This video shows the difference between nominal and real accounts in financial accounting. Nominal accounts consist of revenues, expenses, and dividends. These accounts are also known as temporary accounts because they are only tracked for a single year, and then are zeroed out during the year-end closing process. This means that at the end of the fiscal year, the balances of these accounts are transferred to the real (aka permanent) account called Retained Earnings. Retained Earnings, like all balance sheet accounts (assets, liabilities, and stockholders’ equity), is a permanent account. Real/permanent accounts include the effect of all transactions since the inception of the firm. The cash account, for example, is a permanent/real account that tracks the cumulative effect of all cash transactions since the firm was created. This is different from nominal/temporary accounts, which only track revenues/expenses/dividends for a single period and then set the accounts back to a zero balance to begin a new fiscal year.

Balance Sheet accounts are real accounts (also known as permanent accounts) and Income Statement accounts are nominal accounts (also known as temporary).  When we say that an account is “nominal” or “temporary” we mean that it is zeroed out at fiscal-year end as part of the closing process.  Let’s say that in its first year of operations Jedi Superfoods had $37 billion in Sales Revenue for the year ended 12/31/19 and $25 billion in expenses for a Net Income of $12 billion.  Let’s also say that Jedi declared and paid a dividend of $5 billion.   Thus, the company earned a profit of $12 billion but paid out $5 billion to its shareholders in the form of a dividend.  The $7 billion of profit that the firm has accumulated ($12 billion Net Income minus $5 billion of dividends) will now be transferred to the “real” or “permanent” Balance Sheet account “Retained Earnings” and the Sales Revenue, Expense, and Dividend accounts will all be reduced to zero to prepare for next year’s period.

At the beginning of the day on 1/1/20, the balance of the Sales Revenue account will be zero (the same goes for the Expense and Dividend accounts).  This is because we will want to begin tracking the Sales Revenue for 2020 and don’t want the account to contain any of the results from 2019.  If this doesn’t make sense, remember that the Income Statement is only used to measure the profitability of the firm for a period of time.  Once that period of time is ended, we zero the Income Statement accounts out to prepare for the next period we are going to track.  Accounts refer to this process as “closing” and it is a very busy time of the year for the accounting department.

Balance Sheet accounts are permanent because they are never zeroed out.  There will never be a point where we say that we’re done tracking the Cash account for the period and want to zero it out.  In fact, if you see that the Cash account has a balance of zero either:  (1) the company has gone bankrupt or (2) the CFO took the money and is relaxing on a beach in Mexico.  In either case, the company is finished.

Key Takeaways:

1.  Balance Sheet accounts (e.g., Cash) are permanent and are never closed out

2.  Income Statement accounts (e.g., Sales Revenue) are temporary and are closed (zeroed) at the end of each fiscal period

3.  The Dividend account is temporary and is closed (zeroed) at the end of each fiscal period

4.  The amount that was closed out from the temporary accounts is transferred to the Balance Sheet account Retained Earnings, which is a permanent account