Nominal account
A nominal account in the view of Rice A. is each of the items that make up the balance sheet (each of the boxes on the balance sheet chart) [1]. According to D. Khatri "Accounts of all expenses, losses, revenue and profit are collectively grouped as nominal accounts. A separate account is prepared for each item. The reason for maintaining separate account for each item is to have a detailed view about different type of expenses, which can further be used for carrying out an analysis with the aim to exercise control" [2].
As stated in Managerial Economics and Financial Accounting nominal accounts are opened to explain the nature of the transactions. "They do not really exist. For example, salary paid to the manager, rent paid to landlord, commissions paid to salesman, etc. cash goes out of the business and it is something real, while salary, rent or commission as such do not exist" [3]. All the ledger accounts are balanced and included in the trial balance. Nominal accounts will appear there provided they have some balance: a debit balance or a credit balance [4].
Differences between real and nominal accounts
Nominal accounts are accounts of the revenue and expenses of a business for a period of time while real accounts are accounts that include the balances of assets, liabilities and owners' equities of a business at a precise moment in time. Real accounts are active from the first to the last day of business. The balance in this account is the net amount after subtracting decreases from increases [5]. Nominal accounts are closed at the end of a year. After accumulating amounts of sales and expenses for the year their balances are closed. They are reset to zero to start the next year [6].
Nominal accounts and their characters
Expenses and losses (debit balances) [7]:
- Dock dues
- Carriage inward
- Import duty
- Freight
- Motive power
- Wages factory expenses
- Rent
- Salaries
- Advertisement
- Carriage outward
- Audit fees
- Bad debts
- Bank charges
- Discount allowed
- Depreciation
- Loss of sale of assets
Income and profits (credit balances):
- Sales
- Interest received from a bank
- Discount received
- Rent received
- Rebates received
- Bad debts recovered
- Dividend recovered
- Interest on investment
- Commission received
Examples of Nominal account
- Accounts Payable: Accounts Payable are the amounts that a company owes to its suppliers, creditors or other organizations for goods, services and other items purchased. This account is used to track the amounts that are owed to the suppliers and other organizations.
- Accounts Receivable: Accounts Receivable is the amount that a company is owed by its customers for goods or services provided. This account is used to track the money that is owed to the company by its customers.
- Depreciation: Depreciation is an accounting method used to calculate the decrease in the value of an asset over time. It is used to spread out the cost of an asset over its useful life.
- Inventory: Inventory is the amount of goods that a company has in stock. It is used to track the amount of goods that a company has in stock at any given time.
- Wages Expense: Wages Expense is the amount of money that a company pays to its employees for their work. This account is used to track the money that the company pays to its employees.
- Other Expenses: Other Expenses are the expenses that are not categorized under any other specific account. This account is used to track the miscellaneous expenses that a company incurs.
Advantages of Nominal account
Nominal accounts offer several advantages, such as:
- Accurate tracking of finances: Nominal accounts allow for tracking of each individual item on the balance sheet, making it easier to identify any discrepancies or differences in amounts.
- Improved financial analysis: Nominal accounts provide a more detailed view of a company's financials, allowing for more accurate financial analysis.
- Increased control over finances: Nominal accounts give businesses more control over their finances, as it allows for tracking of expenses and revenues, as well as identifying potential areas of improvement.
- Improved forecasting: Nominal accounts allow businesses to better predict future expenses and revenues, helping to ensure that the business is properly prepared for any financial changes that may occur.
Limitations of Nominal account
Nominal accounts can be useful for providing information about the financial activities of a business, however, they have certain limitations. These include:
- Insufficient detail on individual transactions - Nominal accounts are often limited to providing a summary of all transactions that have taken place, rather than providing details on each individual transaction. This can make it difficult to accurately track the performance of specific transactions.
- Limited ability to distinguish between fixed and variable costs - Nominal accounts often have difficulty distinguishing between fixed and variable costs, which can lead to inaccurate financial analysis.
- Difficulty in tracking changes in assets and liabilities - Nominal accounts are typically unable to provide detailed information about changes in assets and liabilities.
- Inability to identify trends in costs - The lack of detail in nominal accounts often makes it difficult to identify trends in costs and to assess the performance of specific activities.
- Difficulty in analysing profitability - Nominal accounts are not designed to provide analysis of profitability, as they do not provide detailed information about costs and revenues.
In addition to Rice A.'s view on nominal accounts, there are other approaches related to nominal accounts.
- The traditional approach states that nominal accounts are used to record income and expenses, as well as gains and losses. This approach allows for a clear view of how much was earned, spent, and how much was gained or lost over a given period.
- The modern approach states that nominal accounts are used to track assets, liabilities, and equity. This approach allows for a detailed view of the financial position of a business and can be used to make informed decisions about investments and expenditures.
- The accrual basis approach states that nominal accounts are used to record transactions that have not been settled yet. This approach allows for the tracking of transactions that have taken place, but are not yet recorded in the financial statements.
- The modified approach states that nominal accounts are used to track both revenues and expenses. This approach allows for a more comprehensive view of the financial performance of a business.
Summary: In addition to Rice A.'s view on nominal accounts, there are other approaches related to nominal accounts such as the traditional, modern, accrual basis, and modified approaches. Each approach provides a different view of the financial position of a business and allows for informed decisions to be made.
| Nominal account — recommended articles |
| Temporary account — Accrued income — Income summary — T account — Sub ledger — Revenue expenditure — Prepaid income — Book of original entry — Time period concept |
References
- Banerjee B. K. (2008), Financial Accounting: A Dynamic Approach, PHI Learning, New Delhi.
- Dholakia S. K. (2009), Guide to Accounts for Advocate-on-Record Examination Frequently Asked Questions, Universal Law Publishing, New Delhi.
- Khatri D. (2015), Accounting for Management, McGraw Hill Education, New Delhi.
- Reddy M. K., Saraswathi S. (2007), Managerial Economics and Financial Accounting, PHI Learning, New Delhi.
- Rice A. (2015), Accounts Demystified: The Astonishingly Simple Guide To Accounting, Pearson Education, UK.
- Tracy J. A. (2006), Accounting Workbook For Dummies, Wiley Publishing, Indiana.
Footnotes
Author: Gabriela Wojtaszek
