Quick Reads
- Real Accounts (for tangible & intangible assets): Debit what comes in, Credit what goes out.
- Personal Accounts (for transactions between individuals): Debit the receiver, Credit the giver.
- Nominal Accounts (for expenses, losses, incomes, gains): Debit all expenses and losses, Credit all incomes and gains.
Understanding the fundamentals of accounting is critical for effectively managing a business, ensuring proper accounting ledger records and journals, and preparing accurate financial statements. The bookkeeping system makes it mandatory to correctly classify all financial transactions into the three main types of accounts, namely, Real, Personal, and Nominal accounts, each having a set of rules (Golden Rules of Accounting).
Whether you are a budding entrepreneur trying to understand your financial needs, a student of finance, or a bookkeeper, understanding these three types of accounts will help ensure that all your entries in the financial journals and ledgers are correct.
What are the Three Types of Accounts?
Any financial transaction entered by an entity impacts at least two accounts. To record these transactions accurately in the journals and ledgers, the accounts are classified into three major types:
1. Personal Accounts
Personal Accounts pertain to all financial transactions with people, entities, and organisations. They measure how much a business organisation owes to other individuals and firms or how much it is owed by others.
Classification of Personal Accounts
- Natural Personal Accounts: Personal Accounts with human beings as the transacting parties. Examples: John’s Account, Sarah’s Account.
- Artificial Personal Accounts: Accounts with companies, institutes, and organisations as the transacting parties. Examples: Bank Accounts, Private Limited Company Account.
- Representative Personal Accounts: Accounts that represent either a natural or artificial person. Example: Outstanding Salary Account, Prepaid Rent Account.
2. Real Accounts
Real Accounts pertain to all properties, tangible (touchable) and intangible (non-touchable), that an individual or business possesses. Unlike other accounts, Real Accounts have persisting balances that remain open throughout the years and are rolled forward to the following financial years.
Classification of Real Accounts
- Tangible Real Accounts: Personal property that can be touched and seen. Examples: Machinery Account, Cash Account, Furniture Account, Inventory Account.
- Intangible Real Accounts: Non-touchable personal property. Examples: Patent Account, Trademark Account, Goodwill Account, Copyright Account.
3. Nominal Accounts
Nominal Accounts pertain to all expenses, losses, incomes, and gains of a business organisation. Nominal accounts are temporary accounts that only record a business’s financial activity for a specific financial year. The balances of these accounts are usually transferred to the Profit & Loss statement at the end of the financial year.
- Examples: Rent Paid Account, Commission Received Account, Salary Account, Interest Received Account, Bad Debts Account.
- Rule: Debit all expenses and losses, Credit all incomes and gains.
What are the Golden Rules of Accounting?
| Account Type | Scope | Golden Rule | Example |
| Personal Account | People, entities, and organisations | Debit the receiver, Credit the giver | Creditor Account, Bank Account |
| Real Account | Tangible and intangible assets | Debit what comes in, Credit what goes out | Building, Machinery, Cash |
| Nominal Account | Expenses, losses, income, and gains | Debit all expenses/losses, Credit all incomes/gains | Rent Expense, Interest Received |
Managing Accounts and Growing Business
Maintaining a clear distinction between Real, Personal, and Nominal accounts ensures that all business owners have a complete view of their daily expenses and assets. However, maintaining accurate ledgers is only half the battle won. Business owners need to maintain sufficient cash flow to meet all liabilities.
Cash flow shortages usually arise for growing companies as their Personal Accounts receivable (money owed to them) dry up while their Nominal Accounts payable (money owed by them) increase. In such instances, financial services can help.
With flexible collateral-free business loans and working capital facilities, we at Lendingkart help businesses finance their working capital requirements without impacting their day-to-day operations or draining their cash reserves. We help small and medium-sized enterprises keep their accounts healthy while facilitating smooth operations.
Conclusion
Understanding the concepts of Real, Personal, and Nominal accounts and following the Golden Rules help business owners and accountants record all their transactions accurately in their financial journals and ledgers. This, in turn, helps prepare accurate balance sheets and financial statements.
Frequently Asked Questions
1. What are the three main types of accounts in accounting?
The three main types of accounts in accounting are Personal Accounts, Real Accounts, and Nominal Accounts. Personal Accounts pertain to all financial transactions with people, entities, and organisations. Real Accounts pertain to all properties, tangible (touchable) and intangible (non-touchable), that an individual or business possesses. Nominal Accounts pertain to all expenses, losses, incomes, and gains of a business organisation.
2. Is Cash a Real or Personal Account?
Cash is a Tangible Real Account, and the accounting rule is to “Debit what comes in, Credit what goes out.” Cash is a physical asset, and, therefore, any increase or receipt of cash is debited, while any decrease or payment of cash is credited. The account’s balance is rolled forward to the next financial year.
3. Which account type does Bank Account fall under?
A Bank Account falls under Artificial Personal Accounts. The accounting rule applicable to a Bank Account is “Debit the receiver, credit the giver.” Since a bank represents a company (artificial person), receiving money is debited, and giving money is credited.
4. Do Nominal accounts carry forward to the next financial year?
No, Nominal accounts do not carry forward to the next financial year. Nominal accounts only record a business’s financial activity for a specific financial year, and, therefore, their balances are usually transferred to the Profit & Loss statement at the end of the financial year. All expense, revenue, gain, and loss accounts are then closed out by directly transferring their balances into the Trading and Profit & Loss Account.
5. Why are the Golden Rules of Accounting important?
The importance of the Golden Rules of Accounting is that they help maintain the books and records of a business accurately. By following the specific rules that apply to each of the accounts, the chances of recording financial transactions incorrectly are minimised, and thus every debit has its corresponding credit.
