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What is Classification of Accounts?

by Bhakti

Accounting is the process of recording, classifying, summarizing, analyzing, and interpreting the financial transactions and communicating the results to the persons interested in such information. Two methods for accounting are Single Entry System and Double Entry System. Mostly, we use Double Entry for better accounting purposes.

Double entry system of accounting deals with two aspects of every business transaction. In other words, every transaction has two effects. For example, a person buys a cold drink from a store and in return pays the money to the shopkeeper for the cold drink.

This transaction has two effects in terms of both buyer and seller. Buyer cash balance will decrease by the cost of purchase on the other hand, he will acquire a cold drink. Seller will have one drink short but his cash balance will increase.

Accounting attempts to record both effects of transactions in the financial statement.  This refers to the double entry concept. Under this every transaction involves two parties, one party gives the benefit and the other party receives it. It is also called a Dual entity of transaction.

Accounting records the two effects which are known as Debit (Dr) and Credit (Cr). Accounting system is based on the duality principle that for every Debit entry, there will always be an equal Credit entry.

Debit entries are ones that account for the following effects:

  1. Increase in assets
  2. Increase in expense
  3. Decrease in liability
  4. Decrease in equity
  5. Decrease in income

Credit entries are ones that account for the following effects:

  1. Decrease in assets
  2. Decrease in expense
  3. Increase in liability
  4. Increase in equity
  5. Increase in income

Accounting equation recorded in double entry are

Assets – Liabilities = Capital

Transactions can be divided into three categories.

  1. Transactions related to individuals and businesses
  2. Transactions related to real estate, goods or cash
  3. Transactions related to costs or losses and income or profits

Therefore, accounts can also be categorized as personal, genuine, or nominal. The classification can be explained as follows.

I. Personal Account: An account related to an individual. Personal accounts include:

i. Natural person: An account related to an individual.

ii. Artificial person: An account associated with an individual or a group of businesses or institutions. For example, HMT Ltd., Indian Overseas Bank, life assurance Corporation of India, Cosmopolitan club.

iii. Representative: An account that represents a particular individual or group of individuals. For example, unpaid payroll accounts, prepaid insurance accounts, and so on.

A business concern may be to maintain business relationships with all of the above personal accounts in order to purchase, sell, rent, or rent goods from them. Therefore, they are either debtors or creditors.

The capital and drawing accounts of the individual owner are also personal accounts.

II. Non-personal accounts: All accounts that are not personal accounts. This can be further divided into two types. Real and nominal accounts.

i. Actual account: Assets owned by business parties and accounts related to the assets. Real accounts include tangible and intangible accounts. For example, land, buildings, goodwill, purchases, etc.

ii. Nominal Accounts: These accounts have no existence, form, or shape. They are related to income and expenses, and profits and losses of business concerns. For example, payroll accounts, dividend accounts, and so on.

Golden Rules of Accounting

1.Personal AccountsDebit the receiver Credit the giver
2.Real Accounts–  Debit what comes in Credit what goes out
3.Nominal     AccountsDebit all expenses and losses Credit all incomes and gains

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