Answer each of the following questions (a-c) with a separate short paragraph per question. (a) What is the difference between a real account and a nominal account? Give an example of each type of account. Why is this distinction important for the

Question

closing process? (b) What two purposes are served in making closing entries? (c) Why is the Dividends account closed directly to Retained Earnings rather than to the Income Summary account?

Answer 1

(a) Balance sheet accounts are called real accounts because they are permanent and are not closed at the end of a period. Conversely, income statement accounts are called nominal or temporary accounts because they are closed at the end of the period. For example, it would not make sense to close the Equipment account at the end of the period. The account should stay on the books as long as the company keeps the asset. On the other hand, Depreciation Expense on the equipment is a temporary account that indicates the expense associated with using the asset during the period and is therefore closed along with all other income statement accounts at the end of the period.
(b) Closing entries are made at the end of an accounting period. They have two important purposes: (1) to return the balance in all temporary or nominal accounts (revenues, expenses, and dividends) to zero to start the next accounting period and (2) to transfer the net income (or net loss) and the dividends of the period to Retained Earnings.
(c) The Dividends account is closed directly to Retained Earnings because it is not an expense and therefore is not an income statement account. Because it does not appear on an income statement, it is not closed through the Income Summary account, but instead directly to Retained Earnings.