As you may already know, there are many different types of accounts that you can set up to organize your business' finances. Most of these are categorized as either expense accounts or income accounts, but sometimes you will need a more specific type of account to accomplish certain accounting activities. We've already talked about one of these specifically-tailored account types before in our post on valuation accounts, and the nominal account is another example. So let's dive into what a nominal account is and how it works...
Nominal Accounts: The Basics
A nominal account (also known as a temporary account) is an account that is used over the course of a single fiscal year to record certain types of transactions. At year-end, a nominal account will be closed out and its balance will be transferred to a permanent account. This allows the nominal account in question to start off the next fiscal year with a zero balance, ready to accept the new year's transactions.
Types of Transactions
What types of transactions are recorded in nominal accounts? Mainly, they are the types of transactions that are recorded on the income statement and they involve revenues, expenses, gains, and losses.
Some examples of specific transactions that are recorded in nominal accounts would include cost of goods sold (COGS), revenue made from selling goods or services, or a loss incurred from the sale of an asset.
As mentioned above, any balances held in a nominal account will only stay there for the duration of a single fiscal year. How are they transferred out of the nominal account, and where do they end up?
If your business is a sole proprietorship, then the nominal account balances will be transferred to the owner's equity account. If your company is incorporated, then these balances will go to the retained earnings account. (The balances may be transferred directly into retained earnings, or may end up there by way of an income summary account.)
Setting up nominal accounts (and any other types of accounts your business needs) is easy with the right accounting software, and it can also make transferring account balances at fiscal year-end much smoother.
Have questions for us about setting up nominal accounts for your business? Drop us a line anytime at firstname.lastname@example.org.