Classification of Ledger Accounts

All ledger accounts in accounting fall into five categories: assets, liabilities, capital, revenues/gains, and expenses/losses. These five categories can be further grouped into two broad types based on how they are treated at the end of an accounting period — permanent accounts and temporary accounts.

Permanent Accounts (Real Accounts)

Permanent accounts are those whose balances are not closed at the end of the accounting year. Instead, they are balanced and carried forward to the next accounting period. This means the closing balance of one year becomes the opening balance of the next year.

All permanent accounts appear on the Balance Sheet. The three categories that make up permanent accounts are:

• Assets (e.g., Cash, Building, Furniture, Debtors)
• Liabilities (e.g., Creditors, Bank Loan, Outstanding Expenses)
• Capital (e.g., Owner's Capital Account)

Because these accounts represent resources owned, obligations owed, and the owner's claim, they continue from one period to the next.

Temporary Accounts (Nominal Accounts)

Temporary accounts are those whose balances are closed at the end of the accounting period. They do not carry forward a balance. Instead, their entire balance is transferred to the Trading and Profit & Loss Account to calculate the net profit or loss for the period.

All revenue and expense accounts are temporary accounts. The two categories that make up temporary accounts are:

• Revenues/Gains (e.g., Sales, Commission Received, Interest Income)
• Expenses/Losses (e.g., Rent, Salary, Purchases, Depreciation)

Once their balances are transferred to the Profit & Loss Account, these accounts start the next year with a zero balance.

Why This Classification Matters

This distinction is essential for preparing financial statements correctly. The Trading and Profit & Loss Account summarises all temporary accounts to show the business's performance for a single period. The Balance Sheet lists all permanent accounts to show the financial position of the business at a point in time.

Summary Table …