Chapter 3: Types of Accounts

1. Real Accounts vs. Nominal Accounts

Real Accounts

• Definition: These are permanent accounts that carry their ending balances into the next accounting period.
• Examples:
  • Assets (e.g., Cash, Equipment, Land)
  • Liabilities (e.g., Accounts Payable, Loans Payable)
  • Equity (e.g., Owner’s Capital, Retained Earnings)

Key Point:
Real accounts do not get closed at the end of the accounting period. Their balances remain on the balance sheet moving forward.

Nominal Accounts

• Definition: These are temporary accounts used to record financial transactions for a specific period. Their balances are typically closed to equity at the end of each period.
• Examples:
  • Income (Revenue) (e.g., Sales, Service Revenue)
  • Expenses (e.g., Rent, Utilities, Office Supplies)

Key Point:
Nominal accounts get zeroed out (closed) at period-end so that new transactions can be recorded cleanly in the next accounting cycle. Their balances appear on the income statement rather than the balance sheet.

2. Income, Expenses, Assets, Liabilities, Equity

These five categories represent the core building blocks for tracking a company’s finances.

1. Assets
   • What They Are: Economic resources a business owns or controls that provide future benefit.
   • Examples: Cash, Accounts Receivable, Inventory, Equipment, Property.
   • On the Financial Statements: Appear on the Balance Sheet.
2. Liabilities
   • What They Are: Debts or obligations a business owes to external parties (creditors, suppliers, lenders).
   • Examples: Accounts Payable, Loans, Credit Card Balances, Tax Payable.
   • On the Financial Statements: Appear on the Balance Sheet as amounts owed.
3. Equity
   • What It Is: The residual interest in the assets after subtracting liabilities. Also called “owner’s equity” or “shareholders’ equity.”
   • Examples: Common Stock, Retained Earnings, Owner’s Capital.
   • On the Financial Statements: Listed on the Balance Sheet; changes via net income, dividends, or withdrawals.
4. Income (Revenue)
   • What It Is: Money the business earns from its operations—sales of products or services.
   • Examples: Sales Revenue, Service Fees, Interest Income.
   • On the Financial Statements: Appears on the Income Statement; nominal account that resets every period.
5. Expenses
   • What They Are: Costs incurred to generate revenue or run operations.
   • Examples: Rent, Utilities, Salaries, Office Supplies, Marketing.
   • On the Financial Statements: Appears on the Income Statement; nominal account that resets every period.

Key Takeaway

• Real (permanent) accounts — Assets, Liabilities, and Equity — remain on the balance sheet from one period to the next.
• Nominal (temporary) accounts — Income (Revenue) and Expenses — are closed out at period-end to calculate net profit (or loss) and update equity.
• Understanding each type of account helps maintain clear, accurate records and ensures financial statements reflect the true state of the business.