What Is a Nominal Account? Definition & Example
Understanding how to do all your accounting processes accurately is important for business. You want to know where you are with financial performance, your financial statements, and year-end. And in accounting, there are different types of accounts. These can range from personal accounts, permanent accounts and ledger accounts.
Another is a nominal account, which helps track all of your income-related financial transactions. So what exactly is a nominal account? Let’s take a closer look.
Here’s What We’ll Cover:
What’s the Difference Compared to a Real Account?
What Is a Nominal Account?
Do you take care of your accounting transactions or do you have someone look after your accounting books? Either way, bookkeeping is going to include real accounts as well as nominal accounts. However, your nominal accounts are only temporary.
At the beginning of each accounting year, they start with a zero balance. Then, they’re going to shrink or increase as you record more transactions. At the end of the accounting year, you’re going to close out your nominal accounts.
They can also be known as temporary accounts. A nominal account helps to track any of your transactions that affect income statements. This can include expenses, revenues and gains, and losses.
At the end of the accounting year, you close your nominal accounts by transferring them into retained earnings. Or, you can place them into an income summary account which would lead to transferring the total balance. Completing this process helps you reset the nominal accounts back to a balance of zero for the next accounting year.
Nominal Account Example
Let’s say that you have revenue and expense nominal accounts. These accounts are where you’re going to record all your sales income and the different business expenses that you incur.
At the end of the accounting year, you have R35 000 in your revenue account and R30 000 in your expense account. You’re then going to debit the revenue account for the total R35 000 and credit your income summary. And you do the same thing with your revenue account.
So, at the end of the year after expenses, your total income would be R5 000. Then, you are going to debit your income summary for that total income amount. Finally, you credit that amount to your retained earnings.
The good news is that doing this process doesn’t have to be a huge challenge. Most accounting and bookkeeping software will do it for you automatically. Doing it this way might even mean you won’t need to have an income summary account. This is because the software can add your income and expenses and then transfer the amount to your retained earnings.
What’s the Difference Compared to a Real Account?
A real account is always going to keep a running balance as each fiscal year passes. And these accounts are going to include everything that you’re able to find on your balance sheet. The main difference is that the change gets reflected on your income statement and balance sheet.
Key Takeaways
A golden rule with nominal accounts is that you’re always going to debit all your expenses and losses. Then, you’re always going to credit all your income and gains. Understanding these processes helps with cash flows, profit balance, and your financial reporting.
Simply put, a nominal account is a temporary account that you are going to close at the end of each accounting period. You're always going to start new accounting years with nominal account balances of zero. But they will fluctuate as your business operates. This is since you’re going to have various expenses and revenues that will make the nominal account rise or shrink.
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