Accounting Equation and Classification of Accounts
Accounting Equation
American accountants have derived the rules of debit and credit through accounting equation, which is given below:
Assets = Equities
The equation is based on the principle that accounting deals with property and rights to property and the sum of the properties owned is equal to the sum of the rights to the properties. The properties owned by a business are called assets and the rights to properties are known as liabilities or equities of the business.
Equities may be divided into equities of creditors representing debts of the business known as liabilities and equity of the owner known as capital. Keeping in view the two types of equities the equation given above can be stated as below:
Assets = Liabilities + Capital
or Capital = Assets – Liabilities
or Liabilities = Assets – Capital
Rules of Accounting Equation
1) Regarding assets: Increases in assets are debits and decreases in assets are credit.
2) Regarding Liabilities: Increases in liabilities are credit and decreases in liabilities are debits.
3) Regarding Capital: Increases in capital are credits and decreases in capital are debits.
4) Regarding Expenses: Increases in expenses are debits and decreases in expenses are credits.
5) Regarding Incomes or Profits: Increases in Incomes or profits are credits and decreases in incomes or profits are debits.
Classification of Accounts
We can classify the Accounts in Two parts
1. PERSONAL ACCOUNTS
2. IMPERSONAL ACCOUNTS
In Personal Accounts we can include:
• Natural Person’s Personal Account:-An account recording transactions with an individual human being is known as a natural person’s Personal Account, e.g., Rajiv’s Account.
• Artificial Person’s Personal Account:-An account recording financial transactions with an artificial person created by law or otherwise is called an artificial person’s personal account, e.g., Golden Industries Ltd., Bank Account, Rajiv & Bros. Co. etc.
• Representative Personal Account:-An account indirectly representing a person or persons is known as a representative personal account. When accounts are of a similar nature and their number is large, it is better to group them under one head and open a representative personal account. Examples of such types of accounts can be: Salaries Outstanding Account, Interest Outstanding Account, Prepaid Insurance Account etc. Salaries Outstanding Account is a personal account representing salaries payable to the staff.
In Impersonal Accounts we can include:
1. Real Account:-These are the accounts of assets. Asset entering the business is given debit and asset leaving the business is given credit. For example, when goods are sold for cash. Cash Account will be given debit as cash comes in and sales (of Goods) Account will be created as goods go out. So, the rule is debit what comes in and credit what goes out. Real Account are of two types:
• Tangible Real Account- Such type of account relates to an asset which can be touched, Felt, seen and measured e.g., Machinery Account, Cash Account, Furniture Account, Stock Account etc.
• Intangible Real Account- Such type of account relates to an asset which cannot be touched physically but can be measured in value. For example, Goodwill Account, Patents Account, Trade Marks Account, Copy Rights Account etc.
2. Nominal Account:-These accounts deal with expenses, incomes, profits and losses. Accounts of expenses and losses are debited and accounts of incomes and gains are credited. For example, when rent is paid to the landlord, Rent Account will be debited as it is an expense and Cash Account (Real account) will be credited as it goes out.
Popularity: 1% [?]
