Types Of Accounts
First, let's start with the Major Categories. These are the Types Of Accounts that are used to organize our financial information. The Major Types of Accounts are Assets, Liabilities, Owner's Equity, Revenue, Expense, and Draws. I'll present a formal and an informal definition for each term.
Formal Definition-The properties used in the operation or investment activities of a business.
Informal Definition-All the good stuff a business has (anything with value). The goodies.
Additional Explanation-The good stuff includes tangible and intangible stuff.
Tangible stuff you can physically see and touch such as vehicles, equipment and buildings.
Intangible stuff is like pieces of paper (sales invoices) representing loans to your customers where they promise to pay you later for your services or product. Examples of assets that many individuals have are cars, houses, boats, furniture, TV's, and appliances.
Some examples of business type assets are cash, accounts receivable, notes receivable, inventory, land, and equipment.
Formal Definition-Claims by creditors to the property (assets) of a business until they are paid.
Informal Definition- Other's claims to the business's stuff. Amounts the business owes to others.
Additional Explanation-Usually one of a business's biggest liabilities (hopefully they are not past due) is to suppliers where they have bought goods and services and charged them. This is similar to us going out and buying a TV and charging it on our credit card. Our credit card bill is a liability. Another good personal example is a home mortgage. Very few people actually own their own home. The bank has a claim against the home which is called a mortgage. This mortgage is another example of a personal liability.
Some examples of business liabilities are accounts payable, notes payable, and mortgages payable.
Owner's Equity (Capital)
Formal Definition- The owner's rights to the property (assets) of the business; also called proprietorship and net worth.
Informal Definition- What the business owes the owner. The good stuff left for the owner assuming all liabilities (amounts owed) have been paid.
Additional Explanation-Owner's Equity represents the owner's claim to the good stuff (assets). Most people are familiar with the term equity because it is so often used with lenders wanting to loan individuals money based on their home equity. Home equity can be thought of as the amount of money an owner would receive if he or she sold their house and paid off any mortgage (loan) on the property.
Revenue (Income), Expenses, and Draws - Revenues, expenses, and draws are sub categories of owner's equity.
Revenue (Also Called Income)
Formal Definition-The gross increase in owner's equity resulting from the operations and other activities of the business.
Informal Definition- Amounts a business earns by selling services and products. Amounts billed to customers for services and or products.
Additional Explanation-Individuals can best relate by thinking of revenue as their earnings or wages they receive from their job. Most business revenue results from selling their products and or services.
Expense (Also Called Cost)
Formal Definition-Decrease in owner's equity resulting from the cost of goods, fixed assets, and services and supplies consumed in the operations of a business.
Informal Definition- The costs of doing business. The stuff we used and had to pay for or charge to run our business.
Additional Explanation- Some examples of personal expenses that most individuals are familiar with are utilities, phone, clothing, food, gasoline, and repairs.
Some examples of business expenses are office supplies, salaries & wages, advertising, building rental, and utilities.
Formal Definition-Decrease in owner's equity resulting from withdrawals made by the owner.
Informal definition- Amounts the owner withdraws from his business for living and personal expenses.
Additional Explanation- The owner of a sole proprietorship does not normally receive a 'formal' pay check from the business, but just like most of the rest of us needs money to pay for his house, car, utilities, and groceries. An owner's draw is used in order for the owner to receive money or other 'goodies' from his business to take care of his personal bills.
We use detail accounts to actually collect a business's financial information. The Detail Accounts are normally grouped by the Major Category that they belong to. The number of detail accounts depends on the needs of the business.
Some examples of detail accounts are cash, accounts receivable, inventory, accounts payable, sales, cost of goods sold, wages & salaries, utilities, building rental ...
Chart Of Accounts
What Is The Chart Of Accounts ? The Chart Of Accounts is a listing of all the individual accounts in the General Ledger that contains the account's name, a brief description of the account, and optional other identifiers (codes) or a coded account number assigned to aid in recording, classifying, summarizing, and reporting transactions.
Your accounting system is built around this skeleton list of account names called the chart of accounts and is organized by the types of major accounts. The accounts you set up are tailored for your particular type of business.
What's an Account ? An Account is a separate record for each type of asset, liability, equity, revenue, and expense used to show the beginning balance and to record the increases and decreases using debits and credits for a period of time and the resulting ending balance at the end of the period. All the Individual Accounts make up or become a part of the Chart Of Accounts.
How Are They Organized ? The chart of accounts is typically organized and listed in a special order. Balance Sheet Accounts are listed first followed by the Income Statement Accounts. Note-This USA Order may vary depending on your country. Normally, the order of the listing of the asset and liability accounts is based on liquidity. The most liquid accounts are listed first. Thus, when listing assets, cash is listed before accounts receivable which comes before inventory. Likewise for liabilities, accounts payable comes before notes payable because accounts payable are normally paid before notes payable.
Revenue and expense accounts tend to follow the standard of first listing the items most closely or directly related to the operations of the business. The revenues or sales resulting from normal operations are listed before revenue or income resulting from non-operating sources. Likewise, the operating costs and expenses that are most closely related to the operations of the business are listed before the non-operating expenses. Cost of Sales is listed first followed by operating expenses and then the non-operating expenses. The operating expenses are often grouped into additional categories such as Selling Expenses and General and Administrative Expenses. There are no rigid rules as to the order that the operating expenses are listed within a category.
Why Is The Chart Of Accounts Important ? Setting up a chart of accounts is one of the first, if not the first, task you perform when setting up an accounting system whether a manual or computerized system. A business needs and should want to know where the money is coming from and where it is going !!! Your chart of accounts is a tool for gathering and organizing this type of information.
A business must have useful information in order to be able to survive in today's competitive business world. You notice that I said information - raw data is not very useful until it has been 'massaged' and summarized into meaningful information. Your accounting system should be designed and used to provide much of this detailed, summarized, and needed information.
The information available for your financial reports (summary and or detailed) often depends on how well you designed your chart of accounts. One of the main keys to a properly designed accounting system is your chart of accounts. The chart of accounts is the Foundation that your financial record keeping system is built upon. In a nutshell, the Chart Of Accounts is simply an organized and coded listing of all the individual accounts used to record your business transactions and that also makeup the General Ledger. It is a major key to a business having the information needed for managing and reporting its activities.
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