Meaning of Nominal Account Explained with an Example

Nominal accounts are the general ledger accounts that are associated with the income, gains, expenses or losses of an organisation. Read on to know how nominal accounts work and how they are different from other types of accounts.

A nominal account, also known as a temporary account, deals with transactions of a company for one financial year. Towards the end of each financial year, the amount in the nominal account is transferred to a permanent or capital account. A new nominal account will start with a balance of zero at the beginning of each financial year. 

Nominal accounts work as an organisation’s income statement and include all types of financial records like revenue, sales, profit, and loss.

In accounting, there are primarily three types of accounts:

• Personal
• Real
• Nominal

A real account is essentially the opposite of a nominal account. It is kept in sync with the balance sheet and keeps an account of the assets and liabilities. It does not close at the end of each fiscal year like nominal accounts. Instead, it keeps an account of the balances and carries them over to the next accounting year. 

Personal accounts, as the name suggests, are maintained by individuals or entities. It is most probably the simplest type of account. These accounts can be operated by individuals as well as companies, charities and trusts.

Every organisation has multiple departments that carry out various operations throughout a financial year. This results in a company dealing with a large number of transactions and payments, which can get hectic to keep track of. 

For this reason, a nominal account is essential to every business. It keeps an account of every type of transaction carried out by different departments in a segmented manner. Hence, it is absolutely important to have nominal accounts to avoid mishaps and last-minute complications at the end of the financial year.

The golden rules for nominal account are:

• Credit the incomes and profits 
• Debit the expenditures and losses

Nominal accounts are temporary accounts that keep track of the revenues, sales, profits, loss, and every other aspect of debit and credit in a segmented manner. However, these accounts are temporary and start from zero every year. Hence, it is important to transfer the retained amount into a permanent account for adjustments in the next financial year. Here are the basic steps for transferring:

Step 1: Make an account of the revenues generated during one fiscal year. 

Step 2: Differentiate the expenses from the revenues further and make appropriate changes in the debit and credit report.

Step 3: Calculate the profit from the difference between revenue and expenses and transfer that into the real account for carrying over to the next FY.

It is important to maintain records of the cash inflow and outflow of an organisation. Nominal accounts make this task easier by keeping track of every transaction made in and out of the company. Passing them through the check of Golden Rules of accounting makes sure that funds and resources of a company are being utilised efficiently.