Nominal or temporary accounts are income statements accounts that are closed to Income Summary
at the end of the reporting period.
Real or permanent accounts are balance sheet accounts which have a continuous nature and
accumulate data from period to period; such accounts are not closed at the end
of the reporting period.
Such a classification can be
explained through the following statement: Balance sheet accounts are as of a certain date, while
income statement accounts are for a certain period. In other words,
balance sheet accounts present information as of a balance sheet date whereas
the income statement accounts present information accumulated during a period.
Nominal or temporary accounts may
include but are not limited to:
- revenue accounts
- cost of goods sold accounts
- administrative expenses accounts
- selling expenses accounts
- other income statements accounts
Real or permanent accounts may be
represented by the following accounts:
- cash
- accounts receivable
- allowance for doubtful accounts
- inventory
- prepaid insurance
- accounts payable
- accrual liabilities (expenses)
- owner’s equity
- other balance sheet accounts
Nominal
or temporary accounts are closed in the following way:
- The credit accounts (i.e. revenue accounts) are closed by making a
debit entry to the account and a credit entry to Income Summary.
- The debit accounts (i.e. expense accounts) are closed by making a
credit entry to the account and a debit entry to Income Summary.
The income and expense account
balances are transferred to a new temporary account – income summary.
Income Summary
Balance = Sales – Expenses |
The
balance in the Income Summary account is then transferred to Retained
Earnings. Retained Earnings is a line shown within the Owner’s Equity
(Shareholder’s Equity) section of the balance sheet.
