5 Categories of Accounts
There are five categories of accounts:
- Assets: Anything of value that a business owns
- Liabilities: Debts that a business owes; claims on assets by outsiders
- Stockholders’ equity: Worth of the owners of a business; claims on assets by the owners
- Revenue: Income that results when a business operates and generates sales
- Expenses: Costs associated with earning revenue
Different accounts fall into different categories. Cash is an account that falls in the asset category. The Cash account keeps track of the amount of money a business has. Checks, money orders, and debit and credit cards are considered to be cash.
Assets can be defined as objects or entities, whether tangible or intangible, that the company owns that have economic value. Tangible assets are physical entities that the business owns such as land, buildings, vehicles, equipment, and inventory. While Intangible assets are things that represent money or value, e.g. Accounts Receivables, patents, contracts, and certificates of deposit (CDs). Assets are also grouped according to either their life span or liquidity – the speed at which they can be converted into cash.
Liabilities are the debts, or financial obligations of a business – the money the business owes to others. Liabilities are classified as current or long-term. Current liabilities are debts that are paid in 12 months or less, and consist mainly of monthly operating debts. They are usually paid with current assets; i.e. the money in the company’s checking account. A company’s working capital is the difference between its current assets and current liabilities. Managing short-term debt and having adequate working capital is vital to a company’s long-term success. Long-term liabilities are typically mortgages or loans used to purchase or maintain fixed assets.
Equity is of utmost importance to the business owner because it is the owner’s financial share of the company – or that portion of the total assets of the company that the owner fully owns. Equity may be in assets such as buildings and equipment, or cash. Equity is also referred to as Net Worth. For example, if you purchase a $30,000 vehicle with a $25,000 loan and $5,000 in cash, you have acquired an asset of $30,000, but have only $5,000 of equity. The Balance Sheet equation is:
Assets = Liabilities + Owner’s Equity
Income or Revenue
Income is money the business earns from selling a product or service, or from interest and dividends on marketable securities. Other names for income are revenue, gross income, turnover, and the “top line.”
Income is “realized” differently depending on the accounting method used. When a business uses the Accrual basis accounting method, the revenue is counted as soon as an invoice is entered into the accounting system.If the Cash basis accounting method is used, the revenue is not realized until the invoice is paid.
Expenses are expenditures, often monthly, that allow a company to operate. Examples of expenses are office supplies, utilities, rent, entertainment, and travel.Like revenue accounts, expense accounts are temporary accounts that collect data for one accounting period and are reset to zero at the beginning of the next accounting period. Most accounting programs perform this task automatically.