Accounts are classified using two approaches:
- Traditional approach (also known as the British approach)
- Modern approach (also known as the American approach)
This article briefly discusses how accounts are classified under both approaches.
Classification of Accounts Under the Traditional (or British) Approach
According to the traditional approach, accounts are classified into three types: real accounts, nominal accounts, and personal accounts. Given that it is an old system for classifying accounts, it is used rarely in practice.
Personal accounts are the accounts that are used to record transactions relating to individual persons, firms, companies, or other organizations.
Examples of such accounts include an individual’s accounts (e.g., Mr. X’s account), the accounts held by modern enterprises, and city bank accounts.
Impersonal accounts are those that do not relate to persons. There are two types:
- Real accounts (or permanent accounts)
- Nominal accounts (or temporary accounts)
Real accounts exist even after the end of accounting period. For the next accounting period, these accounts start with a non-zero balance, which is carried forward from the previous accounting period.
Examples of such accounts include machinery accounts, land accounts, furniture accounts, cash accounts, and accounts payable accounts.
Usually, real accounts are listed in the balance sheet of the business. For this reason, they are sometimes referred to as balance sheet accounts.
Nominal accounts are closed at the end of the accounting period. For the next account period, these accounts start with a zero balance. Nominal accounts typically cover issues such as income, gains, expenses, and losses.
Normally, nominal accounts are used to accumulate income and expense data. In turn, these data can be used to prepare income statements or trading and profit and loss accounts. For this reason, nominal accounts are sometimes referred to as income statement accounts.
Examples of nominal accounts include sales, purchases, gains on asset sales, wages paid, and rent paid.
Classification of Accounts Under the Modern (or American) Approach
The modern approach has become a standard for classifying accounts in many developed countries.
The main types of accounts used under this approach are mostly self-explanatory.
Specifically, under the modern approach, accounts are classified into the following five groups:
- Asset accounts: Examples include land accounts, machinery accounts, accounts receivable accounts, prepaid rent accounts, and cash accounts.
- Liability accounts: Examples include loan accounts, accounts payable accounts, wages payable accounts, salaries payable accounts, and rent payable accounts.
- Revenue accounts: Examples include sales accounts, service revenue accounts, rent revenue accounts, and interest revenue accounts.
- Expense accounts: Examples include wage expense accounts, commission expense accounts, salary expense accounts, and rent expense accounts.
- Capital/owner’s equity accounts: An example is an individual owner’s account (e.g., Mr. X’s account).
Consider the list of accounts shown below. Our task is to classify these accounts using both the traditional and modern approaches.
- Plant and machinery
- Land and building
- Sam’s capital
- Loan from city bank
- Plant and machinery > Real account
- Purchases > Nominal account
- Sales > Nominal account
- Rent expense > Nominal account
- Land and building > Real account
- Cash > Real account
- Sam’s capital > Personal account
- Loan from city bank > Personal account
- Plant and machinery > Asset account
- Purchases > Expense account
- Sales > Revenue account
- Rent expense > Expense account
- Land and building > Asset account
- Cash > Asset account
- Sam’s capital > Capital/owner’s equity account
- Loan from city bank > Liability account