Classification of accounts
( Basic Elements of Financial Position )
Two types of accounts: The financial condition or position of a business enterprise is represented by the relationship of assets to liabilities and capital.
First: Accounts belong to the Balance Sheet and represent the basic accounting equation.
These accounts are:
1. Assets 2. Liabilities 3.Owners Equity
( Remember : Assets must be equal to the sum of Liabilities and Owners equity)
It should balance after every transaction.
This relationship - which is called the accounting identity or basic accounting equation, is expressed in equation form as:
A = L + E
Assets = Liabilities + Owners Equity
where A = Total assets, L = Total liabilities, and E = Equity. Because creditor claims are paid before equity claims if a healthcare organization is liquidated - liabilities are shown before equity both on the balance sheet and in the basic accounting equation.
Note that the accounting identity can be rearranged as follows:
E = A − L
This format reinforces the concept that equity represents a residual claim against the total assets of the business and the fact that equity can be negative.
If a business writes down (decreases) the value of its assets, its liabilities are unaffected because these amounts are still owed to creditors and others. If total assets are written down so much that their value drops below that of total liabilities - then the equity reported on the balance sheet becomes a negative
amount.
If a business writes down (decreases) the value of its assets, its liabilities are unaffected because these amounts are still owed to creditors and others. If total assets are written down so much that their value drops below that of total liabilities - then the equity reported on the balance sheet becomes a negative
amount.
The basic accounting equation is simply an algebraic form of the balance sheet.
1. Assets
Assets are the cash and non cash resources owned by a business and have economic value, and
used in carrying out future services or benefits to the entity using them.
Classification of assets:
- Current assets
Current assets are cash and other types of assets that are reasonably expected
to be converted into cash, sold, or used up during the normal operating year.
Examples of current assets include:
Cash, Bank, Goods, Accounts Receivable, Prepaid expenses, Inventory and
Marketable securities etc.
- Fixed assets
Fixed assets are those assets that are used in the normal operations of the
entity to produce and sell goods or perform services for customers. Fixed assets
are expected to service for a number of years are not for re-sell.
Examples of fixed assets include:
Lands, cars, buildings, equipments, and furniture etc.
- Intangible assets
Intangible assets are those assets that have no physical substance but they
are expected to provide benefits to the entity for several years.
Examples of intangible assets include:
Patents, trade marks, copyrights, goodwill, franchise fees, and trade name.
2. Liabilities
Liabilities are claims against assets, Amounts owed to outsiders, such as notes payable, accounts
payable, bonds payable.
Classification of Liabilities:
- Short-term Liabilities
Short-term liabilities are obligations of the entity that are reasonably
expected to be paid or settled in the next year or the normal operating cycle.
Examples of short-term liabilities include:
Short-term notes payable, accounts payable, salaries and wages payable and
other types of accrued liabilities for services received but not yet paid for.
- Long-term Liabilities
Long-term liabilities are those obligations that do not require payment within
the next year or the normal operating cycle. In other words, liabilities not classified
as short-term are reported in the Long-term liabilities section of the balance sheet.
Examples of long-term liabilities include:
Loan, bonds, and any other obligation that mature in a period more than one
year beyond the balance sheet date is reported as long-term.
3. Owner’s Equity
Owner’s equity represents the owner’s interest in the assets of the entity.
It is equal to total assets minus total liabilities, also known as Capital.
There are two main sources of owner’s equity:
(١) Amounts contributed by the owner (Capital)
(٢) Amount earned by the entity but not yet taken by the owner.
Second: Accounts belong to the Income Statement and involve in the determination of
net income or net loss of a business entity for a specific period of time. These accounts
are:
1. Expenses 2. Revenues
1. Expenses
Expenses are the cost of assets consumed or services used in the process of earning revenue in other words; expenses are outflows or other uses of assets resulting from the sale or delivery of goods or the provision of services by the entity during specific time period.
Examples of expenses include:
Utility expenses (electric and water), telephone bill expense, rent expense, wages and salaries expense and depreciation expense etc.
Expenses are the cost of assets consumed or services used in the process of earning revenue in other words; expenses are outflows or other uses of assets resulting from the sale or delivery of goods or the provision of services by the entity during specific time period.
Examples of expenses include:
Utility expenses (electric and water), telephone bill expense, rent expense, wages and salaries expense and depreciation expense etc.
2. Revenues
Revenues are cash in-flow result from the sale of goods or the rendered of services.
To illustrate the affect (increase & decrease) of a financial transaction on the above classified accounts, study the following chart:
Basic Accounting Equation
You have already learned the basic accounting equation. However, in the above illustration note the expansion of the basic accounting equation to show the accounts that comprise owner’s equity besides expenses and revenues with their effect (increase, decrease) of the debit /credit rules on each type of account.
To student
Please study the above diagram carefully; it will help you understand the fundamentals of the double-entry system.
------------------------------- Example -------------------------------
During the month of January, Mr. Tom Banana, lawyer,
1. Invested $6,000 to open his law practice.
2. Bought office supplies on account, $500.
3. Received $3,000 in fees earned during the month.
4. Paid $100 on the account for the office supplies.
5. Withdrew $500 for personal use.
These transactions could be analyzed and recorded as follows:
Assets = Liabilities + Capital
Cash Tom, Capital
1. + $6,000 = + $6,000
Supplies Accounts Payable
2. + $500 = + $500
Cash
3. + $3,000 = Fees Income
+ $3,000
Cash
4. − $100 = Accounts Payable
− $100
Cash
5. − $500 = Tom, Capital
− $500
Notice that for every transaction, two entries are made. After every transaction, the accounting equation remains balanced.
Notice that for Preparing a new equation A = L + C after each transaction would be cumbersome and costly, especially when there are a great many transactions in an accounting period. Also, information for a specific item such as cash would be lost as successive transactions were recorded. This information could be obtained by going back and summarizing the transactions, but that would be very time-consuming. Thus we begin with the account, Account which records the accounting transactions so you must know what the accounting transactions and how to post accounting transaction (Double-entry bookkeeping system)
Quiz -Tested yourself
1. The accounting equation is _______ = ________ + ________.
2. Items owned by a business that have monetary value are ______.
3. _________ is the interest of the owners in a business.
4. Money owed to an outsider is a(n) _________.
5. The difference between assets and liabilities is ___________.
6. An investment in the business increases _______ and ________.
7. To purchase “on account” is to create a ___________.
Answers: 1. Assets, liabilities, capital; 2. Assets; 3. Capital; 4. Liability;
5. Capital; 6. Assets, capital; 7. Liability
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14 comments:
Accounting equation suggests that for every debit there must be a credit. Assets, liabilities and owners’ equity are the three components of accounting equation that make up a company’s balance sheet.
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Accounting equation suggests that for every debit there must be a credit. Assets, liabilities and owners’ equity are the three components of accounting equation that make up a company’s balance sheet.
Thanks for sharing useful Information with me and it's very helpful. i learned You have already learned the basic accounting equation. However, in the above illustration note the expansion of the basic accounting equation to show the account .Being Best CA coaching Centre in Hyderabad One of the Leading Coaching Centres in Hyderabad for Chartered Accountancy.
Thanks for sharing useful Information with me and it's very helpful. I learned that information could be obtained by going back and summarizing the transactions, but that would be very time-consuming. Thus we begin with the account . Being Best CA coaching Centre in bangalore One of the Leading Coaching Centres in bangalore for Chartered Accountancy.
Thanks for sharing useful Information. i learned that This relationship - which is called the accounting identity or basic accounting equation, is expressed in equation form.Being Best CA coaching Centre in Coimbatore One of the Leading Coaching Centres in Coimbatore for Chartered Accountancy.
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