Notes

Understand the meaning of accounts in accounting. Explore the types of accounts in accounting and see the characteristics of these account categories.
What Is An Account?
Have you ever put together a jigsaw puzzle? Personally, I enjoy it. I find a good deal of satisfaction in the ability to take all these pieces and put them together to make a final picture. When I think about the role of accounts in accounting, it reminds me of a puzzle. Each account is one small part of the entire picture. What exactly is an account? The textbook definition of an account is that it is a place to record transactions that occur within a business, but to me, an account is just a piece of the puzzle.

How Are Accounts Classified?
There are three main categories of accounts that are used in accounting. They are assets, liabilities, and owner's equity accounts. Assets are things that a company owns. Liabilities are things that a company owes. Owner's equity is the amount of money that an owner invests into the business. Every single financial transaction that occurs in a business falls into one of these three categories. It's the job of an accounting professional to decide what category that is.

Asset Accounts
Asset accounts are broken down into two subcategories: current assets and noncurrent assets. Current assets are those assets that will be used up or sold within one year. Cash is a current asset. Another current asset is accounts receivable, which is what others owe to you. Another example of a current asset is prepaid expenses. Prepaid expenses are expenses that have been paid in advance and will be expensed out throughout the year. Inventory and supplies are two other examples of current asset accounts. Noncurrent assets, also called long-term assets, are things that a business has that will not be used up or turned into cash within a year. Examples of noncurrent assets are land, buildings, and equipment.

Liability Accounts
Like asset accounts, liability accounts are also broken down into current and noncurrent subcategories. Current liabilities are bills or any other debt obligation of a company that is due within one year. Payroll expenses, utility bills, and short-term loans are good examples of current liabilities. Noncurrent liabilities are debt obligations that will extend for longer than 12 months. Payments on big ticket items, such as machinery, land, and buildings, are good examples of noncurrent liabilities.

Owner's Equity Accounts
The final type of account classification that is used in accounting is owner's equity, oftentimes just called equity. Equity accounts are further broken down into the owner's capital account, which is where his direct investment is categorized, and stockholder's equity, which is where any equity that comes from the sale of stocks or bonds and any investments by stockholders is categorized.

How Transactions Affect Accounts
Before you can start to put the accounting puzzle together, there is one more piece of information that you need to know. The most common form of accounting that is used today is called double-entry accounting. Double-entry accounting states that for every one transaction, two or more accounts will be affected. Now let's look at a few examples to see how all this works.

1. Bob's Auto Repair is a pretty busy place. Since Bob services all makes and models of vehicles, he must keep a number of different parts in stock. Each week, Bob places an order for stock inventory from Bill's Auto Emporium and charges them to his charge account. This week, his order totaled $2,540.67.

When Bob's bookkeeper analyzes this transaction, what accounts will be affected? For this transaction, there will be both an asset and a liability account that is affected. The asset account will be inventory, which will have a balance increase of $2,540.67. The liability account that will be affected will be accounts payable, which will have an increase in the same amount.

2. A few weeks later, Bob pays his bill at Bill's Auto Emporium in the amount of $9,972.34. What accounts are affected in this transaction? Once again, this transaction affects an asset and a liability account. The asset account, cash, will have a decrease in its balance of $9,972.34. The liability account, accounts payable, will also have a decrease in its balance in the same amount.

As you can see using Bob's Auto Repair as an example, every transaction does affect at least two accounts. Once all transactions for an accounting period have been analyzed and recorded, then it's time to put the pieces of the puzzle together. The end result is a picture of the true financial health of the company.

Lesson Summary
An account is a place to record transactions that occur within a business. Accounts are divided into three specific categories: assets, liabilities, and owner's equity. Assets are things that a business owns. Liabilities are things that a company owes. Owner's equity is the amount of money that company owners have invested in the business. These three types of accounts are used as the main classifications of accounts.

The asset and liability categories are broken down into two subcategories. These two subcategories are current and noncurrent. Current assets are those assets that will be used up or sold within one year. Noncurrent assets, also called long-term assets, are things that a business has that will not be used up or turned into cash within a year. Current liabilities are bills or any other debt obligation that is due within one year. Noncurrent liabilities are debt obligations that will extend for longer than 12 months.

The owner's equity accounts may also be broken down into two different subcategories. They are the owner's capital, which is where direct investments are categorized, and the stockholder's equity account, which is where any equity that comes from the sale of stocks or bonds is categorized as well as where investments by stockholders are classified.

Each and every transaction that occurs in a business is analyzed and recorded in at least two accounts. Why, you ask? Well, remember that the most often used system of accounting in the modern accounting industry is double-entry accounting. Double-entry accounting states that for each transaction, at least two accounts will be affected. Once every transaction is analyzed and every entry is made into the appropriate account, the numerous pieces of the puzzle are put together, and one big financial picture is complete.