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Lesson # 5
CLASSIFICATION OF ACCOUNTS
Learning Objective
Account
An accounting system keeps separate record of each item like assets, liabilities, etc. For
example, a separate record is kept for cash that shows increase and decrease in it.
This record that summarizes movement in an individual item is called an Account.
Classification of Accounts
Assets
Assets are the properties and possessions of the business to pay in future. Can be amount
payable for material purchased, expenses etc.
Liabilities
Liabilities are the debts and obligations of the business. Liability is the obligation of the
business to provide a benefit or asset on a future date.
Asset is a right to receive and liability is an obligation to pay, therefore, these are opposite to
each other.
Assets are created out of capital invested plus liability to third party.
Income
Income / Revenue is the value of goods or services that a business charges from its customers
Or the reward / return received from the resources committed in the business.
Expenses
Expenses are the costs incurred to earn the revenue. The resources spent and the efforts made
to earn the income, when translated in money terms are the expenses of the business
Profit
Loss
Capital Expenditure
It is the expenditure to create an asset that helps in generating future income and its life is more
than 12 month. For example machinery purchases, furniture purchases etc.
OR
Capital Expenditure is the amount used during a particular period to acquire or improve long-
term assets such as property, plant or equipment.
Revenue Expenditure
It is the day to day expenses whose benefit is drawn immediately. For example, salary of the
employee, rent of the building, etc.
OR
Revenue Expenditure is the cost of resources consumed or used up in the process of generating
revenue, generally referred to as expenses.
From our discussion up to this point, we have established following rules for Debit and Credit:
As explained in the case of Debit, whenever an account provides benefit to the business the
business will have a responsibility to return that benefit at some time in future and so it is
Credit.
Similarly we have established that whenever a business transfers a value / benefit to an account
and as a result creates some thing that will provide future benefit; the ‘thing’ is termed as
Asset. By combining both these rules we can devise following rules of Debit and Credit for
Assets:
o Reversing the above situation if the asset is sold, which is termed as disposing
off, for say cash, the asset account provides benefit to the cash account.
Therefore, the asset account is Credited
ii. Decrease in Asset is Credit
Anything that transfers value to the business, and in turn creates a responsibility on part of the
business to return a benefit, is a Liability. Therefore, liabilities are the exact opposite of the
assets.
o When the business returns the benefit or repays the liability, the liability account
benefits from the business. So it is Debited
iv. Decrease in Liability is Debit
Just like assets, we have to pay for expenses. From assets, we draw benefit for a long time
whereas the benefit from expenses is for a short run. Therefore, Expenditure is just like Asset
but for a short run.
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Financial Accounting - I – MGT101 VU
Using our rule for Debit and Credit, when we pay cash for any expense that expense account
benefits from cash, therefore, it is debited.
o Reversing the above situation, if we return any item that we had purchased, we
will receive cash in return. Cash account will receive benefit from that
Expenditure account. Therefore, Expenditure account will be credited
vi. Decrease in Expenditure is Credit
Income accounts are exactly opposite to expense accounts just as liabilities are opposite to that
of assets. Therefore, using the same principle we can draw our rules of Debit and Credit for
Income