Knowing how to accurately perform all accounting procedures is crucial for businesses. You need to be aware of your financial performance, financial statements, and year-end status. Also, there are various account types in accounting you need to be aware of like personal accounts, permanent accounts, and ledger accounts. A nominal account is another type of account. It is a general ledger account that shows the gains, losses, income, or expenses of an organisation. So, what is a nominal account exactly? Let’s take a closer look at them, and figure out how their characteristics set them apart from other kinds of accounts.
What is a Nominal Account?
Simply put, a nominal account is a general ledger maintained by an organisation. This ledger maintains a comprehensive record of the company’s revenues, expenses, and profits or losses for a given fiscal year. The company closes this account at the end of the relevant fiscal year.
In every accounting cycle, the account starts with a zero balance. Upon closing, the net balance is moved to the company’s capital account or retained earnings account, depending on its ownership structure.
Accounting transaction information, such as income, expense, gain, and loss transactions, is obtained using nominal accounts and appears on the income statement. This data is contained in the income statement. Transactions employing nominal accounts include income from the sale of services, expenditures linked to products sold, and losses incurred while selling assets.
Temporary accounts and nominal accounts are sometimes used interchangeably since transactions are recorded in nominal accounts until the end of a fiscal year.
Example of Nominal Account
Consider a temporary account like a sales account that is opened during the year to record the sale of products and services. At the end of the fiscal year, the total sales are deposited into the revenue statement account. Similarly, expenses are recorded in the expense account and transferred to the revenue statement account at the end of the fiscal year. The positive/negative adjustments (revenue – expenses) are then transferred to a permanent account on the balance sheet.
Based on how often money comes in and out of the account, the account is divided as follows:
- An income is a source of short-term funds during the fiscal year.
- During the fiscal year, expenses are the short-term outflows of the fund.
- An asset is the long-term inflow of funds whose time horizon can be spread over several years to determine asset value as the present value of future cash flow.
- A liability is a long-term outflow of funds that continues beyond the fiscal year.
Types of Nominal Account
There are numerous types of nominal accounts, such as:
1. Revenue accounts
These accounts document the revenue earned by a business via the selling of goods or services. For example, sales revenue, service revenue, interest revenue, and rental income.
2. Expense accounts
These accounts document the expenses incurred by the business in the course of its operations. Examples include salary and wage expenses, rent expenses, supply expenses, and advertising expenses.
3. Gain accounts
These accounts document any income made by the company that is unrelated to its principal operations. For example, gains from the sale of assets or investments.
4. Loss accounts
These accounts document any losses sustained by the company that is unrelated to its principal operations. Some examples include losses from the sale of assets or investments.
Difference between Real Account and Nominal Account
- While we are differentiating these two accounts, the primary criteria that we take into consideration are the balances that are present in each of these accounts at the end of the financial year.
- A nominal account begins with a zero balance and ends with a zero balance; hence it is the only account considered temporary. In contrast, the balance in a real account is carried over to the following fiscal year rather than being reset to zero at the end of the current fiscal year.
- Nominal accounts are for recording income, costs, profits, and losses. Contrarily, a real account is connected to a balance sheet account, or an account for tallying assets, liabilities, and owner’s equity.
- The balances in the nominal (temporary account) account are moved to a real account at the end of each fiscal year to reflect the net change over the accounting year. The balance is carried over to a real account and the nominal account rule is reset to zero.
- Entries in the nominal account are made based on the time and date of the journal entries.
Rules to be followed for Nominal Accounts
When it comes to nominal accounting, one of the most important golden rules of accounting comes into play. Here are the rules to follow for nominal accounts:
- Debit all expenses and losses
- Credit all income and gains
Want to witness this in action? No issue! Let’s quickly examine how these rules operate.
Let’s imagine you paid INR 5,000 cash for a product. You must debit your Purchase account and credit your Cash account to register the transaction. In this manner, you debit the expense and credit the outflow.
How to transfer funds from a Nominal Account to a real account?
Temporary accounts known as nominal accounts segmentally track all aspects of debit and credit, including revenues, sales, profits, losses, and other financial transactions. These accounts, however, are temporary and reset to zero each year. So, it’s crucial to put the retained money into a permanent account so that modifications can be made in the next fiscal year. The fundamental transfer procedure follows these steps:
1. Create a record of the revenue received during a fiscal year.
2. Differentiate expenses and income further and update the debit and credit reports accordingly.
3. Determine the profit from the difference in revenue and expenses, and then transfer that money into the real account to carry it over to the current financial year.
Keeping track of an organization’s financial input and outflow is crucial. This process is made simpler by nominal accounts, which record all transactions performed within and outside the organisation. By running them through the Golden Rules of accounting, a company can make sure that its money and resources are being used well.
Why should organisations have a Nominal Account?
Every organisation has different departments that do different things over a financial year. Because of this, a business has to deal with a lot of transactions and payments, which can be hard to keep track of.
This is the major reason why every business needs to have a nominal account. It keeps a separate record of each type of transaction that is done by each department. So, it is very important to have nominal accounts so that things don’t go wrong or get complicated at the last minute at the end of the financial year.
Conclusion
With nominal accounts, the golden rule is that you always have to debit all your expenses and losses. Furthermore, you will always credit all your income and gains. So, knowing how these things work can help you with cash flows, the balance of your profits, and your financial reports.
Simply put, a nominal account is a temporary account that you’ll close at the end of each accounting period. You will always start a new nominal account with zero balances in your new accounting nominal year. But they’ll fluctuate as your business grows and operates. This is because you’ll have different expenses and revenues that will cause the nominal account to grow or shrink.
FAQs
1. Which account is considered a Nominal Account?
Ans: Simply put, a nominal account is a general ledger maintained by an organisation. This ledger maintains a comprehensive record of the company’s revenues, expenses, and profits or losses for a given fiscal year. Examples of nominal accounts are Commission Received, Salary Account, Rent Account, Interest Account, and others.
2. What is an income statement of a company?
Ans: An organisation’s income statement is a financial document that details its expenses and earnings for a single accounting year. Knowing whether the organisation is generating money or going bankrupt is useful.
3. What is the Nominal Account rule?
Ans: When it comes to nominal accounting, one of the most important golden rules of accounting comes into play. Here are the rules to follow for nominal accounts:
1. Debit all expenses and losses
2. Credit all income and gains
4. What is a real account?
Ans: A real account is one that, at the end of an accounting period, preserves the ending amount and uses it as the opening balance for the subsequent accounting period.
