Distinguishing Real and Nominal Business Accounts
A real account in a business is a record of the amount of asset, liability, or owners’ equity at a precise moment in time. Nominal accounts summarize a business’s revenue and expenses over a period of time, such as a year.
The recordkeeping process for bookkeepers is fundamentally the same: Adopt a chart of accounts, make original entries using debits and credits to keep the books in balance, make adjusting entries to get profit for the period right, and close the books at the end of the year.
Businesses keep two types of accounts:
Real accounts are those reported in the balance sheet, which is the summary of the assets, liabilities, and owners’ equities of a business.
The label real refers to the continuous, permanent nature of this type of account. Real accounts are active from the first day of business to the last day. (A real account could have a temporary zero balance, in which case it’s not reported in the balance sheet.)
Real accounts contain the balances of assets, liabilities, and owners’ equities at a specific point in time, such as at the close of business on the last day of the year. The balance in a real account is the net amount after subtracting decreases from increases in the account.
Nominal accounts are those reported in the income statement, which is the summary of the revenue and expenses of a business for a period of time.
Balances in nominal accounts are cumulative over a period of time. Take the balance in the sales revenue account at the end of the year, for example. This balance is the total amount of sales over the entire year.
The balance in advertising expense is the total amount of the expense over the entire year. At the end of the period, the accountant uses the balances in the nominal accounts of a business to determine its net profit or loss for the period.
Here’s a rough analogy to help explain the difference between real and nominal accounts: Consider the water held behind a dam at a particular point in time. Compare this body of water with the total amount of water that flowed through the dam over the last year. This water isn’t there because it has already gone downriver. This amount is the measure of total flow for a period of time. Assets are like the water behind the dam, and sales revenue is like the flow of water over the year.
Nominal (revenue and expense) accounts are closed at the end of the year. After these accounts have done their jobs accumulating amounts of sales and expenses for the year, their balances are closed. Their balances are reset to zero to start the new year. Nominal accounts are emptied out to make way for accumulating sales revenue and expenses during the following year.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
