Understanding Accounting: Types of Accounts

• An account refers to a record within the general ledger utilized for sorting and storing similar transactions.
• Accounts play a role In accounting systems for classifying and summarizing financial data.
• They offer a structured method to monitor increases and decreases in assets, liabilities, equity, revenues, and expenses.
• Every company uses a chart of accounts; a comprehensive list of every account in the company's general ledger
• The chart of accounts is used to organize all of a company's accounts and makes it easier to find information

Types of Accounts

• Asset Accounts: represent what a company owns.
  • Examples are cash, accounts receivable, inventory, and equipment.
• Liability Accounts: represent what a company owes to others.
  • Examples are accounts payable, salaries payable, and loans payable.
• Equity Accounts: represent the owners’ stake in the company.
  • Examples include common stock, retained earnings, and additional paid-in capital.
• Revenue Accounts: represent the inflows of assets from the sale of goods or services.
  • Examples include sales revenue and service revenue.
• Expense Accounts: represent the outflows of assets used to generate revenue.
  • Examples include rent expense, salaries expense, and utilities expense.

The Basic Accounting Equation

• The basic accounting equation serves as the foundation of double-entry accounting.
• The equation states that assets are equal to the sum of liabilities and equity: Assets = Liabilities + Equity.
• This equation must always balance to make sure accounting records are consistent.
• Accounting transactions impact one or more elements of the accounting equation.

Double-Entry Accounting

• Each transaction affects a minimum of two accounts.
• For example, if a company borrows cash from a bank, the cash account (an asset) and the loans payable account (a liability) both increase.
• Debits increase asset and expense accounts, while decreasing liability, equity, and revenue accounts.
• Credits increase liability, equity, and revenue accounts, while decreasing asset and expense accounts.
• The total value of debits must equal the total value of credits to keep the accounting equation in balance.

Debits and Credits

• Debits are entries recorded on the left side of an account.
• Credits are entries recorded on the right side of an account.
• The rules for debits and credits hinge on the account type.
  • Assets: Increase with a debit, decrease with a credit.
  • Liabilities: Increase with a credit, decrease with a debit.
  • Equity: Increase with a credit, decrease with a debit.
  • Revenue: Increase with a credit, decrease with a debit.
  • Expenses: Increase with a debit, decrease with a credit.

Normal Balance

• An account's normal balance represents the side (debit or credit) that increases the account.
  • Assets: Debit
  • Liabilities: Credit
  • Equity: Credit
  • Revenue: Credit
  • Expenses: Debit
• The normal balance is where the increases to the account are recorded.

Journal Entries

• Journal entries are used for recording transactions in the general journal.
• Each journal entry includes:
  • The transaction date
  • The accounts affected
  • The debit and credit amounts
  • A brief transaction description
• Journal entries mark the first formal step in the accounting cycle.

Ledger Accounts

• Ledger accounts (T-accounts) summarize the effects of journal entries on individual accounts.
• A T-account exists for each account, showing debits on the left and credits on the right.
• An account's balance equals the difference between its total debits and total credits.

Steps in the Accounting Cycle

- Transaction Analysis: Identify and analyze transactions, determining which accounts are affected and how.
- Journal Entries: Record transactions in the general journal.
- Posting to Ledger: Transfer journal entries to the appropriate ledger accounts.
- Trial Balance: Prepare a trial balance to ensure debits equal credits.
- Adjusting Entries: Make necessary adjustments to accounts at the end of the accounting period.
- Financial Statements: Prepare financial statements (income statement, balance sheet, statement of cash flows).
- Closing Entries: Close temporary accounts (revenue, expense, and dividend accounts) to retained earnings.
- Post-Closing Trial Balance: Prepare a post-closing trial balance to verify that all temporary accounts have been closed.

Subsidiary Ledgers

• Subsidiary ledgers provide detailed information about specific accounts in the general ledger.
• Common subsidiary ledgers include accounts receivable ledger (listing individual customer balances) and accounts payable ledger (listing individual vendor balances).
• The total balance in a subsidiary ledger should reconcile with the balance of the related control account in the general ledger.

Control Accounts

• A control account is a general ledger account that summarizes the balances of related subsidiary ledger accounts.
• As an example, the accounts receivable account in the general ledger acts as a control account, summarizing the balances of all individual customer accounts in the accounts receivable subsidiary ledger.

Adjusting Entries

• Adjusting entries are made at the close of an accounting period to update accounts for items not yet recorded.
• Common adjusting entries include:
  • Accrued Revenues: Revenues earned but not yet received in cash.
  • Accrued Expenses: Expenses incurred but not yet paid in cash.
  • Deferred Revenues: Cash received for services to be performed later.
  • Deferred Expenses: Cash paid for expenses to be incurred later.
  • Depreciation: Allocating the cost of a long-term asset over its useful life.

Closing Entries

• Closing entries transfer the balances of temporary accounts (revenue, expense, and dividend accounts) to the retained earnings account at the end of the accounting period.
• This process resets temporary account balances to zero, preparing the accounts for the next accounting period.
• The closing process involves:
  • Closing all revenue accounts toward the income summary account.
  • Closing all expense accounts toward the income summary account.
  • Closing the income summary account toward retained earnings.
  • Closing the dividend account toward retained earnings.

Financial Statements

• Financial statements present a summary of a company's financial performance and position.
• Main financial statements include:
  • Income Statement: Reports a company’s financial performance over a time period (revenues, expenses, and net income/loss).
  • Balance Sheet: Reports a company’s assets, liabilities, and equity at a specific point in time.
  • Statement of Cash Flows: Reports a company’s cash inflows and outflows during a time period.

Classified Balance Sheet

• A classified balance sheet presents assets and liabilities in separate categories.
• Assets are typically classified as current assets (expected to be converted to cash or used up within one year) and non-current assets (long-term assets).
• Liabilities are typically classified as current liabilities (due within one year) and non-current liabilities (long-term liabilities).
• This classification provides users with a better understanding of a company’s liquidity and financial flexibility.

Learn about accounts in the general ledger, used to sort similar transactions. Explore asset, liability, and equity accounts. Discover how revenue accounts reflect inflows and expense accounts track outflows.