A nominal account, also known as a temporary account, acts as a repository of transaction data for an accounting period of usually one fiscal year. Nominal accounts are also called temporary accounts because they are zeroed out at the end of the fiscal year. This allows them to begin the next period with a clean slate.
Nominal accounts are mostly income statement accounts. All revenue and expense accounts are temporary. In addition, the income summary account, if the company chooses to create one during the closing process, is also a temporary account, as is the dividends account.
In contrast, a real account is an account that will always be a part of a company's books once opened. For this reason, real accounts are also called permanent accounts. They carry their balance forward at the end of each accounting period. Balance sheet accounts: assets, liabilities, and stockholders' equity are real accounts.
Funds can be transferred from a nominal account to a real account by zeroing out the balance with a journal entry. If the account is an expense account with a normal debit balance, then an entry that credits the expense account for the amount of the balance and debits the permanent account where the balance should be moved to is one way to transfer funds out. If the account is a revenue account with a normal credit balance, then it would be zeroed out with a debit and the permanent account where the funds are being transferred to would get a credit for the same amount.
Rules of Nominal Account
When making a journal entry, there are three types of accounts: nominal, personal, and real. It is sometimes difficult to assess which side of the account the entry should be on, debit or credit. In order to make this easier to remember, there are The Three Golden Rules of Accounting, also known as the traditional rules of accounting or the rules of debit and credit. The third rule relates to nominal accounts. This rule directs an accountant to:
- Debit all expense and losses.
- Credit all revenue, income and gains.
For real accounts, it decrees the accountant should:
- Debit what comes in.
- Credit what goes out.
For personal accounts, it prescribes to:
- Debit the receiver.
- Credit the giver.
Real Account vs Nominal Account
The difference between a real account and a nominal account is that a real account does not get zeroed out at the end of the fiscal year. Its balances carry forward year after year. The ending balance at the end of one accounting period is the beginning balance at the start of the next accounting period. Consequently, this balance is permanent and (with the exception of retained earnings), is not a part of the closing process. A nominal account, on the other hand, is temporary. It begins with a zero balance at the start of the fiscal year and ends with one at the end of the same.
One way to identify what is a real account and what is a nominal account is to look at the amount of time that balances accumulate in the account. If the account started with a zero balance at the start of the fiscal year (assuming this is not the company's first year in operation), then the account is likely a nominal account. If it carries a balance forward, it is probably a real account.
Transferring Funds From Nominal Account to Real Account
Funds can be transferred from a nominal account to a real account by zeroing out the balance with a journal entry. If the account is an expense account with a normal debit balance, then an entry that credits the expense account for the amount of the balance and debits the permanent account where the balance should be moved to is one way to transfer funds out. If the account is a revenue account with a normal credit balance, then it would be zeroed out with a debit and the permanent account where the funds are being transferred to would get a credit for the same amount.
This happens during the closing process for companies that do not use an income summary account. When the income summary account is skipped, then the revenue and expense accounts are all closed out to the permanent retained earnings account.
Below is an example of the closing out process for the temporary revenue account, expense accounts, and dividends account, all to the permanent retained earnings account.
1. Closing the revenue account to retained earnings:
| # | Account | Debit | Credit |
|---|---|---|---|
| 1 | Sales Revenue | $750,000 | |
| 2 | Retained Earnings | $750,000 |
2. Closing the expense accounts to retained earnings:
| # | Account | Debit | Credit |
| 1 | Retained Earnings | $250,000 | |
| 2 | Utilities Expense | $5,000 | |
| 3 | Selling and Distribution Expenses | $12,500 | |
| 4 | Employee Wages Expense | $200,000 | |
| 5 | Depreciation Expense | $7500 | |
| 6 | Other Expenses | $25,000 |
3. Closing the dividends account to retained earnings:
| # | Account | Debit | Credit |
| 1 | Retained Earnings | $350,000 | |
| 2 | Dividends | $350,000 |
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