Accounts Used in Accounting
How to Classify Accounts as Assets, Liabilities, or Equity
A summary of the types of accounts used in accounting, how they fit into the chart of accounts, and how they are related.
Accounting can be a confusing subject for many people, including small business owners. Part of this confusion is due to the accounts used in accounting and how they relate. This can be particularly confusing when you throw double entry accounting into the mix and the chart of accounts. Accounting accounts can be broken down into one of three categories. These categories are assets, liabilities, and equity (or owner’s equity).
Assets
Asset accounts can be broken into current and fixed assets. Current assets include accounts such as petty cash, checking accounts, savings accounts, money market accounts, investment accounts, and certificates of deposit that mature in the short-term (less than one year). Other current asset accounts may include work-in-process accounts, prepaid expenses, accounts receivable, and inventory accounts. Items like expenses will subtract from these accounts.
Fixed asset accounts may include land, buildings, furniture, fixtures, equipment, vehicles, and other items that can be depreciated. There are also fixed asset accounts that are called contraasset accounts which include items such as depreciation. These accounts counter (or subtract from) asset accounts.
Liabilities
Liability accounts are broken into current and long-term liabilities. Current liabilities include items such as accounts payable, wages payable, taxes (various types) payable, and deposits from customers (for work not completed yet). Once a bill is paid it is moved from accounts payable and counted as an expense. This removes the money from the asset account it is paid from (e.g. a business’ checking account) and removes the amount from the accounts payable account.
Long-term liability accounts include loans (that have a term exceeding one year). This can include liabilities for anything from equipment and vehicles to bank and land loans.
Equity Accounts
Equity (or owner’s equity) accounts are also called capital accounts. These accounts include any capital invested by owners as well as stock accounts. Since they directly affect capital, expense and income accounts can be considered a part of this grouping as well.
Accounts used in accounting affect one another in the basic manner of Assets = Liabilities + Equity. Double entry accounting teaches us that whenever one account is affected, it must affect at least one other account. For example, if a company purchases $1,000 of inventory on account from their vendor, both the inventory and accounts payable accounts will increase. This supports the accounting equation of Assets (+$1,000 to inventory) = Liabilities (+$1,000 to accounts payable) + Equity. The equation is still in balance.
By understanding this basic equation and what types of accounts go into each of the accounting categories, a small business owner (or interested person) can gain a solid foundation to learn more of the basics of accounting.
Related Articles:
Financial Statements: The P & L: The Income Statement or Profit and Loss Statement
What is GAAP?: An Explanation of Generally Accepted Accounting Principles
Management and Public Accounting: Comparing CPA and CMA Designations
