Types of Accounts in Accounting - Real,Personal and Nominal

 

What is Accounting ?

Accounting is the process of recording, summarizing, and analyzing financial transactions. It helps businesses and individuals track their income, expenses, and overall financial health. The goal of accounting is to provide clear and accurate financial information to aid decision-making.

What is the accounting equation ?

The core principle of accounting lies in the accounting equation:

Assets = Liabilities + Equity

This equation is the foundation of all financial statements, ensuring that a company’s resources are always balanced against its obligations and ownership. Accounting follows the double-entry system, where every transaction affects at least two accounts, ensuring accuracy and consistency in the financial records.

Here are some common accounting definitions to help you understand basic terms:

1. Asset: Anything of value owned by a business or individual. Assets can be tangible (e.g., machinery, cash) or intangible (e.g., patents, goodwill).
2. Liability: A financial obligation or debt owed by a business or individual to others. Examples include loans, accounts payable, and mortgages.
3. Equity: The owner's claim on the assets of the business after all liabilities have been paid. It’s calculated as Assets minus Liabilities.
4. Revenue: The income a business earns from its normal operations, such as selling goods or services.
5. Expense: The costs incurred in the process of earning revenue, such as rent, salaries, utilities, and materials.
6. Balance Sheet: A financial statement that shows the financial position of a business at a specific point in time. It includes assets, liabilities, and equity.
7. Profit and Loss Statement (Income Statement): A financial statement that summarizes the revenues, costs, and expenses over a period of time, showing whether the business made a profit or a loss.
8. Debit: An entry that increases assets or expenses and decreases liabilities or equity in a double-entry accounting system.
9. Credit: An entry that decreases assets or expenses and increases liabilities or equity in a double-entry accounting system.
10. Journal: A detailed record of all financial transactions in chronological order.
11. Ledger: A book or collection of accounts where all journal entries are categorized by type (e.g., assets, liabilities, expenses).
12. Trial Balance: A report that lists all the balances from the ledger to check the accuracy of the accounting entries and ensure that debits equal credits.
13. Accrual Accounting: A method of accounting where revenue and expenses are recorded when they are earned or incurred, not when cash is received or paid.
14. Cash Flow: The total amount of cash being transferred into and out of a business, especially as affecting liquidity.
15. Depreciation: The allocation of the cost of a tangible asset over its useful life. It reflects the decrease in value of the asset due to wear and tear or obsolescence.
16. Amortization: The process of gradually writing off the cost of an intangible asset over its useful life.

Types of Accounts in Accounting 

There are 3 main types of accounts in accounting forms the backbone of the entire financial structure of the organisation. It is a process for keeping track of the company’s financial health by determining the incurred costs and profits earned through appropriate accounting procedures. Maintaining accurate financial records is important for maintaining transparency in the business, managing funds efficiently and making informed decisions. The company’s financial transactions are organised into different accounts, which are categorised as - real, nominal and personal.

Before we learn about types of accounts lets understand what is accounting and some concepts of accounts 

3 Golden Rules of Accounting 

the golden rules of accounting are

1. Personal Account: Debit the receiver, Credit the giver.
2. Real Account: Debit what comes in, Credit what goes out.
3. Nominal Account: Debit all expenses and losses, Credit all incomes and gain

3 Fundamental Types Of Accounts In Accounting

Real accounts

Real accounts are used for recording assets, liabilities, and owner’s equity of a business. It maintains records of cash, accounts receivables, investments, inventory, equipment, and other assets.

Golden rule of Real accounts 

• Debit what comes in
• Credit what goes out.

For instance, when a business purchases raw material, the amount paid for the purchase is recorded as debit. When the business receives cash payments from a customer or pays cash to the supplier, it is recorded as a debit in the cash account. Also, when a business sells inventory, it is recorded as a credit in the inventory account. 

A few examples of real accounts in accounting:

• Cash
• Common stock
• Accounts receivable
• Retained earnings
• Fixed assets
• Wages payable
• Accounts payable

Real accounts are also known as permanent accounts as they continuously maintain balance and aren’t closed at the end of an accounting year. So, at the year’s end, the final amounts recorded in the permanent accounts become the business’ retained earnings into the new year. Thus, the final balance from the previous business year in the real account becomes the opening balance for the next accounting year. The opening or beginning balance will consist of cash, fixed assets and inventory accounts. 

Personal Accounts

In personal accounts, the business maintains records of transactions with individuals or organisations with whom they have financial dealings. These are closed at the end of an accounting period and hence they are also known as temporary accounts.

Golden rule of Personal accounts 

• Debit the receiver
• Credit the giver

There are three categories of personal accounts - natural, artificial and representative. Natural personal accounts are related to individual persons such as Hema’s Account, Mr. Dayal’s Account, Creditor’s Account etc. Artificial accounts are attributed to legal entities created by human beings. For instance, the State Bank of India Account, Caterer’s Account, Insurance Account etc. Finally, the representative account represents a person or a group. For instance, Prepaid expense accounts, accrued interest accounts, unearned commission accounts etc. 

Personal accounts record accounts payable, accounts receivable and owner’s equity. Some instances of a personal account are when a business sells goods or services on credit, it is recorded as a debit under accounts receivable. When the customer pays outstanding dues, it is recorded as a credit under accounts receivable. When a business purchases goods or services on credit, it is recorded as a credit under accounts payable. When it pays off its outstanding dues, it is recorded as a debit under the accounts payable. 

Nominal Accounts

Nominal accounts are used to maintain records of revenues, profits losses and expenses. Since they are closed at the end of an accounting period, they are also known as temporary accounts. 

Golden rule rules of nominal accounts are - 

• Debit all expenses and losses
• Credit all incomes and gains

The three types of nominal accounts are -

• Revenue account - it holds records of all financial transactions related to the income receipts. 
• Expense account - it holds records of records the day-to-day spending of a business within a financial year. 
• Gain and loss account - it offers a summary of the expenses and revenues of a business during a specific fiscal year.

Nominal accounts maintain records of rent, sales, salaries, advertising, interest earned etc. Some instances include, when a business incurs expenses such as paying rent or salaries, it is recorded as a debit under the expense account. When a business earns sales revenue, it is recorded as a credit under the revenue account. Further, when a business incurs loss from loss or damage to inventory, it is recorded as a debit under the loss account. Or, when the business earns income from the sale of some asset, it is recorded as a credit under the profit account. 

Classification Of Accounts Under Modern Approach 

In modern accounting practices, accounts are categorised into five main groups that help organise financial records:

1. Assets: Resources owned by a business, such as cash, inventory, and equipment.
2. Liabilities: Amounts owed to others, such as loans, accounts payable, and taxes.
3. Equity/Capital: The owner’s stake in the business, including retained earnings and capital investments.
4. Income/Revenue: The earnings generated from the company’s operations, such as sales, interest income, or service revenue.
5. Expenses: The costs associated with running the business, including salaries, rent, and utilities.

8 Most Common types of accounts 

Tax Accounting

 Tax accounting focuses on the preparation of tax returns and ensuring compliance with tax laws. Tax accountants help individuals and businesses minimize their tax liabilities by applying tax strategies while adhering to the law.

Financial Accounting

 This type of accounting deals with the preparation of financial statements for external use, such as balance sheets, income statements, and cash flow statements. It ensures that financial information is accurate and in compliance with generally accepted accounting principles (GAAP).

Management Accounting

 Also known as managerial accounting, this type focuses on providing internal reports to managers to help them make informed decisions. It includes budgeting, performance evaluation, and cost management, often involving forecasts and projections.

Cost Accounting

Cost accounting tracks and analyzes the costs of producing goods or services. It helps businesses determine how much it costs to make a product and helps in pricing, budgeting, and controlling costs. Key elements include direct materials, direct labor, and overhead.

Forensic Accounting

Forensic accountants investigate financial discrepancies, fraud, or other financial crimes. They analyze financial records to uncover wrongdoing and may be involved in legal proceedings to present findings as evidence.

Governmental Accounting

 Government accountants manage and track the finances of government entities. They follow specific regulations and standards set by the Governmental Accounting Standards Board (GASB) to ensure transparency and accountability in public funds.

International Accounting

This type of accounting deals with financial practices across different countries. International accountants must understand and apply international financial reporting standards (IFRS) to ensure global consistency, especially for businesses that operate internationally.

Auditing

Auditing involves reviewing financial statements and records to ensure their accuracy and compliance with regulations. Auditors examine financial documents to detect any discrepancies, fraud, or misstatements, and provide an independent evaluation of a company’s financial health.

 Common Errors in Accounting

• Misclassification of Accounts: For example, incorrectly categorizing an expense as an asset.
• Double-Entry Mistakes: Failing to properly debit and credit accounts.
• Omitting Entries: Forgetting to record a transaction, leading to incomplete financial statements.

Solved Problems on Entries

Problem 1: Purchase of Inventory with Trade Discount

Problem: A company purchases inventory worth 50,000 with a trade discount of 10%. The company pays ?5,000 in cash and the remaining amount is on credit. Prepare the journal entry for this transaction.

Solution:

1. Calculate the trade discount:

• Trade Discount = 50,000 × 10% = 5,000

• Net Purchase Price = 50,000 - 5,000 = 45,000

2. Journal Entry:

• Debit Inventory 45,000

• Credit Cash 5,000

• Credit Accounts Payable 40,000

 

Problem 2: Payment of Salaries

Problem: A company pays salaries amounting to 30,000 in cash. Additionally, it incurs an employer’s provident fund contribution of 3,000. Prepare the journal entry for this transaction.

Solution:

1. Journal Entry:

• Debit Salary Expense 30,000

• Debit Provident Fund Expense 3,000

• Credit Cash 33,000

 

Problem 3: Sale of Goods with Returns

Problem: A company sells goods worth 80,000 on credit. Later, goods worth ?5,000 are returned by the customer. Prepare the journal entries for both the sale and the return.

Solution:

1. Journal Entry for Sale:

• Debit Accounts Receivable 80,000

• Credit Sales Revenue 80,000

2. Journal Entry for Return:

• Debit Sales Returns 5,000

• Credit Accounts Receivable 5,000

 

Problem 4: Interest Expense on Loan

Problem: A company takes a loan of 2,00,000 from the bank at an interest rate of 12% per annum. Prepare the journal entry for the interest expense at the end of the year.

Solution:

1. Interest Calculation:

• Interest Expense = 2,00,000 × 12% = 24,000

2. Journal Entry:

• Debit Interest Expense 24,000

• Credit Interest Payable 24,000

 

Problem 5: Receipt of Cash from Debtors

Problem: A company receives 15,000 in cash from a debtor. The original sale was recorded on credit. Prepare the journal entry for the cash received.

Solution:

1. Journal Entry:

• Debit Cash 15,000

• Credit Accounts Receivable 15,000

 

Problem 6: Adjusting Entry for Prepaid Expenses

Problem: A company pays 12,000 for insurance coverage for the next 12 months. At the end of the first month, prepare the adjusting journal entry for the insurance expense.

Solution:

1. Monthly Expense Calculation:

• Monthly Insurance Expense = 12,000 / 12 = ?1,000

2. Journal Entry:

• Debit Insurance Expense 1,000

• Credit Prepaid Insurance 1,000

 

Problem 7: Accrued Revenue

Problem: A company completes services worth ?20,000 but has not yet received payment. Prepare the journal entry to record the accrued revenue.

Solution:

1. Journal Entry:

• Debit Accounts Receivable 20,000

• Credit Service Revenue 20,000

 

Frequently Asked Questions (FAQs)