Chapter 6 Types of Major Accounts PDF

Fundamentals of Accounting, Business, and Management Chapter 6 Types of Major Accounts Fundamentals of Accounting, Business and Management | BMEC3 Chapter 6 Types of Major Accounts Introduction Accounts are at the foundation of financial acc...

Fundamentals of Accounting, Business, and Management Chapter 6 Types of Major Accounts Fundamentals of Accounting, Business and Management | BMEC3 Chapter 6 Types of Major Accounts Introduction Accounts are at the foundation of financial accounting. Each business transaction increases or decreases balance in one account or another. The entire accounting concept is based on maintaining a chart of accounts, but what is an account? Specific Objectives At the end of the lesson, the students should be able to: 1. Discuss the five major accounts. 2. Cite examples of each type of account. 3. Prepare a Chart of Accounts 6.1 The Account Account is the basic storage of information in accounting. It is a record of increases and decreases in a specific item of asset, liability, equity, income or expense. Accounts are typically named and numbered in order to categorize and keep track of them. Accounts also have accounts. All accounts are kept or recorded in the general ledger. An account may be depicted through a “T-account.” A “T-account” is called as such because it resembles the letter “T.” A “T-account” has three parts, namely: 1. Account title – describes the specific item of asset, liability, equity, income or expense. 2. Debit side – the left side of the account. 3. Credit side – the right side of the account. Cash This is the “account Debit Credit title” Jan.1 500 The term credit (Cr) simply refers to Jan. 3 1,000 800 Jan. 4 the right side of the account. It is Balance 700 sometimes referred to as the “value The term debit (Dr) simply parted with” refers to the left side of the account. It is sometimes The difference between the referred to as the “value total debits and credits in the received”. account represents the balances The Five Major Accounts of the account. The five major accounts, also called the elements of the financial statements, are actually the items in the expanded accounting equation, discussed in the previous chapter. Fundamentals of Accounting, Business and Management | BMEC3  1. ASSETS – are the resources that is owned or controlled by a company that have resulted from past events and can provide you with future economic benefits. Other words, assets are items that a company uses to generate future revenues or maintain its operations. 2 KINDS OF ASSETS Current Assets include cash and those assets which can be readily converted into cash or sold or consumed within one year or consumed within one year or the normal operating cycle whichever is longer. Non-current Assets are assets that cannot be realized (collected, sold, used up) one year after year-end date. Tangible Assets – are physical assets. Intangible Assets – are non-physical assets such as patents, trademark, goodwill 2. LIABILITIES – are your present obligations that have resulted from past events and can require you to give up resources when settling them. 3. EQUITY – is assets minus liabilities. It is the owner’s interest in the company assets 4. INCOME – are increases in economic benefits during the period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to investments by the business owners. Income includes both revenue and gains. a. Revenue arises in the course of the ordinary activities of a business e.g., sales and service fees. b. Gains represent other items that meet the definition of income and may or may not arise in the course of ordinary activities of an entity. 5. EXPENSES – are decreases in economic benefits during the period in the form of outflow or depletions of assets or increases of liabilities that result in decreases in equity, other than those relating to distributions to the business owners. Expenses include both expenses and loses. a. Expenses arise in the course of the ordinary activities b. Losses represent other items that meet the definition of expenses and may, or may not arise in the course of the ordinary activities of the entity. Classification of the Five Major Accounts The five major accounts are classified according to the financial statements where they appear as follows: Fundamentals of Accounting, Business and Management | BMEC3  BALANCE SHEET ACCOUNTS INCOME STATEMENT ACCOUNTS 1. ASSETS 1.INCOME 2. LIABILITIES 2. EXPENSES 3. EQUITY Ø The balance sheet (or the statement of financial position) is one of the components of a complete set of financial statements. The balance sheet shows the financial position of a business. Ø The income statement (or the statement of profit or loss) is a sub-component of the statement of comprehensive income, which is also one of the components of a complete set of financial statements. The income statement shows the profit or loss of a business. Chart of Accounts A chart of accounts is a list of all the accounts in the general ledger of an accounting system used by a business. The following is an example of a basic chart of accounts. Chart of Accounts Account No. Description Account Financial Statements Type 110 Cash Assets Financial Position (Balance Sheet) 120 Accounts Receivable Assets Financial Position (Balance Sheet) 125 Allowance for bad debts Assets Financial Position (Balance Sheet) 130 Notes receivable Assets Financial Position (Balance Sheet) 140 Inventory Assets Financial Position (Balance Sheet) 150 Prepaid supplies Assets Financial Position (Balance Sheet) 155 Prepaid rent Assets Financial Position (Balance Sheet) 160 Prepaid insurance Assets Financial Position (Balance Sheet) 170 Land Assets Financial Position (Balance Sheet) 180 Building Assets Financial Position (Balance Sheet) 185 Accumulated depreciation-Building Assets Financial Position (Balance Sheet) 190 Equipment Assets Financial Position (Balance Sheet) 195 Accumulated depreciation-Equipment Assets Financial Position (Balance Sheet) 210 Accounts payable Liabilities Financial Position (Balance Sheet) 220 Noted payable Liabilities Financial Position (Balance Sheet) Fundamentals of Accounting, Business and Management | BMEC3  230 Interest payable Liabilities Financial Position (Balance Sheet) 240 Salaries payable Liabilities Financial Position (Balance Sheet) 250 Utilities payable Liabilities Financial Position (Balance Sheet) 260 Unearned income Liabilities Financial Position (Balance Sheet) 310 Owner’s capital Equity Financial Position (Balance Sheet) 320 Owner’s drawings/withdrawals Equity Financial Position (Balance Sheet) 410 Service fees Income Income Statement 420 Sales Income Income Statement 430 Interest Income Income Income Statement 440 Gains Income Income Statement 510 Cost of Sales Expenses Income Statement 515 Freight-out Expenses Income Statement 520 Salaries expense Expenses Income Statement 525 Rent expense Expenses Income Statement 530 Utilities expense Expenses Income Statement 535 Supplies expense Expenses Income Statement 540 Bad debt expense Expenses Income Statement 545 Depreciation expense Expenses Income Statement 550 Advertising expense Expenses Income Statement 555 Insurance expense Expenses Income Statement 560 Taxes and licenses Expenses Income Statement 565 Transportation and travel expense Expenses Income Statement 570 Interest expense Expenses Income Statement 575 Miscellaneous expense Expenses Income Statement 580 Loses Expenses Income Statement Account numbers are assigned to the accounts to facilitate recording, cross-referencing, and retrieval of information. Although there is no standard way of assigning account numbers, account numbers should be assigned in a manner that the accounts are categorized logically. The account titles in the chart of accounts shown above are numbered in the following manner: 1. The first digit in the 3-digt numbering refers to the major types of accounts: Major types of accounts Assigned number ASSETS 100-199 LIABILITIES 200-299 EQUITY 300-399 INCOME 400-499 EXPENSES 500-599 Thus, in the chart of accounts, the 3-digit numberings of all assets start with 1; the 3- digit numberings of all liabilities start with 2; etc; 110 Cash The first digit signifies that this account is an asset account. Fundamentals of Accounting, Business and Management | BMEC3  2. The second digit in the 3-digit numbering refers to the account titles and the sequence on how they are listed in the chart or accounts. Thus, in the chart of accounts, the second digit in the 3-digit numbering of “Cash” is 1 because it is the first asset account listed in the chart; the second digit in the 3-digit numbering of “Accounts receivable” is 2 because it is the second asset account listed in the chart; etc, 110 Cash 120 Accounts receivable The second digits to specific account titles and the sequence on how they are listed in the chart of accounts. 3. The third digit in the 3-digit numbering, if not zero, signifies that the account is a contra account or an adjunct account to a related account. 180 Building 185 Accumulated depreciation – Bldg. The third digit signifies that this account, ‘Accumulated depreciation – Bldg.’ is a contra account to the ‘Building’ account. Common Account Titles The following are the common account titles and their descriptions. BALANCE SHEET ACCOUNTS ASSETS Current assets Ø Assets are considered current if they are held for the purpose of being traded, expected to realized or consumed within twelve months after the end of the period or its normal operating cycle (whichever is longer), or if it is cash. Cash – includes money or its equivalent that is readily available for unrestricted uses, e.g., cash on hand and cash in bank. Accounts receivable – receivables supported by oral or informal promises to pay. Allowance for bad debts – the aggregate of estimated losses from uncollectible accounts receivable. Another term is “allowance for doubtful accounts.” Notes receivable – receivables supported by written or formal promises to pay in the form of promissory notes. Inventory – represents the goods that are held for sale by a business. For a manufacturing business, inventory also includes goods undergoing the process of production and raw materials that will be consumed in the production process. Fundamentals of Accounting, Business and Management | BMEC3  Prepaid supplies – represent the cost of unused office and other supplies. Prepaid rent – rent paid in advance. Prepaid insurance – cost of insurance paid in advance. Non-current Assets Ø Assets that do not meet the criteria to be classified as current. Hence, they are long- term in nature – useful for a period longer that 12 months or the company’s normal operating cycle. Land – the land on which the building of the business has been constructed or a vacant lot which is to be used as a future plant site. Land is not depreciable. Building – the structure owned by a business for use in its operations. Accumulated depreciation – building – the total amount of depreciation expenses recognized since the building was acquired and made available for use. Equipment – consists of various assets such as: a. Machineries and other factory equipment b. Transportation equipment, e.g., vehicles, delivery trucks c. Office equipment, e.g., desks, cabinets, chairs d. Computer equipment, e.g., server, personal computers, laptops e. Furniture and fixtures e.g., desks, cabinets, movable partitions Accumulated depreciation – equipment – the total amount of depreciation expenses recognized since the equipment was acquired and made available for use. Intangible Assets – long-term assets with no physical substance, such as goodwill, stock investments, patents, websites, trademark and copyright. Collectively, land, building and equipment are referred to as “Property, plant and equipment,” “Capital assets,” or “Fixed assets.” LIABILITIES Current Liabilities Ø A liability is considered current if it is due within 12 months after the end of the balance sheet date. In other words, they are expected to be paid in the next year. Accounts payable – obligations supported by oral or informal promises to pay by the debtor. Accrued expenses – since accounting periods rarely fall directly after an expense period, companies often incur expenses but don’t pay them until the next period. These expenses are called accrued liabilities. Non-current Liabilities Ø Liabilities are considered non-current if they are not currently payable, i.e., they are not due within in the next 12 months after the end of the accounting period or the company’s normal operating cycle, whichever is shorter. Notes payable – obligations supported by written or formal promises to pay by the debtor in the form of promissory notes. Fundamentals of Accounting, Business and Management | BMEC3  Bonds payable – many companies choose to issue bonds to the public in order to finance future growth. Bonds are essentially contracts to pay the bondholders the face amount plus interest on the maturity date. Bonds are almost always long-term liabilities. Unearned Revenue – is slightly different form other liabilities because it doesn’t involve direct borrowing. Unearned revenue arises when a company sells goods or services to a customer who pays the company but doesn’t receive the goods or services. EQUITY Owner’s capital (or Owner’s equity) – the residual amount after deducting liabilities from assets. The Owner’s Capital account is INCREASED by: DECREASED by: Ø Investments or contributions by Ø Withdrawals or distributions to the owners. the owners. Ø Income or Profit earned by the Ø Expenses or Loss incurred by business. the business. Owner’s drawings – this account is used to record the temporary withdrawals of the owner during the period. At the end of the accounting period, any balance of this account is closed to the ‘Owner’s capital’ account. INCOME STATEMENT ACCOUNTS INCOME Service fees – revenues earned from rendering services (e.g., service fee of a spa, services of a beauty salon, etc.). Sales – revenues earned from the sale of goods (e.g., sale of barbecue, sale of souvenir items, etc.). Interest income – revenues earned from the issuance of interest-bearing receivables. Gains – income earned from the sale of assets (except inventory) or from enhancements of assets or decreases in liabilities that are not classified as revenue. EXPENSES Cost of sales (or Cost of goods sold) – represents the value of inventories that have been sold during the accounting period. Freight-out – represents the sellers’ cost of delivering goods to customers. Other terms for freight-out are “delivery expense,” “transportation-out”, and carriage outwards”. Salaries expense – represents the salaries earned by employees for the services they have rendered during the accounting period. Rent expense - represents the rentals that have been used up during the accounting period. Utilities expense – represents the cost of utilities (e.g. electricity, water, telephone, internet, cable TV) that have been used during the accounting period. Supplies expense – represents the cost of supplies that have been used during the period. Fundamentals of Accounting, Business and Management | BMEC3  Bad debt expense – the amount of estimated losses from uncollected accounts receivable during the period. Other term is “doubtful account expense.” Depreciation expense – the cost of depreciable asset (e.g. building or equipment) that has been allocated to the current accounting period. Advertising expense – represents the cost of promotional or marketing activities during the period. Insurance expense – represents the cost of insurance pertaining to the current accounting period. Taxes and licenses – represents the cost of business and local taxes by the government for the conduct of business (e.g., mayor’s permit, other percentage taxes, community taxes). Transportation and travel expense Ø Transportation expense – represent the necessary and ordinary cost of employees getting from one workplace to another which are reimbursable by the business, e.g., reimbursable taxi fares of employees running some errands and those who are working on late shifts. Ø Travel expenses – represent costs incurred when travelling away from home on business trips, e.g., out-of-town travel costs of employees sent to seminars. Interest expense – represents the cost of borrowing money. It is the price that a lender charges a borrower for the use of the lender’s money. Miscellaneous expense – represents various small expenditures which do not warrant separate presentation. Losses – expenses which may or may not arise from the ordinary course of business activities. Fundamentals of Accounting, Business and Management | BMEC3 Activity Sheet FUNDAMENTALS OF ACCOUNTING, BUSINESS AND MANAGEMENT ACTIVITY #6 NAME: SCORE: COURSE/YEAR/SECTION: DATE: I. Identification Instruction: Indicate whether each of the accounts listed below is an ASSET, LIABILITY, EQUITY, INCOME or EXPENSE account. 1. Accounts receivable 2. Interest expense 3. Cash 4. Owner’s capital 5. Equipment 6. Freight-out 7. Gains 8. Sales 9. Inventory 10. Unearned income 11. Notes receivable 12. Notes payable 13. Salaries expense 14. Salaries payable 15. Owner’s drawings 16. Building 17. Cost of Sales 18. Service fees 19. Prepaid insurance 20. Depreciation II. Indicate whether each of account listed below is a BALANCE SHEET account or an INCOME STATEMENT account. 1. Notes receivable 2. Inventory 3. Interest expense 4. Unearned revenue 5. Land 6. Prepaid insurance 7. Service fees 8. Allowance for bad debts 9. Bad debt Expense 10. Mortgage payable Fundamentals of Accounting, Business and Management | BMEC3 Fundamentals of Accounting, Business and Management | BMEC3