Nominal Account

A nominal account is a type of account used in accounting to record financial transactions related to income, expenses, gains, and losses.

What is Nominal Account?

A nominal account is a type of account used in accounting to record financial transactions related to income, expenses, gains, and losses. Unlike real accounts (which include assets, liabilities, and equity) that are carried forward to the next accounting period, nominal accounts are temporary and are reset to zero at the end of each accounting period. This resetting is done through the closing process to prepare the accounts for the next period.

Types of Nominal Accounts:

1. Income Accounts: These accounts track revenue and income from various sources, such as sales revenue, interest income, and service fees. For example:
   • Sales Revenue
   • Interest Income
2. Expense Accounts: These accounts record costs and expenses incurred during the accounting period, such as rent, utilities, and salaries. For example:
   • Rent Expense
   • Salaries Expense
   • Utility Expense
3. Gains and Losses Accounts: These accounts capture gains and losses that occur from activities outside of regular business operations. For example:
   • Gain on Sale of Assets
   • Loss on Sale of Investments

Key Characteristics of Nominal Accounts:

• Temporary Nature: Nominal accounts are temporary and are closed out at the end of each accounting period to start fresh in the next period.
• Closed to Income Summary: At the end of the accounting period, the balances of nominal accounts are transferred to an income summary account, which then ultimately affects the retained earnings or capital account in the equity section of the balance sheet.
• Reflect Period Performance: They help in determining the performance of a business over a specific period by summarizing all income and expenses.

Example of Closing Nominal Accounts:

1. Income Statement Preparation: Summarize all income and expense accounts to prepare the income statement.
   • Debit all income accounts to close them out.
   • Credit all expense accounts to close them out.
2. Income Summary Account: Transfer the net result (total income minus total expenses) to the income summary account.
3. Retained Earnings: Finally, transfer the net income or loss from the income summary account to the retained earnings or owner’s equity account.

By resetting nominal accounts to zero at the end of each period, businesses ensure that financial performance is measured accurately for each accounting period, making it easier to assess and compare performance over time.