Bookkeeping Accounts-2
Bookkeeping Accounts
Let's dive deeper into the Types Of Accounts. We'll review what we discussed earlier and add some additional information about the types of accounts.
Assets
We'll start with assets, what assets are and how they are classified.
What is an Asset ?
Simply put, an Asset is anything of value that a business owns or controls. Think of assets as the economic resources that a business uses to operate, generate revenue, and keep the doors open.
To qualify as an asset in bookkeeping, an item must meet three criteria:
- It must provide a future economic benefit (help the business make money or save money).
- The business must have ownership or control over it.
- It must have a cost or value that can be measured in money.
Assets are generally grouped into two major categories (buckets) based on how quickly they can be converted into cash.
Current Assets
Current assets are short-term resources. These are assets that a business expects to convert into cash, sell, or consume within one year or within the normal operating cycle.
Examples include:
- Cash and Cash Equivalents: Money in the checking account, savings account, and petty cash.
- Accounts Receivable: Money that customers owe the business for goods or services already delivered.
- Inventory: The goods and materials a business holds specifically to sell to customers.
- Prepaid Expenses: Advanced payments for future expenses, such as prepaid insurance or rent.
Non-Current (Fixed) Assets
Non-current assets are long-term resources. These are physical assets that a business purchases to use in its operations over a long period (more than one year). They are not intended for immediate sale to customers.
Examples include:
- Land: The physical property owned by the business.
- Buildings: The offices, warehouses, or storefronts owned by the company.
- Equipment and Machinery: Tools, manufacturing machines, and delivery trucks.
- Furniture and Fixtures: Desks, chairs, display racks, and shelving.
Let's also dive deeper into what liabilities are and how they are classified.
Liabilities are what your business owes. Understanding liabilities is crucial because it tells you how much of your business is financed by outside lenders versus your own investment.
What Exactly is a Liability? In plain English, a liability is a legal obligation to pay someone else because of a past transaction.It’s not just bank loans. If a vendor sends you an invoice that you haven't paid yet, or if you owe your employees their weekly wages, those are liabilities.
The Two Main Categories: Liabilities are divided into two buckets based on when they need to be paid off:
- Current Liabilities:Debts that must be paid within one year or less. Examples include Accounts Payable, Credit Card Balances, Short-term Loans, Sales Tax Collected, and Employee Wages Owed.
- Long-Term Liabilities: Debts that are due beyond one year. Examples include Mortgages and Equipment Loans.
When you are categorizing transactions, you won't just label something Liability. You'll use specific accounts. Here are the big ones:
- Accounts Payable: This is the most common liability account. It tracks money you owe to suppliers or vendors for goods or services you bought on credit.
- Accrued Expenses: These are expenses you've incurred but haven't been billed for or paid yet. Example: Your employees worked last week but hasn't been paid. You must record Accrued Wages so your financial statements are accurate.
- Unearned Revenue (Deferred Revenue) This one trips a lot of people up! If a client pays you before you do the work (like a retainer or a deposit for a future project), that money is actually a liability. Why? Because you owe them the service or a refund. It only becomes revenue after you deliver the work.
Now we'll dive deeper into Equity.
Owner's Equity represents the owner's remaining claim on the business assets after all the liabilities are subtracted. It is the true net worth or value of the business to the owner. If you cleared out the business today by selling off all the assets and paying off all the debts, whatever cash is left over belongs to the owner. That leftover amount is Owner's Equity.
The Four Components of Owner's Equity:
Owner's equity is not a static number. It constantly changes based on daily business activities. There are exactly four things that can change the value of owner's equity: two of them increase it, and two of them decrease it.
- Things That Increase Equity:
Capital Investments:When an owner puts personal money, tools, or equipment into the business to get it started or to help it grow, this directly increases owner's equity. This is tracked in an account usually named Owner's Capital.
Revenues:When the business earns money by selling products or providing services, that fresh inflow of value belongs to the owner. Revenue increases owner's equity.
Things That Decrease Equity:
Expenses:Running a business costs money. Paying rent, buying advertising, or covering utility bills are necessary costs of doing business. These outflows take away from the business's value, meaning expenses decrease owner's equity.
Withdrawals (Draws):When an owner takes cash or assets out of the business for personal use, they are reducing their stake in the company. This is tracked in an account usually named Owner's Drawing, and it decreases owner's equity.
Now, we'll discuss Revenue.
Whether you are running a small lemonade stand or managing a multi-million dollar corporation, understanding revenue is fundamental to tracking financial success.
We will break down what revenue actually is and the critical rules for recording it.
What is Revenue ? Revenue is grouped on the Income Statement into two categories:
- Operating Revenue
Operating Revenue is the total amount of money a business earns by selling its goods or providing its services to customers. It is often referred to as the "top line" because operating revenue sits at the very top of the Income Statement.
Common examples of operating revenue include:
- Sales Revenue: Selling physical products (like books, clothing, or electronics).
- Service Revenue: Providing a service (like consulting, bookkeeping, or plumbing).
- Other Income
Other revenue (or non-operating revenue) is peripheral income from secondary sources.
Common examples of other revenue include:
Interest, dividend payouts, and gains from selling assets.
The Revenue Recognition Principle
When exactly do you record revenue? The answer depends on the accounting method your business uses. There are two primary methods:
Cash Basis Accounting
Under this method, you only record revenue when you actually receive the cash from the customer. If you perform a service in May but don't get paid until June, the revenue is recorded in June. This is common for very small businesses.
Accrual Basis Accounting
Under Generally Accepted Accounting Principles, businesses must use the Accrual Basis. This relies on the Revenue Recognition Principle, which states that revenue must be recorded when it is earned, regardless of when the cash is received.
Example: You design a website for a client in May. You send them an invoice, and they pay you in June. Under the accrual method, you record the revenue in May because that is when the work was completed and earned.
Without accurate revenue tracking, it is impossible to know whether a business is truly profitable or just burning through cash.
Lastly, we are tackling one of the most important parts of running a business: Expenses
Whether you're tracking a multi-million dollar corporation or a local coffee shop, knowing exactly where money is going is the key to staying afloat. Let's break down what expenses are, how they differ from other costs, and how to record them properly.
What Exactly Is an Expense ? An expense is the cost of operations that a business incurs to generate revenue. Essentially, it’s the money spent or liability incurred in an effort to make money. If you spend money to keep the lights on, advertise your product, or pay your team, you are dealing with an expense.
To keep financial statements organized, expenses are generally split into two primary categories in the Income Statement:
- Cost of Goods Sold: These are the direct costs attributable to the production of the goods sold by a company. If you don't sell a product, you don't incur this type of expense.
Examples: Raw materials, factory labor, and overhead.
- Operating Expenses: These are the indirect costs required to run the daily operations of the business, regardless of how many products you sell.
Examples: Rent, advertising, insurance, office supplies, and administrative salaries.