Classification of Accounts

We can classify accounts in two different ways. These are: 1. Traditional classification of accounts 2. Modern classification of accounts Traditional Classification of Accounts: This is very old method of classifying accounts and is not used in most of the advanced countries. Under this method, accounts are classified into four types. These are: 1. Personal accounts 2. Real accounts 3. Nominal accounts 4. Valuation accounts These four types of accounts are briefly explained below: Personal Accounts: These accounts show the transactions with the customers, suppliers, money lenders, the bank and the owner. A business may have many credit transactions with the above persons or organizations. A separate account is to be prepared for each of them. Persons or organizations with whom the business has credit transactions are either debtors or creditors. If they have to give some money to the firm, they are called debtors. Conversely, if the firm is to pay them some money they are known as creditors. The main purpose of preparing personal accounts is to ascertain the balances due to or due from persons or organizations. Real Accounts: These accounts are accounts of assets and properties such as land, building, plant, machinery, patent, cash, investment, inventory, etc. When a machinery is purchased for cash, the two accounts involved are machinery and cash - both are real accounts. But if the same machine is purchased from Z & Co. on credit, the two accounts involved will be those of machinery and Z &Co., the former being a real account and the later being a personal account. Nominal Accounts: These are the accounts of incomes, expenses, gains and losses. Examples of nominal accounts are wagespaid, discount allowed or received, purchases, sales,etc. These accounts generally accumulate the data required for the preparation of income statement or trading and profit and loss account. Valuation Accounts: These are the accounts of provision for depreciation and provision for doubtful debts. Where fixed assets are maintained in the books of accounts at original cost,to reflect the actual book value of the assets, a provision for depreciation account on the credit is maintained. In the balance sheet, it is shown as deduction from the original cost of the asset. Similarly, if the debtors' personal accounts are retained at total amount due, a valuation account on the credit - provision for doubtful debts is required. In the balance sheet, it is shown as a reduction from sundry debtors account to reflect estimated realizable value. Example: Classify the following into real, nominal, personal and valuation accounts: 1. Plant and machinery 2. Purchases 3. Investment 4. Bank 5. Provision for bad and doubtful debt 6. Tata Iron & steel Co. 7. Rent 8. Land and Building 9. Carriage outward 10. Capital 11. Leasehold 12. Trademark 13. Return outwards 14. Import duty 15. Provision for depreciation Solution: 1. Real account 2. Nominal account 3. Real account 4. Personal account 5. Valuation account 6. Personal account 7. Nominal account 8. Real account 9. Nominal account 10. Personal account 11. Real account 12. Real account 13. Nominal account 14. Nominal account 15. Valuation account Modern Classification of Accounts: According to Modern approach Accounts are classified into five groups: 1. Asset Account 2. Expense Account 3. Revenue Account 4. Liability Account 5. Capital Account.