Knowing how to execute accounting processes properly is essential for an accountant and the business as a whole. A lot of company decisions depend on different financial transactions and their analysis. Understanding whether the business is earning profit or going through a tough financial ground helps higher authorities make necessary financial changes.

A clear concept of how a nominal account works will be helpful in better financial recordings. In this article, we will give you a detailed analysis of what a nominal account is, its rules and some examples.

What is a Nominal Account?

A nominal account is a part of the general ledger that is closed at the end of every financial or accounting year. You can store all financial transactions in your nominal account for one fiscal year. At the end of a financial year, balances of nominal accounts get transferred to permanent or real accounts. 

The nominal account must start at zero balance at the start of every fiscal year. The statement of different types of transactions is associated with this account, such as expenses, losses, gains and revenue. 

Types of Nominal Account

Three types of nominal accounts are used while recording financial transactions of the business. Check below to get a detailed understanding of some types of nominal accounts: 

• Revenue Account

A revenue account stores financial transactions related to the income receipts of a company or an individual. This type of nominal account is present in the company's income statements and indicates how the entity is performing financially. Having a higher revenue indicates a good financial situation, whereas a low revenue highlights financial issues in the company.

• Expense Account

This account records the day-to-day spending of a business within a financial year. This nominal account is generally present for either a quarter, month or year and at the end of that period, a new expense account is created with zero balance.

• Gain and Loss Account

A gain and loss account is an important nominal account that summarises the expenses and revenues of a business during a specific fiscal year. The information derived from this account helps make significant business decisions on how to improve the company's financial standing.

Nominal Account Rule

When it comes to creating a nominal account for your business, it is important to keep certain rules in mind to avoid discrepancies in recording financial transactions. The rules for the nominal account are a part of the 'golden rules of accounting', and they are:

• All profits and income have to be credited
• The losses and expenses have to be debited

Let us take an example to understand this rule clearly.

Suppose you purchased machinery worth Rs.10,000 in cash. Hence, to record this transaction, you have to debit from the Purchase account (machinery), and your cash account will be credited. This shows that the expense is debited, and what is going out is credited.

Examples of Nominal Account

Still confused about how nominal accounts work? Well, before the financial year ends, you record all the transactions in a nominal or temporary account for your general ledger. But how the nominal entries work will only be clear if you take a look at an example.

For instance, you have a temporary sales account in your books that records the sale of services or goods during the financial year. The sales values are transferred to the revenue account at the end of the financial year. The same goes for your expenses as well.

On the basis of how often the money comes in and goes out, the amount in the account has to be divided, as discussed below.

• Your expenses reflect a short-term outflow of your money.
• The income or revenue acts as short-term funds received during the year.
• Any liability is denoted as a long-term outflow of money that continues after the end of the financial year.
• On the other hand, your assets are a long-term inflow of money, where the determination of present asset value denotes the future cash flows as well.

How to Transfer Funds from Nominal Account to Real Account?

Nominal accounts are temporary accounts, recording and keeping track of your profits, revenues, expenses, losses and other key debit and credit items of the financials. As they are temporary accounts, transferring and adjusting funds in a permanent or real account is important in the next financial year.

Here are the steps to transfer your funds from a nominal account to a real account:

1. Create a revenue account for all sales and revenue generated during a specific financial year.
2. You need to differentiate all expenses from revenues to properly make changes in your debit or credit report.
3. Lastly, calculate your profit or loss by computing the difference between your expenditures and earnings and transferring that to real accounts for carrying it to the next financial year.

Difference Between Real And Nominal Account

There are certain points of difference between a real account and a nominal account that you must understand to ensure a seamless recording of financial transactions. The differences are as follows:

• A nominal account, at the beginning and end of the financial year, starts and ends with zero balance, respectively. On the other hand, in a real account, the balance gets carried over to the next financial year and does not reset to zero during the current fiscal year.
• The balance of the nominal account gets transferred to a real account at the end of the fiscal year. However, the balance of a real account is used to determine the company's losses or gains over an entire financial year.
• A nominal account records costs, incomes, losses and profits. At the same time, a real account, linked to the balance sheet, is used to tally the owner's equity, liabilities or assets.

Conclusion

While recording and accounting for your financial transactions, it is always important to know the golden rules of accounting. This will help you to record transactions and make necessary financial decisions seamlessly. A nominal account is the base of your company's financial statement. So, you must be extra careful while correctly putting all transaction details.

Frequently Asked Questions

What is a nominal account with an example?

A nominal account is a general ledger or temporary account formed and maintained by a business. It includes all necessary records of the business's expenses, losses, gains and revenues for a particular financial year. When the amounts are transferred to real accounts after the end of a fiscal year, the balance in nominal accounts becomes zero again.

Examples: salary account, purchase account, rent account and more.

Is a trading account a nominal account?

Yes, a trading account is considered a nominal account. This is because a trading account shows information related to both credit and debit transactions for a financial year. 

Is the purchase account real or nominal?

A purchase account is a nominal account. Purchase account records transactions related to business purchases completed during a financial year.

Is the discount received credited to the nominal account?

Discount received is a type of income. Thus, it is deposited in the nominal account of the company.

Is the loan a nominal account?

No. The loan becomes a part of a real account. A loan account generally signifies a type of personal account representing the giver or receiver of loans. Hence, it is a real account as it is a company's tangible asset. 

How to close nominal accounts?

To close nominal accounts, you need to make the balance of that account zero. This is because the amount in a nominal account is not carried forward to the next accounting year.