We can classify the financial accounts under two types of accounts, one is the Traditional Approach and another one is the Modern Approach. Let us deal here with the traditional approach.
Classification and Types of Accounts
We record business transactions in accounts. Thus, an account is an individual and a formal record of a person, firm, company, asset, liability, goods, incomes and expenses. We need to prepare one account for each type of asset, liability, income or expense.
Hence, we record all the transactions related to a particular item in its account. For example, all-cash transactions whether receipts or payments will be recorded in the Cash A/c. After this, we will calculate the balance of Cash A/c.
However, here the classification of accounts is important. We can classify the accounts as per the traditional classification under the following heads:
I. Personal Accounts
We further classify these as:
- Natural Personal Accounts
- Artificial Personal Accounts
- Representative Personal Accounts
Let us study these accounts in detail.
- Natural Personal Accounts: Natural Persons are human beings. Therefore, we include the accounts belonging to them under this head. For instance, Debtors, Creditors, Capital A/c, Drawings A/c, etc.
- Artificial Personal Accounts: Artificial persons are not human beings but can act and work like humans. They have a separate identity in the eyes of law and are capable to enter into agreements. These include H.U.F, partnership firms, insurance companies, co-operative societies, companies, municipal corporations, hospitals, banks, government bodies, etc. For example, Bank of Baroda, Oriental Insurance Co,
- Representative Personal Accounts: These accounts represent the accounts of natural or artificial persons. When the expenses become outstanding or pre-paid and incomes become accrued or unearned, they fall under this category. For example, Outstanding Salary A/c, Pre-paid Rent A/c, Accrued Interest A/c, Unearned Brokerage A/c, etc.
II. Impersonal Accounts
Impersonal Accounts are further classified as:
- Real Accounts
- Nominal Accounts
Let us now understand these accounts in detail.
- Real Accounts: These are the accounts of all the assets and liabilities of the organization. We do not close these accounts at the end of the accounting year and appear in the Balance Sheet. Thus, we carry forward the balances of these accounts to the next accounting year. Therefore, we can also say that these are permanent accounts. We can further classify these into:
- Tangible Real Account: It consists of assets, properties or possessions that can be touched, seen and measured. For example, Plant A/c, Furniture and Fixtures A/c, Cash A/c, etc.
- Intangible Real Account: It consists of assets or possessions that cannot be touched, seen and measured but possess a monetary value and thus can be purchased and sold also. For example, Goodwill, Patents, Copyrights, etc.
- Nominal Accounts: Nominal Accounts are the accounts relating to the expenses, losses, incomes, and gains. These are temporary accounts and thus we need to transfer their balances to Trading and Profit and Loss A/c at the end of the accounting year. Therefore, these accounts have no balance to be carried forward next year as they are closed.
Rules for Debit and Credit for all types of accounts:
Debit the Receiver
Credit the Giver
Debit what comes in
Credit what goes out
Debit all expenses and losses
Credit all incomes and gains
Representative Personal Account:
Debit the Debtor
Credit the Creditor
Solved Example on Types of Accounts
Analyze the following transactions and state the types of accounts that need to be debited and credited.
- Suryani commenced business with cash ₹ 1, 00,000.
- Purchased machinery for cash ₹ 10,000
- Purchased goods from Romil on credit ₹ 50,000
- Sold goods for cash ₹ 10000
- Paid wages to Jaimin ₹ 15,000
- Paid to Romil ₹ 25000
- Wages to be paid to Raj is outstanding ₹ 5000
- Brokerage earned but not received ₹ 2000
- Deposited ₹ 15000 into the bank.
- Suryani withdrew cash for personal use ₹ 10000
Analysis of transactions
|Transaction||Accounts||Nature of Accounts||Reason for Effect on Accounts||Debited or Credited|
|1.||Cash A/c Capital A/c||Real A/c Personal A/c||Cash is coming in Suryani is the giver||Debit Credit|
|2.||Machinery A/c Cash A/c||Real A/c Real A/c||Machinery is coming in Cash is going out||Debit Credit|
|3.||Purchases A/c Romil’s A/c||Real A/c Personal A/c||Goods are coming in Romil is the giver||Debit Credit|
|4.||Cash A/c Sales A/c||Real A/c Real A/c||Cash is coming in Goods are going out||Debit Credit|
|5.||Wages A/c Cash A/c||Nominal A/c Real A/c||Wages are an expense Cash is going out||Debit Credit|
|6.||Romil’s A/c Cash A/c||Personal A/c Real A/c||Romil is the receiver Cash is going out||Debit Credit|
|7.||Wages A/c Wages Outstanding A/c||Nominal A/c Representative Personal A/c||Wages is an expense Wages is payable to Raj and thus he is our creditor.||Debit Credit|
|8.||Accrued Brokerage A/c Brokerage A/c||Representative Personal A/c Nominal A/c||Brokerage is receivable from the client, so the client is our debtor Brokerage is an income||Debit Credit|
|9.||Bank A/c Cash A/c||Personal A/c Real A/c||The bank is receiving the amount Cash is going out||Debit Credit|
|10.||Drawings A/c Cash A/c||Personal A/c Real A/c||Suryani is the receiver Cash is going out||Debit Credit|