The Difference Between Real and Nominal Accounts Explained

The terms “nominal account” and “real account” are well-known in accounting. Financial transactions must be recorded based on accounting principles, so that each entry is categorized appropriately.

This approach ensures financial reports are organized and easy to understand by relevant parties. Pero kung mano-mano ang recording, nakakapagod at prone pa sa errors, na pwedeng makasama sa negosyo.

To address these challenges, this article will discuss the key differences between real and nominal accounts, their roles in financial reporting, and how businesses can leverage Accounting Software to automate processes.

What is a Nominal Account?

A nominal account, often referred to as a temporary account, records transaction data for a specific accounting period, typically one fiscal year. These accounts are considered temporary because their balances are reset to zero at the end of the fiscal year, preparing them for the next period.

Nominal accounts primarily include income statement accounts such as revenues and expenses. Additionally, the income summary and dividends accounts, if utilized during the closing process, are also classified as temporary accounts.

What is a Real Account?

Real accounts, also known as permanent accounts, remain part of a company’s books indefinitely. Their balances carry forward at the end of each accounting period. Examples of real accounts are balance sheet accounts like assets, liabilities, and stockholders’ equity.

To transfer funds from a nominal account to a real account, the balance is cleared through a journal entry. For an expense account with a debit balance, the balance is zeroed by crediting the expense account and debiting the permanent account receiving the funds.

Conversely, for a revenue account with a credit balance, the transfer involves debiting the revenue account and crediting the corresponding permanent account.

Difference between Nominal Accounts and Real Accounts

“Nominal Accounts” and “Real Accounts” are terms used in accounting to classify different types of accounts in a business’s records. They come from the double-entry bookkeeping system and organize transactions into two main groups:

1. Nominal Accounts

These accounts include income, expenses, gains, and losses, like those on an income statement, plus the drawing account. They are temporary accounts, meaning their balances are reset to zero at the end of each accounting period.

Any remaining balance is transferred to the capital account (or retained earnings for companies). Examples include sales, rent expense, salaries, and interest income.

2. Real Accounts

These accounts represent assets, liabilities, and equity (excluding the drawing account), like those on a balance sheet.

They are permanent accounts because their balances carry over from one period to the next, providing a continuous record of the business’s financial position. Examples include cash, accounts receivable, inventory, and accounts payable.

In short, nominal accounts track income and expenses for a set time, while real accounts show the ongoing value of a business’s assets, debts, and equity.

Functions of Nominal Accounts and Real Accounts

Functions of Temporary Accounts (Nominal)

• Facilitate accurate categorization of transactions, ensuring precise calculations and reliable financial reports.
• Support the matching concept, linking related accounts like revenue, COGS, and expenses in income statements.
• Simplify the preparation of financial position reports, such as calculating retained earnings or losses.
• Enable faster financial reporting through accounting systems, which can generate income statements in seconds.
• Optimize cash flow reporting by integrating with CRM-Sales systems for better tracking of outstanding invoices.

Temporary accounts provide a detailed view of income and expenses, but manual methods require extra accuracy to avoid errors. Accounting software can greatly streamline the process, ensuring faster and more accurate financial reporting.

Functions of Permanent Accounts (Real)

• Reflect the company’s financial condition by maintaining continuous balances across periods, indicating ongoing operations.
• Serve as key observation points during internal and external audits to ensure compliance with reporting standards.
• Offer insights into the company’s growth potential and net worth for stakeholders, shareholders, and investors.

Permanent accounts play a crucial role in showing the company’s financial health and supporting informed decision-making, such as investment or loan approvals. Understanding the cut-off date is also essential for distinguishing between nominal and real accounts.

Examples of Nominal Accounts

Temporary accounts primarily include sales, cost of goods sold, and expenses found in the income statement. They also cover dividends and withdrawals in the statement of changes in equity, as well as prepaid expenses.

In general, temporary accounts consist of two main categories: expenses and revenue.

1. Expenses

Expenses are costs incurred by a company for its business activities. They can be divided into two subcategories:

• Operational expenses: Costs required to generate revenue, such as supplies, rent, salaries, insurance, and advertising expenses.
• Non-operational expenses: Costs not directly related to the company’s core operations, such as interest expenses and bad debt losses.

2. Revenue

Revenue refers to the increase in assets resulting from business and operational activities. Revenue can also be divided into two types:

• Operational revenue: Income generated from the company’s core sales or activities, such as sales revenue for trading businesses and transportation fees for logistics companies.
• Non-operational revenue: Income from outside the company’s core operations, often irregular, such as commission income or interest income.

Accounting software offers a solution for businesses to easily categorize nominal accounts. This allows companies to accurately identify revenue and expenses for a specific period, making calculations simpler and ensuring accurate results.

Examples of Real Accounts

Real accounts typically include those found in the statement of financial position. These accounts are generally divided into three categories: assets, liabilities, and equity.

1. Assets

Assets include items such as cash, bank accounts, trade receivables, deposits, and fixed assets. These serve as the primary tools for a company’s operational activities.

2. Liabilities

Liabilities cover obligations such as trade payables, salary payables, and mortgages that the company must settle. It’s important to track the due dates or repayment periods of these liabilities.

3. Equity

Equity represents the total assets or wealth owned by the company, such as land, cash, buildings, and other forms of ownership. In the financial position statement, equity includes retained earnings (or losses) and owner’s equity.

With advancements in technology, accounting staff no longer need to worry about distinguishing account types. Modern Accounting Systems can help businesses monitor financial conditions comprehensively, including cash balances, receivables, payables, and other accounts.

Benefits of Knowing the Differences of Real and Nominal Accounts

To optimize financial management, it is crucial for companies to understand the difference between real and nominal accounts. Differentiating these accounts is essential, as each serves a unique purpose.

Grouping accounts allows for more organized financial recording, helping businesses gain clearer insights into their financial information.

Another benefit is that it enables companies to track the growth and development of their assets more effectively. This is achieved by carefully reviewing records of all transactions, whether nominal or real.

As a result, asset development can be easily monitored and used to make forecasts, providing valuable insights for companies when formulating policies.

Simplifying Real and Nominal Accounts with HashMicro’s Accounting Software

Understanding real and nominal accounts is key to accurate reporting and decisions. As businesses grow, manual management becomes harder, especially with BIR compliance and accuracy demands.

For businesses in the Philippines, HashMicro’s Accounting Software is your go-to tool for automating account categorization and ensuring accurate financial reports. Kaya mas madali na rin mag-comply sa BIR standards, hassle-free.

With real-time insights and seamless integrations, it helps you manage everything, from daily expenses to long-term assets, so you can focus on growing your business and boosting profits. And below are the advanced features that make your job easier:

• Bank Integration – Auto Reconciliation: Ensures that internal bookkeeping aligns with bank transaction records, which provides financial data for both real (e.g., assets, liabilities) and nominal (e.g., expenses, revenue) accounts.
• Profit & Loss vs Budget & Forecast: Tracks deviations between actual profit/loss (nominal accounts) and budgeted figures.
• Cash Flow Reports: Monitors cash inflows and outflows (real accounts like cash).
• Financial Statement with Budget Comparison: Compares actual financial performance (real accounts) with budgeted expectations, enabling better financial oversight and control.
• Multi-Level Analytical (Compare Financial Statement per project, branch, etc.): Provides detailed analysis of financial data across categories like branches or projects.

Conclusion

Real and nominal accounts are essential for the proper tracking and reporting of transactions. Nominal accounts refer to temporary transactions, such as income and expenses, that are reset each fiscal period. Meanwhile, real accounts record assets, liabilities, and equity that are carried forward to subsequent periods.

For businesses in the Philippines, manual account management is tiring and error-prone. HashMicro’s Accounting Software automates processes and provides real-time insights, ensuring BIR-compliant and efficient reporting.

HashMicro’s advanced tools, such as Auto Reconciliation and Cash Flow Reports, are designed for your business success. Whether you’re managing daily expenses or long-term assets, the software ensures accurate data and sound decisions.

Take control of your finances with HashMicro and try the free demo today!

FAQ on Real and Nominal Accounts

• Can a single account be both real and nominal?

  No, an account is classified as either real or nominal based on its nature. Real accounts pertain to assets, liabilities, and equity, while nominal accounts relate to revenues, expenses, gains, and losses.

• How do real and nominal accounts impact financial statements differently?

  Real accounts appear on the balance sheet and reflect the company’s financial position at a point in time, carrying their balances forward. Nominal accounts are reported on the income statement, showing performance over a period, and are closed at period-end.

• Why is it important to distinguish between real and nominal accounts?

  Proper classification ensures accurate financial reporting, aids in applying the correct accounting rules, and helps in analyzing financial performance versus financial position.

• What is the process for closing nominal accounts?

  At the end of an accounting period, nominal account balances are transferred to the income summary account, which is then closed to retained earnings, resetting nominal accounts to zero for the next period.