
Although they’re not one and the same, you need to know about both a real account and nominal account to fully understand both of them. Not to mention, they go hand in hand in your accounting processes.
Need a quick cheat sheet to tell the difference? We’ve got you:
|Nominal Accounts||Real Accounts|
|Also called temporary accounts||Also called permanent accounts|
|Balances reset to zero after fiscal year||Balances do not reset to zero (they carry over from period to period)|
|Income statement accounts||Balance sheet accounts|
Nominal accounts rules
When it comes to a nominal accounting, one of the golden rules of accounting comes into play. For nominal accounts, follow these rules:
- Debit all expenses and losses
- Credit all income and gains
Need to see this in action? No problem! Let’s take a quick look at how these rules work.
Say you purchased something for $5,000 using cash. To record the transaction, you need to debit your Purchase account and credit your Cash account. That way, you debit the expense and credit what’s going out.
Nominal account example
Let’s take a look at an example of a nominal entry to see how they work in your books. Ready, set, go!
Say the accounting period is over, and you want to transfer funds from a nominal account to a real account. You have $25,000 in revenue and $7,000 in expenses. To transfer the amounts, you must complete a few journal entries.
First, shift your $25,000 in revenue for the period to your Income Summary account by debiting your Revenue account and crediting your Income Summary account.
Next, shift your $7,000 in expenses to your Income Summary account by debiting your Income Summary account $7,000 and crediting your Expenses account $7,000.
Lastly, make a journal entry for the $18,000 net profit balance ($25,000 – $7,000). Debit your Income Summary account $18,000 and credit your Retained Earnings account $18,000.
You can handle nominal account journal entries by hand. To make recording transactions easier, you may also consider using accounting software to streamline processes.