Definition
A nominal account is a category used in accounting that includes accounts related to expenses, losses, income, or gains. The balances in these accounts are reported and recognized in the company’s income statement. At the end of the accounting year, these accounts are closed or reset for the next period.
Key Takeaways
- Nominal accounts are financial accounts that track the revenue, expenses, gains, and losses of a company. They are used to ascertain a company’s financial performance over a specified period.
- At the end of each accounting period, nominal accounts are closed and begin the next period with a zero balance because they are directly related to the income statement, which reflects the company’s performance over discrete periods of time.
- The third key point is ‘Contra’ Nominal accounts, which are accounts with a balance opposite the normal balance of nominal accounts. Examples include sales returns, purchase discounts, and other similar accounts.
Importance
Nominal accounts are essential in financial accounting because they allow for the accurate recording and management of a company’s income, expenses, losses, and gains.
All of these entries are recorded in nominal accounts and reflect the financial health and performance of a company over a given period.
At the end of each financial year, these accounts are balanced and transferred to the company’s capital or retained earnings account.
Therefore, they play a significant role in forming the basis of financial statements and assessment of the financial status of a business, aiding in decision-making and strategic planning.
Without proper tracking through nominal accounts, a company may lack the necessary insights to efficiently manage its financial resources.
Explanation
The primary function of a Nominal Account is to track a company’s income and expenses over a specific period. This accounting tool provides detailed insights into a company’s financial performance, supporting decision-makers in evaluating current strategies and devising future plans.
It acts as an effective tool for gauging whether the business is making a profit or suffering a loss. The Nominal Account’s main elements – revenue, expense, gain, and loss – are central to the operations of a business, playing crucial roles in the profit and loss statement.
The Nominal Account plays a pivotal role in closing the accounts at the end of the accounting period. After recording all the revenues and expenses, the Nominal Account balance is transferred to the capital account to reflect the net profit or loss.
This ensures the accurate calculation of the company’s net income, providing a transparent image of the financial health of the enterprise. The data contained within the Nominal Account thus serves as a historical record, guiding future decision-making by highlighting successful and unsuccessful strategies.
Examples of Nominal Account
Rent Expense Account: In a given accounting period, the rent paid is recorded in the rent expense account, which is a nominal account. It is debited as it is an expense for the firm, and at the end of the accounting period, the account is closed by transferring the balance to the Income Statement.
Sales Revenue Account: The revenue earned from the company’s operations like the sale of goods or rendering of services is recorded in the Sales Revenue Account. This is another example of a nominal account where all the revenue earned throughout the accounting year is credited and at the end of the accounting period, it is transferred to the Trading and Profit and Loss Account.
Electricity Bill Account: Businesses also need to account for operating expenses such as electricity bills. The costs associated with the electricity consumption for a particular period is recorded under this nominal account. At the end of the accounting period, this account, along with all other nominal accounts, is closed by transferring its balance to the final accounts.
Nominal Account FAQ
What is a Nominal Account?
A Nominal Account refers to accounts related to incomes, expenses, losses, and gains. These are accounts that are reported on the income statement. The balance in a nominal account is closed at the end of the accounting year.
What are examples of Nominal Accounts?
Examples of Nominal Accounts include: Sales Account, Purchase Account, Wages Account, Rent Account, Interest Received Account, Loss by Fire Account, and Commission Received Account.
How are Nominal Accounts used in accounting?
In accounting, Nominal Accounts are used to record transactions pertaining to expenses, losses, income, or gains during a specific accounting period. The amount in these accounts are transferred to the capital account at the end of the financial year.
Why is it important to close Nominal Accounts at the end of the accounting year?
Nominal Accounts are important to close at the end of the accounting year because these accounts reflect the incomes and expenses for only a particular period. Closing these accounts allows the business to start fresh in the next accounting cycle.
How does a Nominal Account differ from a Real Account?
While Real Accounts carry forward their balances into the next accounting year, Nominal Accounts don’t carry forward any balance. The balance in a Nominal Account is closed at the end of the accounting year and Directly transferred to the capital account.
Related Entrepreneurship Terms
- Accrual Accounting
- Revenue Account
- Income Statement
- Expense Account
- Profit and Loss Account
Sources for More Information
- Investopedia: A comprehensive source for financial education which includes a dictionary that explains the term “Nominal Account”.
- AccountingTools: A website that offers a wide range of resources for accounting and finance education, particularly concerning different account types.
- Corporate Finance Institute: An accredited institution that provides financial modeling and valuation analyst certification along with a glossary explaining various finance terms, including “Nominal Account”.
- AccountingCoach: A platform dedicated to helping people worldwide learn accounting and bookkeeping, potentially explaining the concept of a “Nominal Account”.
