The entity concept separates the concerns of the owners from the business. An extension of the same concept is the concept of accounts which splits up the business’s affairs further. The account concept becomes clearer once the double entry system of accounting is explained. That is done at a later stage in the tutorial.
Transactions within the Firm
The firm conducts transactions with outside parties and the accounting system is capable of keeping a track of the same. However there are many transaction that are internal to the firm. For instance when a company undertakes production, it converts raw material into finished products. This transaction is internal to the firm but has a material effect. If the firm were considered as one unit, it would be impossible to account for the transaction as the same party cannot be on both sides of the transaction.
Entity Split Up into Accounts
An appropriate analogy to draw would be that of the human body. The business is the complete entity i.e. the body. Accounts on the other hand are like lungs, kidneys, heart etc. They are like the vital organs that are constituent parts of the entity. They have their own independent existence. However, it is the relationship between these accounts that is of prime importance. That is why it is called the accounting system.
Types of Accounts
All accounts within the organization can be split into three types. An account can be of one and only one of the following type and not more. Here are the various types of accounts.
- Personal: Personal accounts make most intuitive sense. We keep a track of all the transactions that we have undertaken with a particular person in them. We all maintain personal accounts like the money we owe our friends, the grocer and so on.
- Real: Real accounts are accounts which have been created to account for tangible things. Accounts such as land and building, machinery a/c etc are called real accounts. Although they are not living beings, we still transact with such entities. Records of such transactions are kept in real accounts.
- Nominal: Nominal accounts are a special category of accounts. While the other accounts can hold balance and carry it forward, nominal account are automatically reset to zero as soon as the time period is over. Their balance is carried forward to other accounts and the books for that period are closed. Examples of such accounts are Profit a/c, depreciation a/c etc.