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Nominal accounts are temporary accounts that are used as part of a standard accounting system. Accounts that are classified as nominal are normally used to track gains and losses as well as revenues and expenses for a specified period of time. One common example of a nominal account is the income statement account that shows key information regarding income for the usual accounting periods employed by the firm. Many businesses utilize accounting methods that involve use of the account as part of their overall strategy during the year, and also as a helpful component when it comes to reconciling the accounting records at year’s end.
One of the easiest ways to understand the nominal account is to consider it to be a mechanism for accounting for income and related expenses on a short-term basis. This is in contrast to what is known as balance sheet accounts. Accounts of this type are used to track assets, liabilities, and owner’s equity, and are sometimes identified as real accounts or permanent accounts. The function of a nominal account is temporary in nature, effectively serving as a holding place for revenues and expenses until they are assigned to a permanent account.
The purpose of a nominal account is to provide an easy way to identify shifts in the company’s income and expenses over a period of time. In most applications, a temporary account serves as the means of housing the data until the balance of the account is transferred to an account that is considered permanent. Some companies use a model of documenting income and expenses using a nominal account throughout the business year, transferring the balance of the account to a permanent account as part of the year-end closing. At that point, a nominal account contains a balance of zero, making it possible to begin the new accounting year with a clean slate.
Depending on the structure of the company’s assets, the balance in a nominal account may be transferred to one or more permanent accounts. With a sole proprietorship, this often means that the balance is moved into the owner’s equity account at the end of the business year. For corporations, there is a good chance that the nominal account balance will ultimately be transferred into what is known as a retained earnings account. The exact process of using these temporary accounts as part of the accounting process and where the balances ultimately are transferred is sometimes influenced by governmental regulations that a business must follow in order to comply with standards put in place that a local, state, or federal monitoring agency.