Nominal Account in Accounting: All You Need to Know

Accounting is a crucial aspect of every business, irrespective of its type or scale. The field of accounting involves working with different types of accounts as a part of processing the financial information of organizations. As per prevailing laws, each economic entity has to present financial details to all the stakeholders. These details must be accurate, account for all the transactions, and present the complete picture of business financials. To maintain uniformity in accounting and compare financial health, there are different types of accounts, one of which is a nominal account.

Think of a nominal account as one of the cornerstones on which the discipline of accounting is based. It also helps understand the financial status of your company and maintain consistency in the accounting process.

In this comprehensive, we will take you through nominal account rule, definition, importance, the golden rules of accounting, and more.

What is a Nominal Account?

A nominal account is a type of account that is maintained to record monetary transactions in a specific accounting year. Being a general ledger, it includes various types of transactions related to a business, such as income, expenses, profits, and losses. Moreover, the balances in a nominal account are taken back to zero and start afresh for every new financial year. Besides this, transactions like expenditures related to products sold, income from selling services, and losses borne from the sale of assets are all covered under nominal accounting. 

The nominal account rule says it is also divided as per the cash flow, considering:

• Income to be a short-term financial infusion during a fiscal year
• Expenses to be short-term fund outflow
• Assets to be a long-term money infusion for a specific time horizon 
• Liabilities to be long-term capital outflows

What Does It Mean to Have a Nominal Account?

As mentioned above, a nominal account in the general ledger is zeroed out once the fiscal year ends. After that, the sum of money in the account is transferred to a different account for long-term holding. Once the closure procedure is concluded, every nominal account’s balance is set to zero to ensure the accuracy of accounting.

Nominal accounts are also termed temporary accounts as the transactions are held until the end of a fiscal year. 

To better understand nominal account meaning, you must know about the golden rules of accounting. You might not know that these rules form the foundation of passing journal entries, that in turn is useful for accounting and bookkeeping. Let’s dive deeper into these rules first. 

What Do the Golden Rules of Accounting Include?

Think of these rules as a set of guidelines that accountants follow to record financial transactions systematically. They are based on the dual entry system covering both credit and debit. As a part of following these rules, one must know which type of account is to be credited and which is to be charged.

The golden rules of accounting are easy to understand and simplify many complicated aspects of bookkeeping. These are as follows:

As mentioned above, you must know about the right type of account for every transaction to be processed. Since each account type follows a certain set of principles over every transaction, it becomes imperative to know more about the three different types of accounts.

Interesting Read: Tax Planning: Importance, Benefits, Tips, and More

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Types of Accounts Covered Under the Golden Rules of Investing

Every transaction entry in financial accounting falls under any of the following types of account:

• Personal account

Think of this as a general ledger related to associations, companies, and people. This is further categorized into:

• Real account

A real account is also a general ledger like a personal or nominal account but contains transactions pertaining to the assets and liabilities of your company. Here, the assets are further subdivided into tangible and intangible assets.

This type of account does not close at the end of a financial year but is carried forward in the following year. It also appears in the balance sheet of a company.

• Nominal account

As already detailed above, this general ledger contains business transactions including income, profit, loss, and expenses. Nominal account examples include salary accounts, commission accounts, rent accounts, etc. 

Consider these nominal account examples to better understand how these accounts are related –

A company named Shaurya Mills started its business with an initial capital of Rs. 3,00,000. It rents a warehouse or property worth Rs. 30,000. The company bought raw materials worth Rs. 1, 20,000 from Rana Mills on credit. 

The firm then sold goods worth Rs. 1,80,000 and then paid Rana Mills in cash for the purchased raw material. It also paid Rs. 70,000 worth of salaries to the mill workers. 

Here’s how different types of accounts related to this example will look like: 

Under the golden rules of accounting, given below are the journal entries:

• Shaurya Mills started the business with a capital of Rs. 3,00,000

Since cash is considered a tangible asset, this transaction will be a part of the firm’s real account. Besides this, the capital is related to the personal account. 

As per the golden rules, debit what comes in and then credit the giver.

• The firm rented a property worth Rs. 30,000

Since rent is an expense, it falls in the nominal account category. Also, cash falls into the real account. Hence, the golden rules say that you need to credit what is going out and then debit all expenses and losses.

• The company purchased raw materials worth Rs. 1,20,000

Any business-related purchase is considered under expenses and hence falls under the nominal account. Besides this, Rana Mills will be covered under the personal account.

• The firm sold goods worth Rs. 1,80,000

Income from selling goods becomes a part of the nominal account. However, cash is a part of the real account. 

• Shaurya Mills then paid Rana Mills in cash for the goods purchased

Since Rana Mills comes under the personal account and cash is for the real account, debit the receiver and then credit what goes out.

• The company paid a total salary of Rs. 70,000

Salary is termed as an expense to the business and hence, falls under the nominal account. In addition, cash comes under the real account. 

Interesting Read: All You Need to Know About Zero Based Budgeting (ZBB)

Conclusion

Since every transaction related to business is to be accounted for, you must know what will fall into the  nominal account meaning and what not. This requires the right knowledge of the golden rules of accounting and different types of accounts.

FAQs

What are the three nominal accounts?

Nominal accounts include expense, revenue, and profit & loss accounts.

How is a nominal account different from a real account?

There is one primary difference between a real and nominal account: 

A real account begins with the ending balance from the previous fiscal year. However, the nominal account begins with a zero balance in the next financial year.

Does cash fall under the real account?

Cash does fall into the real account. 

What are ledger books?

Ledger books refer to the records of important business information that is required for creating financial statements.

What is an accounting cycle?

It refers to the process in which a business entity records, sorts, accepts, and credits payments within a specific period.

Who created the three golden rules of accounting?

These rules were created by Fru Luca Pacioli and Leonardo Da Vinci.

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