Modern Approach of Classification

An Introduction

The process of accounting which is used for financial transactions is classified into two different types. There is the modern approach of classification and there is the traditional approach of classification. We all know that the traditional approach is the British one and the modern approach is the American one. In the notes we have for this chapter, students are going to learn about the modern approach and the methods that are currently in use for the modern approach. With the help of these notes, they will surely be able to get good marks in the exams. Let us start by understanding the basic accounting equation in the coming section.

 

Understanding the Basic Accounting Equation

When it comes to the classification of accounts under the modern approach, there are some accounts that are not credit and debit. So, in that case, there is a use of the Accounting Equation to credit the account or debit it. So, the modern approach can also be considered as the Accounting Equation Approach. 

 

The Basic Accounting Equation is: Assets = Liabilities + Capital (Owner’s Equity)

 

Also, the following formula when expanded looks like this, Assets = Liabilities + Capital + Revenues – Expenses

 

Also, Profit = Revenues – Expenses

 

The Accounting Equation needs to remain in a balanced form all the time. This is because every single transaction comes with a certain dual aspect. So, each one of the transactions will affect the credit side or the debit side. Also, transactions might be able to have an impact on two different accounts either on the credit side or the debit side. This is exactly what students need to know about the classification of accounts under the modern approach method.

 

Classifying Accounts Using the Modern Approach

Under the modern approach of classification, the accounts are classified into different groups which are mentioned below.

  1. Assets Accounts

The assets are the possessions, economic resources, or properties of any particular business. These assets tend to play a very important role in helping out some of the essential business operations in earning some revenue for the company. The assets are sometimes measured in the terms of monetary values. Assets are classified as intangible and tangible. Also, there are current assets and fixed assets. Those assets that are held for a long time are fixed assets. Some examples might include furniture, machinery, land, and buildings. Some assets are held for a shorter period and are called current assets. Some examples might include bank balance, debtors, and bills. 


  1. Liabilities Accounts

Another important group in the classification of accounts under the modern approach would have to be the liabilities accounts. These are the accounts that tend to owe some amenities to the outsiders. These might be some sort of debts or obligations that the business might have. Liabilities are also Current and Long-Term. 


Long-term liabilities are those that are payable after one year. For example, debentures, bank loans, etc. The term "current liabilities" refers to liabilities that must be paid within a year. For example, creditors, rent outstanding, bank overdraft, etc.

  1. Capital Accounts

Another important part of the classification of accounts under the modern approach method would be capital accounts. This is the money that is brought to the business or the company by the owner. That is why it is also known as the Owner’s Equity. 


As a result, the Capital is shown on the Balance Sheet's liabilities side. After the owner deducts the Drawings, the capital account is shown. Drawings are the amount of cash, goods, or assets taken from the business by the owner for personal use. 


  1. Revenue Accounts

The amount that is earned by any business when they sell their goods or render their services is known as revenue. Also, some other incomes are included in the revenue accounts such as rents, commissions, interests, dividends and so much more. The items of revenue can be grouped under the classification using the modern approach. 


  1. Expenses Accounts

There are certain costs and monetary spending that the company has to incur so that the revenue for the company can be earned. These costs are known as expenses. One of the important things to keep in mind is that when all the benefits that come from spending the money are completely exhausted within the given period of a single year, then it would be known as an expense. 


As a result, the cost of goods sold is an expense, while the cost of goods purchased is an expenditure. Rent, salary, electricity, interest, and other expenses are examples of expenses. Purchases of assets, short-term investments, and other similar purchases fall under the category of expenditure.

 

Example

Consider the list of accounts shown below. Our task is to classify these accounts using the modern approach of accounting.

  1. Plant and machinery

  2. Purchases

  3. Sales

  4. Rent

  5. Land and building

  6. Cash

  7. Sam’s capital

  8. A loan from city bank

 

Here are the accounts classified using the modern approach of accounting:

  1. Plant and machinery > Asset account

  2. Purchases > Expense account

  3. Sales > Revenue account

  4. Rent expense > Expense account

  5. Land and building > Asset account

  6. Cash > Asset account

  7. Sam’s capital > Capital/owner’s equity account

  8. Loan from city bank > Liability account

FAQs on Modern Approach of Classification

1. What are the Two Different Approaches Used In the Classification of Accounts?

Two different methods are used in the classification of accounts. One is the modern approach or the American method and the other one is the traditional approach of the British method.

2. Name a Few Examples of the Assets?

Some of the examples of assets would include land, machinery, buildings, furniture, bills, and so much more.

3. What Is the Basic Accounting Formula?

The Basic Accounting Equation is Assets = Liabilities + Capital


We hope that with the help of the notes of the classification of accounts under the modern approach method, the students can have a clear idea of the chapter and score good marks. 

4. Classify the following accounts:

  1. Building 
  2. Cash 
  3. Outstanding Exp 
  4. Creditors 
  5. Drawings 
  6. Debtors 
  7. Capital  
  8. Sales 
  9. Rent Paid 
  10. Commission paid. 
  11. Purchases  
  12. Salary​ 

Here are the classifications:

  1. Building ➺ Asset Account
  2. Cash ➺ Asset Account
  3. Outstanding Expenses ➺Liability Account
  4. Creditors ➺ Liability Account
  5. Drawings ➺ Withdrawal Account
  6. Debtors ➺ Asset Account
  7. Capital ➺ Capital Account
  8. Sales ➺ Revenue Account
  9. Rent Paid ➺ Expenses Account
  10. Commission paid ➺ Expenses Account
  11. Purchases ➺ Expenses Account
  12. Salary ➺ Expenses Account 


5. Here are the transactions. Analyze them and show their effects on the assets and liabilities using the Modern Approach to Accounting.

A.  Commenced business with cash ₹100000

B. Paid rent ₹1000

C. Received commission ₹500

D. Additional capital of ₹10000 in cash and 5000 in goods were introduced.

E. Purchased goods ₹20000 from B

F. Sold goods costing ₹10000 at a profit of 25% on the cost

G. Purchased office furniture ₹15000

H. Paid salary in advance ₹1000

The following is an analysis of each transaction. The effects are shown in the form of an accounting equation:

  1. Cash is increasing, so cash should be debited. In addition, capital is increasing, so capital should be credited.

  2. The rent has been paid. So cash is decreasing. Rent is an expense. The rent is deducted directly from the capital. As a result, capital should be debited and cash credited.

  3. The commission is income. Therefore, add it to the capital. In addition, cash will increase. 

  4. Cash and goods keep pouring in. In addition, capital is also increasing. Therefore, cash and goods should be debited, and capital should be credited.

  5. The goods have come in. Therefore, they are increasing. Therefore, the goods should be debited. B becomes a creditor.

  6. Goods go out from here, so credit goods. Therefore, when cash comes in, cash must be debited. In addition, a profit of 2500 rupees is added to the capital. 

  7. Furniture is increasing, while Cash is decreasing. Therefore, cash must be credited and furniture debited. 

  8. Prepaid wages are current assets. Cash is decreasing, so it should be credited. 

6. What are the study materials provided by Vedantu?

Vedantu provides sample papers, previous year papers, important questions, & revision notes. These study materials are important. They help the students in preparing for the exams. These study materials not only help the students in preparation for their exams but also help them to boost self-confidence. The question papers will help them to understand the paper pattern and help them in time management. They will know what type of questions are asked in the exams. You can access them online or download them in PDF format for offline access.


We certainly hope that these notes on the classification of accounts under the modern approach method can help out all the students who seek some additional knowledge on the topics. These notes are carefully created after thorough research by some of the best experts in the subjects. Hence, the authenticity and reliability of the notes are superior. If you have any questions or suggestions, let us know in the comments section below. We are happy to answer them. 

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