Understanding Financial Accounts

• An account records financial transactions related to assets, liabilities, equity, revenue, or expenses.
• Accounts are fundamental to the double-entry bookkeeping system.
• The double-entry bookkeeping system ensures that every financial transaction affects at least two accounts to keep the accounting equation (Assets = Liabilities + Equity) in balance.
• The main types of accounts include asset accounts, liability accounts, equity accounts, revenue accounts, and expense accounts.

Asset Accounts

• Asset accounts showcase what a company owns or controls providing future economic benefits.
• Examples of asset accounts are cash, accounts receivable, inventory, prepaid expenses, land, buildings, equipment, and investments.
• Assets are generally categorized as either current or non-current (long-term) assets.
• Current assets are expected to convert to cash or be used up within one year or the operating cycle, whichever is longer.
• Non-current assets are not expected to convert to cash or be used up within one year.

Liability Accounts

• Liability accounts represent what a company owes to others.
• Examples of liability accounts include accounts payable, salaries payable, unearned revenue, notes payable, bonds payable, and interest payable.
• Liabilities are generally categorized as either current or non-current (long-term) liabilities.
• Current liabilities are obligations due within one year or the operating cycle, whichever is longer.
• Non-current liabilities are obligations not due within one year.

Equity Accounts

• Equity accounts represent the owner's stake in the company's assets after deducting liabilities.
• For corporations, equity is often referred to as stockholders' equity, while for other business types, it may be referred to as owner's equity or partners' equity.
• Key equity accounts include common stock, preferred stock, retained earnings, and additional paid-in capital.
• Retained earnings represent a company's accumulated profits not distributed to owners as dividends.

Revenue Accounts

• Revenue accounts represent the income a company generates from its primary business activities.
• Examples of revenue accounts include sales revenue, service revenue, interest revenue, and rental revenue.
• Revenue increases equity.
• Revenue is recognized when it is earned, regardless of when cash is received, due to the accrual accounting principle.

Expense Accounts

• Expense accounts represent the costs a company incurs to generate revenue.
• Examples of expense accounts include the cost of goods sold, salaries expense, rent expense, utilities expense, depreciation expense, and interest expense.
• Expenses decrease equity.
• Expenses are recognized when they are incurred, regardless of when cash is paid, based on the accrual accounting principle.

Chart of Accounts

• A chart of accounts is a comprehensive list of all the accounts a company uses to record its financial transactions.
• The chart of accounts is organized in a specific order, typically starting with asset accounts, followed by liability accounts, equity accounts, revenue accounts, and expense accounts.
• Each account is assigned a unique number to facilitate data entry and organization.
• A well-designed chart of accounts is essential for accurate and consistent financial reporting.

Normal Balances of Accounts

• The normal balance of an account is the side, debit or credit, where increases to the account are typically recorded.
• Asset, expense, and dividend accounts have normal debit balances.
• Liability, equity, and revenue accounts have normal credit balances.
• Knowing the normal balance helps understand how transactions affect different accounts and identify errors in record keeping.

Temporary vs. Permanent Accounts

• Accounts can be classified as either temporary, nominal, or permanent, real, accounts.
• Temporary accounts record transactions for a specific accounting period, and their balances are closed, zeroed out, at the end of each accounting period.
• Temporary accounts include revenue, expense, and dividend accounts.
• Permanent accounts are not closed at the end of the accounting period, and their balances are carried forward to the next accounting period.
• Permanent accounts include asset, liability, and equity accounts.
• The closing process involves transferring temporary accounts' balances to retained earnings, a permanent account.

Subsidiary Ledgers

• A subsidiary ledger provides detailed information about a specific general ledger account.
• An accounts receivable subsidiary ledger contains individual records for each customer, showing their purchases, payments, and outstanding balances.
• Subsidiary ledgers help maintain detailed records while keeping the general ledger more concise.
• Common subsidiary ledgers include accounts receivable, accounts payable, and inventory.

Control Accounts

• A control account is a general ledger account summarizing the data in a related subsidiary ledger.
• The balance of the control account should equal the sum of the balances in the corresponding subsidiary ledger.
• The accounts receivable account in the general ledger is a control account for the accounts receivable subsidiary ledger, for example.
• Control accounts and subsidiary ledgers provide a system of checks and balances, helping to ensure the accuracy of financial records.

Contra Accounts

• A contra account reduces the balance of another account.
• Contra accounts maintain a record of the original value of an asset or liability while also showing a reduction in that value.
• Contra accounts include accumulated depreciation, which reduces the book value of fixed assets, allowance for doubtful accounts, which reduces the book value of accounts receivable, and sales returns and allowances, which reduces sales revenue.

Account Reconciliation

• Account reconciliation compares the balances in two related accounts or records to ensure they agree.
• Common types of account reconciliation include bank reconciliation, comparing the bank statement balance to the company's cash account balance, and accounts receivable reconciliation, comparing the accounts receivable subsidiary ledger to the accounts receivable control account.
• Account reconciliation helps identify errors, fraud, and discrepancies in financial records.

Accounting Cycle

• The accounting cycle is how companies record, process, and report financial information.
• The steps of the accounting cycle include:
  • Identifying and analyzing transactions
  • Recording transactions in a journal
  • Posting journal entries to the general ledger
  • Preparing an unadjusted trial balance
  • Making adjusting entries
  • Preparing an adjusted trial balance
  • Preparing financial statements
  • Closing the temporary accounts
  • Preparing a post-closing trial balance
• Accounts are used throughout the accounting cycle to ensure that financial information is accurately recorded and reported.