Classification of Accounts
After understanding about the basic accounting terms, let us understand about the classification of accounts. In Accounting, the accounts are majorly classified according the two approaches- modern and traditional approaches. Nowadays, modern approach is vastly used whereas; the use of traditional approach is limited.
Modern Approach
In modern approach, the accounts are classified into 6 different categories that are:
#1 Asset Accounts
Any physical thing or right owned that has a monetary value is called an asset. Assets are divided into tangible and intangible. Any assets that can be touched and seen are called tangible assets. For example, building, machinery, cash, etc.
An asset that cannot be seen or touched but can be felt are known as intangible assets. For example, goodwill trademarks, copyright, etc.
#2 Liability Accounts
Liabilities are the obligations or debts payable to the creditors. The title ends with usually a word known as “payable”. Examples are: accounts payable, bills payable, wages payable, interest payable, rent payable, loan payable etc. Any revenue received in advance is also a liability that is known as unearned revenue.
#3 Capital or owner’s equity Accounts
Capital or owner’s equity is the amount that is invested by the owner of the business to start the business.
Owner’s Equity= Total Assets – Total Liabilities.
The capital account balance increases with the increase in new capital and profits earned. If the business owner withdraws the amount of money or goods and if there are losses, the capital account decreases.
#4 Withdrawal Accounts
Withdrawals or drawings are the cash or assets taken by the business owner for his personal use. In sole proprietorship and partnership firm, drawings account is used for entering all the withdrawals.
#5 Revenue or income accounts:
Revenue or income means the inflow of cash due to sale of goods and services. It is usually calculated by deducting all the expenses from the income generated arriving at the net profit. Examples: primary sale of goods and services, interest income, rent income, commission income, etc.
6. Expense Accounts:
Any service consumed or resources expanded to generate income are known as expense. Examples are: salaries, rent, wages, supplies, electricity, telephone, depreciation, etc.
Traditional Approach
After learning and knowing about the modern approach, let us peek into the traditional approach of accounting. It is basically divided into three major accounts:
1. Personal accounts: An account related to the real persons and organizations are classified as personal accounts. Examples are: Mary’s account, EY account, City bank account, etc.
2. Real Accounts: An account related to any assets (both tangible and intangible) is classified as real accounts. Examples are: cash, inventory, investment, plant and machinery, goodwill, patent, etc.
3. Nominal Accounts: An account related to income, gains, expenses, and losses are classified as nominal accounts. These accounts are mostly used to prepare Income statement or Profit and Loss Account of the company. Examples are: sales, purchase, wages, salaries, interest, rent, gain on sale of assets, loss on sale of assets, etc.
Example:
Now as per the types of accounts and approaches we have learned, let us classify the following transactions according to modern and traditional approaches.
- Miss. Mary started business with cash $20,000.
- Purchased goods for cash $4,000.
- Sold goods for cash $7,000
- Purchased goods for cash $2,500
- Sold goods to John on account $3,000
- Purchased furniture $1,000
- Purchased machinery $ 5,000
- Paid salary $2,000
- Miss Mary withdrawn $100 from business to pay her personal expenses
What are the golden rules of accounting?
After knowing about the different approaches of accounting. We can now move further with the golden rules of accounting. Accounting rules are the guidance established on how to record the transactions.
We have different accounting rules for different approaches;
- Traditional Approach
- Modern Approach
Golden Rules of Debit and Credit (Traditional Approach)
Let ‘s dive into the golden rules of accounting for traditional approach:
#1 Personal Account:
Debit the receiver, credit the giver.
It means if a person receives something, receiver’s account is debited and if a person gives something, giver’s account is credited.
#2 Real Account:
Debit what comes in, credit what goes out.
It means if any asset comes into the business, it shall be debited and if any asset goes out of the business, it shall be credited.
#3 Nominal Accounts:
Debit all expenses and losses, credit all incomes and gains.
If any expense or loss is incurred by the business it is debited, and if any incomes or gains has been received it is credited.
Modern Rules of Accounting
After knowing the traditional golden rules of accounting, let us know more about the modern rules of accounting. The transaction is categorized into 6 different heads and any increase or decrease in the account will have debit or credit effect as per the following table:
Wrapping up
In this article, we have learned about the classification of accounts and described the golden accounting rules. The accounting methods are divided into traditional and modern methods of accounting. In the next blog, you will learn about process of recording financial transactions.
Powered by Froala Editor
