Classification of Accounts

All accounts within a business's ledger fall into one of two primary classes: Personal accounts or Impersonal accounts.

1. Personal Accounts

Personal accounts relate to persons, including sole traders, partnerships, and companies. These are divided into three main subgroups:

  • Trade Receivables (Debtors): These are customers who owe the business money. They typically have debit balances and are collectively known as trade receivables. They are classified as current assets.
  • Trade Payables (Creditors): These are persons, usually suppliers, to whom the business owes money. Their accounts have credit balances and are collectively known as trade payables.
    • Amounts due within one year are classified as current liabilities.
    • Amounts due after one year (such as long-term loans) are non-current liabilities.
  • Owner's Accounts: This group includes the owner’s Capital and Drawings accounts.

2. Impersonal Accounts

Impersonal accounts include all accounts other than personal accounts. These are further sub-classified, often based on whether they typically carry a debit or credit balance:

Subclass

Definition / Components

Type of Balance

Associated Expenditure

Asset (Real) Accounts

Things the business owns or is owed.

Debit

Capital Expenditure (Non-current assets)

Nominal Accounts (Expenses)

Day-to-day costs incurred in running the business (e.g., wages, rent payable, postage).

Debit

Revenue Expenditure (Expense)

Nominal (Revenue/Income)

Accounts recording revenue and other income (e.g., sales, rent receivable, discounts received).

Credit

N/A

Key Distinctions in Impersonal Accounts:

  • Real Accounts: These contain transactions relating to non-current assets.
    • Non-current assets are acquired for use over many years, not for resale (e.g., premises, vehicles, machinery). Spending on these items is capital expenditure.
    • Current assets arise from trading, such as inventories, cash at bank, and trade receivables.
  • Nominal Accounts: These record the revenue and expenses of a business. Costs associated with day-to-day running are revenue expenditure (expense).

The distinction between capital expenditure and revenue expenditure is critical because capital expenditure is shown on the statement of financial position (as an asset, see Chapter 8), while revenue expenditure is found in the income statement

Division of the Ledger

Except in very small businesses, the volume of transactions necessitates dividing the accounts into several specialized ledgers.

The main books into which the single ledger is divided are:

  1. Sales Ledger (or Debtors Ledger): This ledger contains the individual accounts of all the business’s credit customers (trade receivables).
  2. Purchase Ledger (or Creditors Ledger): This ledger contains the individual accounts of all the business’s credit suppliers (trade payables).
  3. General Ledger (or Nominal Ledger): This ledger holds the impersonal accounts, specifically those for assets, revenue, other income, and expenses (the real and nominal accounts).
  4. Private Ledger: This ledger contains accounts deemed to be confidential. These typically include the owner's capital and drawings accounts, loan accounts, income statements, and statements of financial position. The owner may keep this private to prevent employees from knowing the business's profit, debt levels, or owner's drawings.
  5. Cash Book: This book contains the bank and cash accounts.
  6. Petty Cash Book: This book records amounts paid out for minor items, such as postage, tea, or cleaning.

Benefits of Ledger Division

The division of the ledger provides important advantages for managing the accounting system:

  • Work Division: It allows the work to be split among several bookkeepers, meaning staff do not all need to work on the same ledger simultaneously.
  • Internal Control: This division helps to detect and prevent errors or fraud by separating duties.
  • Efficiency: It makes sense to group similar items (e.g., all sales in one ledger).