Different Types of Accounts in Accounting You Must Know

As a business owner, having knowledge of the different types of accounts is imperative for effectively managing cash flow. The different types of accounts have different functions that go beyond keeping your money safe or making it grow with varying interest rates.

However, it can get a little overwhelming to understand the intricacies of these accounts as each has its own rules, figures and technical terms. If you're new to the world of accounting or bookkeeping, this blog will help you understand the different types of accounts in accounting.

What are Accounts in Accounting?

In accounting, an account is a record that is used to track and organise all the transactions of a specific asset, liability, equity, revenue, or expense. Each account gives specific details of the increase and decrease in these categories and assists businesses in monitoring their financial activities in a systematic manner.

Accounts are the building blocks of an accounting system. They are classified in the general ledger, and whenever there is a transaction, it is recorded in one or more related accounts through what is known as double-entry bookkeeping.

Think of an account as a general ledger or diary in which everything about a particular activity or topic is recorded in writing. For example, you can keep an account of your salary, rent, furniture, or even a person, such as your supplier. An account helps to keep finances organised.

What Are the Different Types of Accounts?

All the money transactions under accounting are classified into three broad categories of accounts. Each one of them plays an important role in how we maintain accounts and understand transactions. These accounts are:

• Personal Account
• Real Account
• Nominal Account

1. Personal Account

A Personal Account is, as the name implies, a type of account that belongs to an individual or an organisation that has legal personality. All personal dealings of that personality are included in the personal account. That includes people, companies, banks, and even government departments.

Sub-types of Personal Accounts:

• Natural Persons: These are actual individuals who have legal personality and is used for the storage of personal wealth.
• Artificial Persons: These are businesses, institutions, or organisations that are legally considered people (e.g., Reliance Industries Account, SBI Bank Account).
• Representative Personal Accounts: These represent a group of people or a category. For example:
  • Outstanding Rent Account (you owe rent to someone, so it represents the landlord).
  • Prepaid Salary Account (you've paid your employees in advance, so it represents them).

Examples of Personal Accounts in Use:

• You borrowed ₹10,000 from Ravi → Debit: Cash, Credit: Ravi's account
• You paid ₹5,000 to HDFC Bank → Debit: HDFC Bank, Credit: Cash.

Why Is Personal Account Important?

Personal accounts show how much you owe someone or how much someone owes you. It is very useful in a business that buys or sells on credit.

2. Real Account

A Real Account represents the assets of a company. An asset can be anything that belongs to the company or is used by it to carry out its business. These may be things such as land, furniture, machines, and even cash on hand. There are two kinds of Real Accounts:

(i) Tangible Real Account

Tangible real account keeps track of tangible objects that can be seen, touched or felt. A few examples of tangible real account are as follows:

• Furniture
• Land
• Buildings
• Cash
• Equipment

(ii) Intangible Real Account

Intangible real accounts are intangible assets that you can't see, but they do benefit the business. A few examples of intangible real accounts are as follows:

• Goodwill (business reputation)
• Patents
• Trademarks
• Copyrights

Examples of Real Accounts in Action:

• You purchase a chair for the office → Debit: Furniture Account, Credit: Cash.
• You sell a machine → Debit: Cash, Credit: Machinery Account.

Why Is Real Account Important:

Real accounts are important because they document and monitor the continuous balances of a company's assets, liabilities, and equity. It follows the value of the assets your business owns. The account doesn't close off during the year-end and rolls over to benefit your balance sheet.

3. Nominal Account

A Nominal Account is a type of account that records income, expenses, losses, and gains. These are temporary accounts that are present for just one financial year and are closed afterwards. Their balances are carried forward to the Profit and Loss Account. Nominal accounts help calculate your company's profit or loss during the year.

• Expenses Accounts: Rent, Wages, Electricity Bill, Stationery
• Income Accounts: Commission Received, Interest Earned, Discount Received
• Losses Accounts: Loss by Fire, Loss on Sale of Assets
• Gains Accounts: Profit on Sale of Investments

Examples of Nominal Accounts:

• You pay rent → Debit: Rent Account, Credit: Cash
• You earn commission → Debit: Cash, Credit: Commission Received Account

Why Is Nominal Account Important?

These accounts help you measure how well your business is performing. It is very helpful at the end of the year when you are trying to determine if you made more money than you invested.

Fundamental Principles of Accounting Behind These Types of Accounts

Having learned the three types of accounts, let us now understand the basic accounting principles underlying them that assist in providing accurate financial records.

Separate Idea of Business Entity

This means that the business and the owner are kept as two distinct accounts, even if you own and run the business all by yourself. However, in accounting, your business expenses and your personal expenses are separate.

Example:

If you use business funds to purchase a gift for yourself, it will be considered a drawing or money withdrawn from the business, not a business expense. It's a business purchase if you are buying machinery or equipment.

Concept of Dual Entry

Each transaction has two aspects:

• Debit
• Credit

If you are buying machinery, then:

• The table account is debited (what goes in)
• Cash account is credited (what goes out)

This keeps the books balanced and accurate. The sum of all debits should always be equal to the sum of all credits.

Concept of a Continuing Concern

This is also referred to as the Going Concern Concept. According to this concept, a company will exist for years to come and won't be closing down anytime soon. That's why big purchases such as buildings or machinery are never calculated based on the total cost in a single year. Rather, their value is distributed over many years (this is called depreciation).

Concept of Congruence

Congruence means that all things have to be the same and consistent. The amounts in the accounts have to be the same as the activities of the business. There should not be any difference between what is being recorded and what is happening.

This instils trust in accounting. If the company earned ₹50,000, it has to show ₹50,000, and not ₹80,000 or ₹30,000. Accuracy is of the highest importance in accounting.

Key Differences Between the Types of Accounts

Here are the key differences between the different types of accounts in accounting:

Type of Account	What It Tracks	Examples	Golden Rule
Personal Account	Individuals, firms, companies, organizations	Customer A/c, Bank A/c, Capital A/c	Debit the receiver, Credit the giver
Real Account	Assets (tangible or intangible) owned by the business	Cash A/c, Building A/c, Machinery A/c, Goodwill A/c	Debit what comes in, Credit what goes out
Nominal Account	Expenses, losses, incomes, gains (temporary items)	Rent A/c, Salary A/c, Sales A/c, Commission A/c	Debit all expenses and losses, Credit all incomes and gains
Lifespan	Can carry forward year to year	Permanent accounts	Closed at year-end

Why is Understanding Account Types Important?

Knowing about the different types of accounts, like Personal, Real, and Nominal, is the secret to effective accounting. Without this elementary knowledge, accounting for business transactions would soon become tedious and prone to errors. Here are some reasons why it's important:

1. Accurate Recording of Transactions

Every business transaction will have two accounts. One gets debited and the other credited. But how do you debit and credit? That depends upon the nature of the account that you are dealing with. If you know the rules of every type of account, you can make entries appropriately every time. This minimises the chances of errors in your books.

2. Helps in Creating Reliable Financial Reports

Accurate recording of accounts helps you with reliable financial statements like the Profit & Loss Statement and Balance Sheet. These reports reflect how well your business is performing, the volume of profit being earned, and your financial situation. Inaccurate accounts give rise to incorrect decisions.

3. Saves Time and Effort

After you know the different types of accounts, you won't second-guess or double-check each entry anymore. You will precisely know what you have to do, and that saves your time, particularly if you have hundreds of entries to deal with.

4. Develops Strong Financial Literacy

Once you have a sense of what kind of accounts you have, you can also develop strong financial literacy. It helps you monitor patterns like where your money is going, what your biggest expenses are, and how much income you are bringing from various sources.

5. Maintains Legal and Tax Compliance

Having proper accounts also assists in being lawfully compliant with tax regulations and laws. With your accounts sorted, it's easy to file tax returns or present your finances to banks or investors.

To Conclude

Accounting can seem complex initially, but knowing different types of accounts makes accounting easier. Each type of account follows different rules and offers different benefits. Regardless of whether you're paying rent or collecting from a customer, knowing different types of accounts helps you manage finances and resources effectively.

FAQs

What is a personal account in simple words?

A personal account is related to individuals or companies you deal with. It can be a customer, supplier, or even a bank.

Why is it called a nominal account?

It is called nominal account because it is used to record temporary factors like income and expenses. These accounts are closed at the end of every accounting year.

Can one account fall under two types?

Usually no. Every account serves different purposes. However, some accounts like capital can seem complex. Capital is actually treated as a personal account because it belongs to the owner.

What happens to nominal accounts at the end of the year?

They are closed, and their balances are transferred to the profit and loss account.

What is a real account example?

Cash, furniture, building, land—all are examples of real accounts.