Accounts in accounting are systematic records that categorize and track financial transactions related to a specific aspect of a business. They serve as the building blocks of financial statements, providing a structured way to organize and report financial information. They may have several types based on specific criteria. One of these types is real accounts.
What is a Real Account?
Real accounts in accounting are fundamental components that represent tangible assets, liabilities, and equity within a company’s financial structure. These accounts are referred to as “real” because they pertain to physical or financial entities that exist in reality, such as cash, inventory, accounts payable, loans, property, and equipment.
Real accounts help maintain accurate financial records and provide a continuous snapshot of the company’s financial position over time. Unlike nominal accounts, which are temporary and reset at the end of each accounting period, real accounts are permanent, and their balances are carried forward from one period to the next.
How does a Real Account work?
Real accounts operate within an organization’s accounting system by systematically recording tangible assets, liabilities, and equity. These accounts are permanent and maintain ongoing balances carrying forward from one accounting period to the next. They encompass assets like cash, inventory, property, and equipment, liabilities such as accounts payable and loans payable, and equity components like owner’s equity and retained earnings.
The functionality of real accounts extends beyond transaction recording to facilitate continuous monitoring and assessment of a company’s financial health and performance. By maintaining accurate and up-to-date balances, real accounts provide a reliable snapshot of the organization’s assets, liabilities, and equity at any given time. This information is crucial for stakeholders, including investors, creditors, and management.
What are the differences between Nominal and Real Accounts?
The differences between nominal and real accounts come from different aspects, some of which are below.
Nature
Nominal accounts record transactions related to revenues, expenses, gains, and losses. They capture the flow of income and expenses over a specific period, such as sales revenue, salaries, rent, interest income, etc.
On the other hand, real accounts deal with tangible assets, liabilities, and equity. They record transactions related to physical or financial entities that exist in reality, such as cash, inventory, accounts payable, property, plant, and equipment.
Treatment
At the end of each accounting period, nominal accounts are closed by transferring their balances to the retained earnings or income summary account. This process resets their balances to zero to start fresh for the next accounting period.
Real Accounts are not closed at the end of accounting periods. Instead, their balances are carried forward to the next period. This continuous balance-carrying characteristic makes them permanent accounts.
Impact
Transactions recorded in nominal accounts directly impact the income statement. They determine the company’s net income or net loss for the period, influencing profitability measures and performance evaluation.
Real accounts primarily affect the balance sheet. They contribute to the presentation of assets, liabilities, and equity in the company’s financial position, reflecting the resources, obligations, and ownership interests.
Conclusion
A real account is a systematic record of financial transactions for an asset with a physical form. They relate to tangible assets and get the name “real”. Although the classification does not impact accounting, the categorization is necessary to differentiate between real and nominal accounts. The differences between the two come from their nature, treatment, and impact on the financial statements.
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