First, let's start with the Major Categories. These are the Types Of Accounts that are used to organize our financial information. The Major Types of Accounts are Assets, Liabilities, Owner's Equity, Revenue, Expense, and Draws. I'll present a formal and an informal definition for each term.
Formal Definition-The properties used in the operation or investment activities of a business.
Informal Definition-All the good stuff a business has (anything with value). The goodies.
Additional Explanation-The good stuff includes tangible and intangible stuff.
Tangible stuff you can physically see and touch such as vehicles, equipment and buildings.
Intangible stuff is like pieces of paper (sales invoices) representing loans to your customers where they promise to pay you later for your services or product. Examples of assets that many individuals have are cars, houses, boats, furniture, TV's, and appliances.
Some examples of business type assets are cash, accounts receivable, notes receivable, inventory, land, and equipment.
Formal Definition-Claims by creditors to the property (assets) of a business until they are paid.
Informal Definition- Other's claims to the business's stuff. Amounts the business owes to others.
Additional Explanation-Usually one of a business's biggest liabilities (hopefully they are not past due) is to suppliers where they have bought goods and services and charged them. This is similar to us going out and buying a TV and charging it on our credit card. Our credit card bill is a liability. Another good personal example is a home mortgage. Very few people actually own their own home. The bank has a claim against the home which is called a mortgage. This mortgage is another example of a personal liability.
Some examples of business liabilities are accounts payable, notes payable, and mortgages payable.
Owner's Equity (Capital)
Formal Definition- The owner's rights to the property (assets) of the business; also called proprietorship and net worth.
Informal Definition- What the business owes the owner. The good stuff left for the owner assuming all liabilities (amounts owed) have been paid.
Additional Explanation-Owner's Equity represents the owner's claim to the good stuff (assets). Most people are familiar with the term equity because it is so often used with lenders wanting to loan individuals money based on their home equity. Home equity can be thought of as the amount of money an owner would receive if he or she sold their house and paid off any mortgage (loan) on the property.
Revenue (Income), Expenses, and Draws - Revenues, expenses, and draws are sub categories of owner's equity.
Revenue (Also Called Income)
Formal Definition-The gross increase in owner's equity resulting from the operations and other activities of the business.
Informal Definition- Amounts a business earns by selling services and products. Amounts billed to customers for services and or products.
Additional Explanation-Individuals can best relate by thinking of revenue as their earnings or wages they receive from their job. Most business revenue results from selling their products and or services.
Expense (Also Called Cost)
Formal Definition-Decrease in owner's equity resulting from the cost of goods, fixed assets, and services and supplies consumed in the operations of a business.
Informal Definition- The costs of doing business. The stuff we used and had to pay for or charge to run our business.
Additional Explanation- Some examples of personal expenses that most individuals are familiar with are utilities, phone, clothing, food, gasoline, and repairs.
Some examples of business expenses are office supplies, salaries & wages, advertising, building rental, and utilities.
Formal Definition-Decrease in owner's equity resulting from withdrawals made by the owner.
Informal definition- Amounts the owner withdraws from his business for living and personal expenses.
Additional Explanation- The owner of a sole proprietorship does not normally receive a 'formal' pay check from the business, but just like most of the rest of us needs money to pay for his house, car, utilities, and groceries. An owner's draw is used in order for the owner to receive money or other 'goodies' from his business to take care of his personal bills.
We use detail accounts to actually collect a business's financial information. The Detail Accounts are normally grouped by the Major Category that they belong to. The number of detail accounts depends on the needs of the business.