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What is an account in accounting?

Posted in accounting, PayTraq U, 101

If we are referring to an account with regard to accounting, then it carries a completely different meaning compared to what the majority of people are accustomed to. The use of the word account generally sparks ideas of an account with a bank. In the world of business, account could relate to a customer. Under this meaning, an account is another entity or person for whom a business acts as a supplier, and with whom there may be an outstanding accounts receivable balance.

These two concepts are correct, however in accounting the word account represents an entirely different meaning.

The word account in everyday language is also used as a substitute for an explanation or a report of certain actions or events. In order to explain or to report, you will, of course, have to remember what you were doing or what happened. As it is not always easy to remember, you may need to keep some written record.

In accounting, an account is a specific spot in the general ledger that is used for recording a monetary balance (in dollars, pounds, euros etc.) along with a history of changes to that balance. This balance could be linked to an account at a bank or it might indicate the sum of money payable to you by a customer or client. It might even represent your disclosed revenue, expenditures or the assets value that you have.

Account Numbers

Account numbers are a kind of shortened way of naming accounts. With the large amount of data entry accountants input using the number pad, it is easier to input a 4 digit number compared to spelling out the full account name using the main keyboard. Account numbers are arranged so that the far-left numbers indicate which section of the balance sheet it is situated on and the far-right numbers establish what place the accounts in this particular area are displayed.

Chart of Accounts

A full list of all the company accounts and their number, which you have put in place in your accounting system called chart of accounts. PayTraq lets you rename, renumber and eliminate accounts whenever you wish, therefore if things are not perfect from the very beginning you could fix them.

At the time you initially setup your business in accounting software program you will be introduced to a pre-defined chart of accounts. This pre-defined list corresponds to some of the most typical account categories applied across the majority of businesses. Considering this, make sure you include or eliminate specific accounts to suit the requirements of your business unique needs.

Establishing all of your accounts is the starting point to a smooth and effective experience in accounting software program. More about what a chart of accounts is you can read here.

The Five Types of Accounts in Accounting

Since you have plenty of variety when thinking about accounts we give each of them a type that will determine where the account appears in various reports and exactly how it can be used when entering income, expenses, payments and transfers.

There are five main types of accounts in accounting:

1) Assets accounts are used to track objects or entities, whether tangible or intangible, that the company owns and that have economic value (property, investments, loans made, debtors, cash and bank). This information is shown in a financial statement called a balance sheet.

Assets are also grouped according to either their life span or liquidity - the speed at which they can be converted into cash.

  • Current assets are items that are completely consumed, sold, or converted into cash in 12 months or less.

  • Fixed assets are tangible assets with a life span of at least one year and usually longer. Fixed assets might include equipment, computers, and vehicles.

2) Liabilities accounts represent the debts, or financial obligations of a business - the money the business owes to others. This information is also shown in a balance sheet.

Liabilities are classified as current or long-term.

  • Current liabilities are debts that are paid in 12 months or less. Current liabilities are usually paid with current assets, i.e. the money in the company's bank account.

  • Long-term liabilities are typically mortgages or loans used to purchase or maintain fixed assets, and are paid off in years instead of months.

3) Equity accounts contain those accounts that express the monetary ownership interest in a business. In fact, these accounts contain the net difference between the recorded assets and liabilities of a company. Equity is also referred to as Net Worth. Equity accounts are shown in a balance sheet.

Equity can be created by either owner contributions or by the company retaining its profits. When an owner contributes more money into the business to fund its operations, equity in the company increases. Likewise, if the company produces net income for the year and doesn't distribute that money to its owner, equity increases. Examples of these accounts include owner investments, retained earnings, common stock.

Probably the most significant element of bookkeeping is monitoring your earnings and spendings so the two primary kinds of accounts in an accounting process are income accounts and expense accounts. Income and expense accounts shown in a financial statement called a profit and loss statement.

4) Income or Revenue accounts – are used to monitor the income source to ensure that a company owner is able to track exactly where their income is originating.

There are many different kinds of revenue accounts, but they all represent the same basic concepts: a company receives cash or a claim to cash for the sale of a product or device, or from interest and use of its assets. Revenues are typically separated into two different categories: operating revenues and non-operating revenues or other income.

Income accounts are temporary or nominal accounts because their balance is reset to zero at the beginning of each new accounting period, usually a fiscal year.

Various kinds of income is often taxed different ways and by putting your income into different accounts, it is possible to optimize them for your company and enhance your profits.

5) Expenses accounts – are meant to represent all expenses incurred by a company during an accounting period.

Expenses are expenditures that allow a company to operate and generate revenues. In other words, a business records an expense when it disburses cash or promises to disburse cash for an asset or service used to generate income. Thus, there may be expense accounts for the cost of goods sold, bank fees, office rent, utilities, and so forth.

Like revenue accounts, expense accounts are considered temporary or nominal accounts, that collect data for one accounting period and are reset to zero, to make room for recording of a new set of expenses in the next accounting period.

Debit and Credit accounts

The terms "debit" and "credit" are enough to induce fear in eve the most confident non-accountant. But even though you may never become an accountant, you will need to understand these concepts in order to have a solid grasp of accounting and business.

So what these terms are actually mean and how they are used in the world of accounting?

The word debit simply refers to the left side of the amount columns and the word credit identifies the right side of the amount columns in a traditional accounting book view. Nothing more, nothing less. Debit does not mean something unfavorable and credit does not mean something favorable, as some non-accountants often believe.

Depending on the account, a debit can increase or decrease the account. Accounts that have debit or left balances include assets and expenses accounts. This means that a debit recorded in an asset account would increase the asset account.

Conversely, liabilities, equity and revenue accounts usually have credit or right balances. Thus a debit recorded in a income account would decrease the income account.

There is a standard way of dealing with debits and credits assigned to Assets, Liabilities, Equity, Revenues, and Expenses:

Increases/Decreases in Accounts

  • Assets Increase - Debit
  • Assets Decrease - Credit
  • Liabilities Increase - Credit
  • Liabilities Decrease - Debit
  • Revenue - Credit
  • Expense - Debit