Accounting is the process of documenting, categorizing, and summarizing financial transactions in a meaningful way, as well as analyzing the outcomes. Accounting is an art as well as a science.
It is crucial for all kinds of entities, regardless of size, to have an appropriate accounting system to run their business activities effectively. An accountant needs to be well-versed in accounting terminology and account kinds.
Personal accounts, real accounts, and nominal accounts are the three primary categories into which accounts are traditionally classified. When it comes to documenting financial transactions, each category has a distinct function. We shall examine these classifications in greater detail in this article.
Also Read: Accounting vs Finance: Key Differences and Career Insights
What is an Account in terms of Finance?
The methodical presentation of every transaction about a specific head is called an account. An account displays the condensed records of transactions about a certain individual or item.
For instance, each supplier and customer will have its account when the business engages with multiple suppliers and customers. Statements are used to express accounts. There are two sides to it. An account's left side is referred to as the debit side, while its right side is known as the credit side. "Dr" stands for the debit, and "Cr" for the credit.
Account Types
Each debit or credit transaction record in financial accounting will be associated with one of three account types:
1. Personal Accounts
Personal accounts are associated with people, businesses, organizations, or firms. They stand in for organizations that a business transacts money with. Three categories of personal accounts can be distinguished: representative personal accounts, artificial personal accounts, and natural personal accounts.
* A natural personal account
accounts about certain people, such as a capital account, a drawing account, a creditor's account, a debtor's account, etc.
* Artificial Personal Accounts
These are accounts about entities that are regarded as distinct legal persons, such as businesses, associations, or organizations. Companies use fictitious personal accounts to document transactions with these organizations.
* Personal Accounts of Representatives
These accounts serve as an indirect representation of a person or group of people. For example, when a company incurs costs (such as interest or salary), these sums are documented as representative accounts until they are settled.
2. Real Accounts
These kinds of accounts have something to do with properties or assets. Unlike nominal accounts, which are closed after each accounting period, these accounts stay on the balance sheet for several accounting periods. Tangible and intangible accounts are further divisions of real accounts.
* Real, tangible accounts
These consist of tangible assets that can be handled. A/C for buildings, currency, stationery, inventories, etc. are a few examples.
* Real Intangible Accounts
These accounts are associated with intangible assets that are valuable to the company even if they don't have a tangible existence. for example: goodwill, patents, trademarks, copyrights
3. A Nominal account
A nominal account is a generic ledger that records a company's short-term operations, such as its income, expenses, profits, and losses for a given time frame. It includes every transaction that takes place throughout a single fiscal year. Additionally, when the next fiscal year starts, it starts over from zero. Accounts for rent, salaries, sales, and interest earned are a few examples.
Principal Advantages of Account Categorization
1. Accurate Financial Reporting:
Accurate and meaningful financial reporting, including the income statement and balance sheet, is guaranteed by proper classification.
2. Helps in forecasting for the future and budgeting
A solid budget that is founded on competent accounting procedures can serve as a solid basis for expansion. It also helps with more precise forecasts for the future.
3. Better Decision-Making:
Managers and owners of businesses can make well-informed judgments by using well-organized and transparent financial data due to well-classified accounts.
In Conclusion,
Accounting serves as the foundation of any company by offering a methodical way to document, examine, and evaluate financial activities. Through comprehension of the differences and uses of each account type, companies may keep well-organized financial records, adhere to legal obligations, and create the conditions for long-term success.
Account categorization is an essential procedure that improves the effectiveness and dependability of any accounting system, whether it is used for operational activities, assets, or people.
FAQs about Classification and Account Types
1. Why are accounts being categorized?
Account classification makes it easier to record transactions, guarantees accurate financial reporting, and facilitates the analysis of financial data for improved forecasting and decision-making.
2. Why are there credit and debit sides to accounts?
Financial transactions are regularly recorded and analyzed with the aid of the debit and credit sides. Whereas "Cr" (credit) raises liability, equity, and revenue accounts, "Dr" (debit) raises asset and expense accounts.
3. How do actual, nominal, and personal accounts differ from one another?
Personal accounts: Concern people, groups, or businesses (e.g., debtors, creditors).
Real accounts include both intangible (like goodwill) and tangible (like buildings) assets.
Nominal accounts: Keep track of short-term accounts such as earnings, costs, and profits for a given time frame.
0 Comments