Accounting Rules: Classification of Accounts
An account is an individual accounting record of increase and decrease in a specific asset, liability or owner’s equity items. – Accounting Principles – “Weygandt, Kieso & Kimmel”.
Determining the debit and credit in accounting, its classification is very important. Each transaction has two sides. One side is debit and the other is credit. The classification of accounts is essential for the purpose for which accounting is maintained in a business organization.
Check the Double Entry Accounting for more about Debit and Credit.
Types of Accounts Under Modern Rules
i) Asset Accounts: An asset account is a separately maintained in the organization to track different types of assets. Accounts like Cash, Accounts Receivable, Inventory, Building, Plant and Machineries etc., increase with debits and decrease with credits.
ii) Liability Accounts: A liability account is created when goods are purchased on credit or when a loan is taken. Accounts like Accounts Payable, Loans Payable, etc., increase with credits and decrease with debits.
iii) Equity Accounts: The capital account represents the financial position of an owner’s equity in a business, encompassing initial investments, withdrawals, and retained earnings. Increase with credits and decrease with debits.
iv) Revenue Accounts: When earnings generated through the sale of goods or services is called Revenue Accounts. These accounts increase with credits and decrease with debits.
v) Expense Accounts: Expense accounts created when the costs incurred by an organization in its operations, including expenses for supplies, salaries, rent, utilities, and other necessary expenditures. These accounts increase with debits and decrease with credits.
vi) Drawings Accounts: When business owners uses cash or goods for personal or family needs, a separate account is maintained in the owner’s name to track these transactions. This account is called Drawings Accounts. As withdrawals increase, the owner’s capital decreases.
Classification of Account in Traditional Method
In traditional method, accounts are classified into 3 main categories:
1) Personal Accounts, 2) Real Accounts, 3) Nominal Accounts
1) Personal Account: When an account held in the name of an individual or a business entity is known as a personal account.
Example: John Smith’s account, Tom Hanks’ account, XYZ Bank account, ZYX Housing account, etc.
Personal accounts are further divided into three categories.
i) Natural Personal Accounts: These refer to accounts of individuals, such as Mr. John Smith or Ms. Mary Brown.
ii) Artificial Personal Accounts: These refer to accounts of entities that are not natural persons but are treated as persons in accounting, such as companies, organizations, and institutions (e.g., ABC Ltd., XYZ Bank).
iii) Representative Personal Accounts: These represent a certain group of people rather than an individual or entity. For example, outstanding wages account (representing the employees to whom the wages are payable), prepaid expenses, or accrued incomes.
2) Real Account/Property Account: An account kept separately in the name of each asset present in the organization is called a real account/property account.
Example: cash account, bank account, furniture account, building account.
In classification of accounts Real accounts are further divided into two categories.
a) Tangible Real Accounts: These refer to physical assets that can be touched and measured, such as machinery, buildings, furniture, and cash.
b) Intangible Real Accounts: These refer to non-physical assets that cannot be touched but have value, such as goodwill, patents, trademarks, and copyrights.
3) Nominal or Income-Expense Account: Accounts related to income, expenses, and profit and loss are called nominal or income-expense accounts.
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- Income Accounts: Sales, received commission, received rent, etc.
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- Expense Accounts: Wages, salaries, rent, advertisements, etc.
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- Profit Accounts: Profit from the sale of furniture, profit sent in export business.
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- Loss Accounts: Loss due to fire damage.
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- If any nominal account is associated with advance, outstanding, payable, and receivable, it is considered a personal account.
Golden Rules for Accounting:
The golden rules of accounting represent a basic rule that conducts the recording of a business’s everyday transaction. Common Accounting Rules are also known as bookkeeping, golden rules, or credit and debit rules, these accounting rules play an essential role in the state of accounting. They create the foundation for recording entry in a journal book, without which the whole accounting becomes an defective spheres.
Personal Accounts: Debit the receiver, credit the giver.
Real Accounts: Debit what comes in, credit what goes out.
Nominal Accounts: Debit all expenses and losses, credit all incomes and gains.
Branches of Accounting
Accounting is a broad field that is divided into various branches. Some of the main branches are described below:
Financial Accounting: In this branch financial information of an organization is collected, stored and reported. The main objective is to provide financial information to stakeholders (shareholders, investors, creditors).
Management Accounting: It provides information for the internal management of the organization. Through this, business planning, control and decision making are done.
Auditing: In this branch the financial statements of an organization are audited and evaluated. It determines whether the financial statements have been prepared accurately and faithfully.
Tax Accounting: deals with tax related matters. This includes tax planning, tax filing and compliance with tax laws.
Environmental Accounting: Environmental costs and benefits are measured. It is helpful in evaluating the organization’s activities and its impact on environmental conservation.
IT Accounting (Information Technology Accounting): Accounting information is collected, stored and analyzed through information technology systems.
Forensic Accounting: Collecting and analyzing evidence in legal matters. These include fraud, corruption and financial crime investigations.
Cost Accounting: It analyzes production costs and operating costs, which help in determining business performance and profitability.
More Resources
Thank you for reading our resources on the Classification of Accounts. Enhancing your knowledge more and progressing in your career, you may find the following guides helpful: