Types of Accounts
Do you remember your high school Biology Class where your instructor thought you about cells being the building blocks of the human body?
Well, in a similar fashion - ACCOUNTS are the BUILDING BLOCKS of a company's accounting system.
Now, if we dig a bit deeper into the memories of your Bio Class, you may also remember that cells are categorized differently in the body based on the TYPE of CELL - such as Red Blood Cells, White Blood Cells, Platelets, etc.
ACCOUNTING does kinda the same thing.
It classifies ACCOUNTS into NOMINAL (TEMPORARY), REAL (PERMANENT) and PERSONAL.
UNDERSTANDING THE THREE TYPES OF ACCOUNTS
To fully understand the 3 TYPES of Accounts - you need to understand that Accounting is a system.
A process that starts with a transaction and ends with Reporting of those combined transactions in Financial Statements and closing the books thereafter (See our article on The Accounting Cycle for a full explanation of the Accounting process ).
Certain Accounts hit the 'reset' button at the end of this process, i.e., start over from zero in the next period.
Why do some accounts start over you ask?
To give us a better understanding of how the Business has done over the period being measured in the Accounting Cycle.
For Example - To fully understand 'The Revenue' a company has made over a year, we close the Revenue Account at the end of the year to come up with the Annual Revenue.
Similarly, to know the Expenses, Gains or Losses at the end of the year, we close the accounts at the end of the year to know the Expenses, Gains or Losses at the end of the year.
Now, ALL THE ACCOUNTS THAT CLOSE AT THE END OF THE PERIOD and RESET, i.e., start from a Zero balance again in the next period are called NOMINAL ACCOUNTS.
NOMINAL (Temporary) Accounts are closed by transferring their balances to the REAL (Permanent) Accounts.
Nominal Accounts include
"Resetting" these accounts at the end of the period helps in understanding how the company did during the period as well as comparing period to period (for example - quarter vs. quarter, year vs. year, etc.)
Nominal Accounts are closely tied into a Financial Statement called the Income Statement which is the 'go to' document for how a company has done during a period.
Now, in an OPPOSITE fashion, we also have certain accounts that DO NOT CLOSE at the end of the accounting period.
In other words, the balances in these accounts are carried over to become the beginning balances of the next accounting period.
Examples of these accounts are
Why do these accounts not close?
At the end of a period, let's say Dec 31, 2018.
If a company has a 1,000 dollars of cash in the bank, the cash would also be a 1,000 dollars at the beginning of the next period which is Jan 1, 2019.
Similarly, 5,000 dollars of Inventory at the end of the period would also be 5,000 dollars of Inventory at the start of the next period on Jan 1, 2019.
Now, ALL THE ACCOUNTS THAT DO NOT CLOSE AT THE END OF THE PERIOD and carry forward the balances to the next period are called PERMANENT or REAL ACCOUNTS.
These Accounts are not limited to Assets alone and include Liabilities and Equity Accounts.
Broadly, like the NOMINAL ACCOUNTS are linked to the Income Statement and Real accounts are linked to The Balance sheet.
Other Examples of Real Accounts are
Finally, the last type of Accounts are called PERSONAL ACCOUNTS and are the easiest to understand.
They represent any Individuals, Firms, Companies or Institutions.
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