Are you curious to know about the types of accounts that can help you in a hassle-free record of debit and credit entries? Then this post will take you through two approaches of account classification that will dive deep into- Personal, Real, Nominal, Assets, Liabilities, Equity, Income, & Expenses types of accounts.
So, without any further ado, let us first discuss why these types are essential, and then we will understand what the types of accounts are and how they are classified.
Importance of Types of Account
Accounting is essential for the effective management of the day-to-day affairs of a business and finance.
The primary function of accounting is to make a list of all transactions performed on behalf of the company in a day. Each transaction on this list is then categorized into different accounts. All the transactions are then recorded under either the debit or credit section of the account.
Recording all the transactions a company enters into would make up for a huge bulk of data. It is easier to handle data when it is split into smaller entities. It is where the importance of classifying each transaction becomes essential.
The necessity of classifying the transactions brings another question to the fore.
How can the transactions be classified?
What are the different ways of classifying these transactions?
It led to the two different approaches to how the bulk of these transactions could be classified. Let us go through those types of accounts here and now-
What are the Different Types of Accounts?
There are two approaches to classifying accounts.
Traditional Types of Accounts
Under the traditional approach, there are three types of accounts.
1. Personal Accounts
The accounts related to persons are called Personal Accounts. Accounts of a company, firm, or organization are also called personal accounts.
2. Real Accounts
The accounts related to assets or properties of an organization are called Real Accounts. Real accounts are further classified into:
- Tangible Real Accounts
- Intangible Real Accounts
Tangible Real Accounts are assets of a tangible company or that can be touched. Examples can be building an account, cash account, etc.
Intangible Real Accounts do not have physical existence or cannot be touched. Examples are patent, goodwill, copyright, trademark, etc.
3. Nominal Accounts
The accounts related to profit, loss, expenditure or income, etc., are called Nominal Accounts—for example, rent account, salary account, etc.
Modern Types of Accounts
Under the Modern approach, accounts are classified under five different heads. These are:
1. Assets Account
An asset is any product, physical or not, that adds value to your business. This account is further classified depending on whether they are physical or non-physical. They are:
- Tangible Assets
- Intangible Assets
Tangible Assets are the physical assets of the business, like cash, machinery, vehicles, etc.
Intangible Assets are non-physical assets like the company’s trademark, copyright, patents, etc.
Asset Accounts are also classified depending on their lifespan or how quickly they can be converted into cash (liquidity). They are:
Assets that are converted into cash or entirely consumed within twelve months are called Current Assets. Any cash receivable or expenses that are prepaid are examples.
Fixed Assets are assets that remain with the company for a year or longer and include machinery, vehicles, etc.
2. Liabilities Account
The liabilities or debts of the company are what comes under the purview of this account. It is further divided into:
- Current Liabilities
- Long-Term Liabilities.
Current Liabilities are usually paid off with the company’s current assets or cash.
Long-Term Liabilities are the mortgages and loans the company might have incurred to acquire fixed assets. These debts take years to be paid off instead of months.
3. Equity Account
Equity is also referred to as the Net Worth of the company. Equity is the company’s total assets that the owner owns, the stocks of the company, and the profits. It is basically whatever is left after the liabilities of the company are deducted from the assets.
Equity Accounts are of three types, namely:
- Investment Account
- Withdrawal Account
- Retained Earnings.
An investment Account is an initial investment made by the company owner or capital, and whatever money is invested in the company after that.
A withdrawal Account is all the money withdrawn or debited as personal earnings or profits of the owner or owners.
Retained Earnings is the company’s income accumulated over the years.
4. Income or Revenue Account
Money earned by the company through sales or services is called income. The interest generated on dividends or market securities is also income for the company. In the simplest form, revenue or income is understood as the money that a business earns.
Income or revenue types of accounts track your incoming money from operation as well as from non-operations. Some of the examples of income sub-accounts are-
- Product sales
- Earned interest
- Miscellaneous income
You can increase your revenue accounts by credit the corresponding sub-account, plus in the same way, you can decrease your revenue accounts with a debit.
5. Expenses Account
This account records all the expenses of the company, like office supplies, rent, travel, etc. Expenses can be understood as the costs that a business goes through during its operations. For instance, when you pay office rent, it is your expense.
Some of the sub-accounts that are considered as the expenses types of account are-
- Cost of goods sold (COGS)
The expenses that you make will get increased by debits, and in the same way, it will get decreased by the credits. So, by spending more money, you will increase the amount in your expense account.
Whether a company chooses the traditional or modern approach to accounting, having these different accounts for different transactions is essential, and recording these transactions.
These accounts are different parts of the same entity and have to work in sync and complement each other and function as one unit to run smoothly.
This makes the data easy to handle, and on any given day at any given time, the data is available for analysis. The data is, therefore, easily accessible to the people in charge.
It makes it easier for them to understand how the company performs and make vital business decisions based on this.
Now, on the concluding note, we hope you would have understood different types of accounts and their roles. Share your views about these classifications of the accounts in the comment section below.