Classification of Accounts

In accounting, accounts are classified into different types based on the nature of the transactions
they record. Understanding the classification helps in the proper recording, categorization, and
analysis of financial data. The three main classifications are:

1. Personal Accounts

2. Impersonal Accounts (which includes Real and Nominal Accounts)

1. Personal Accounts

A Personal Account refers to accounts that are related to individuals, firms, companies, or other
entities. These accounts track the amounts owed by or to a specific party (either a person or an
organization).

• Rule: Debit the receiver, credit the giver.

• Examples:

o Debtors: An account representing customers who owe money to the business. For
instance, "John’s Account" (if John owes money to the business).

o Creditors: Accounts representing entities that the business owes money to. For
instance, "ABC Suppliers Account" (if the business owes ABC Suppliers).

o Banks and other financial institutions: Accounts that represent the business’s
dealings with banks or any financial institution, like "XYZ Bank Account".

Example:

• If the business owes money to a supplier, the creditor's account is a personal account. The
transaction may look like this:

o Credit to XYZ Suppliers Account (Personal Account) when the business owes the
money.

2. Impersonal Accounts

Impersonal accounts are divided into two main categories:

• Real Accounts

• Nominal Accounts

Real Accounts:

• Meaning: Real accounts are related to tangible or intangible assets owned by the business.
They include accounts of assets such as cash, property, machinery, and other valuable
resources.

• Rule: Debit what comes in, credit what goes out.

• Examples:

o Assets: Cash, Buildings, Land, Machinery, Inventory, etc.

o Example:
 ▪ When machinery is bought for the business, the Machinery Account (Real
Account) is debited because machinery is coming into the business.

o Transaction Example:

▪ If the business buys equipment for $10,000, the journal entry would be:

▪ Debit: Machinery Account (Real Account) $10,000

▪ Credit: Cash Account (Real Account) $10,000

Nominal Accounts:

• Meaning: Nominal accounts are related to expenses, income, gains, and losses. They are
temporary accounts used to record transactions for a particular accounting period.

• Rule: Debit all expenses and losses, credit all incomes and gains.

• Examples:

o Expenses: Rent, Salaries, Utilities, Depreciation, etc.

o Income: Sales Revenue, Interest Income, Dividend Income, etc.

o Example:

▪ If a business pays a salary of $2,000, the Salaries Account (Nominal Account)

is debited because it is an expense.

o Transaction Example:

▪ When the business pays a salary:

▪ Debit: Salaries Expense Account (Nominal Account) $2,000

▪ Credit: Cash Account (Real Account) $2,000

Summary of Real and Nominal Accounts

Account
Nature Examples Accounting Rule
Type

Assets (Tangible or Cash, Machinery, Debit what comes in, credit what
Real Account
Intangible) Inventory, Buildings goes out.

Nominal Expenses, Incomes, Rent, Salaries, Sales Debit all expenses and losses, credit
Account Gains, Losses Revenue, Interest all incomes and gains.

Reasons and Benefits of Classifying Accounts

1. Simplifies Accounting Process:

o The classification of accounts into personal, real, and nominal accounts simplifies
the process of recording transactions. It provides a structured method for
determining which account to debit or credit, helping to maintain the accuracy of
financial statements.
2. Ensures Proper Financial Reporting:

o By clearly separating personal accounts (related to people) from real accounts

(related to assets) and nominal accounts (related to income and expenses),
accountants ensure that financial statements (such as the balance sheet and income
statement) are accurate and reflect the true financial position of the business.

3. Improves Control and Monitoring:

o Classification helps in tracking individual transactions and account balances. For

example, knowing which accounts represent liabilities (personal accounts) or assets
(real accounts) enables businesses to manage debts, assets, and equity effectively.

4. Helps in Financial Analysis:

o With a proper classification system, businesses can easily analyze their expenses,
income, and asset performance over specific periods. Nominal accounts are
especially useful in determining profit or loss, while real accounts help assess the
business's total assets and liabilities.

5. Facilitates Auditing and Compliance:

o Classification aids auditors in verifying and ensuring that transactions have been
correctly recorded in accordance with accounting principles. It simplifies the process
of checking whether the financial records are compliant with accounting standards
and regulations.

6. Aids in Tax Reporting:

o By classifying accounts properly, a business can distinguish between capital

expenditures (real accounts) and operating expenses (nominal accounts). This
classification is crucial for accurate tax filings, especially for depreciation or
deductions related to expenses.