Assets, Liabilities, Equity, Revenue, and Expenses

Having a good understanding of these account types is a prerequisite

to reading financial reports and posting transactions in the accounting
system.

Account Type Overview

The five account types are: Assets, Liabilities, Equity, Revenue (or
Income) and Expenses. To fully understand how to post
transactions and read financial reports, we must understand these
account types. We'll define them briefly and then look at each one in
detail:

 Assets: tangible and intangible items that the company owns that
have value (e.g. cash, computer systems, patents)
 Liabilities: money that the company owes to others (e.g.
mortgages, vehicle loans)
 Equity: that portion of the total assets that the owners or
stockholders of the company fully own; have paid for outright
 Revenue or Income: money the company earns from its sales of
products or services, and interest and dividends earned from
marketable securities
 Expenses: money the company spends to produce the goods or
services that it sells (e.g. office supplies, utilities, advertising)

Assets
Assets can be defined as objects or entities, whether tangible or
intangible, that the company owns that have economic value.
Tangible assets are physical entities that the business owns such as
land, buildings, vehicles, equipment, and inventory.

Intangible assets are things that represent money or value; things

such as Accounts Receivables, patents, contracts, and certificates of
deposit (CDs).
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 machinery, buildings,
and vehicles. Fixed assets are typically not very liquid. And because
of their higher costs, assets are not expensed, but depreciated, or
"written off" over a number of years according to one of
several depreciation schedules.

Liabilities
Liabilities are the debts, or financial obligations of a business - the
money the business owes to others. Liabilities are classified as current
or long-term.

Current liabilities are debts that are paid in 12 months or less, and
consist mainly of monthly operating debts. Current liabilities are
usually paid with current assets; i.e. the money in the company's
checking account. A company's working capital is the difference
between its current assets and current liabilities. Managing short-term
debt and having adequate working capital is vital to a company's long-
term success.

Long-term liabilities are typically mortgages or loans used to

purchase or maintain fixed assets, and are paid off in years instead of
months.

Equity
Equity is of utmost importance to the business owner because it is the
owner's financial share of the company - or that portion of the total
assets of the company that the owner fully owns. Equity may be in
assets such as buildings and equipment, or cash. Equity is also
referred to as Net Worth.
For example, if you purchase a $30,000 vehicle with a $25,000 loan
and $5,000 in cash, you have acquired an asset of $30,000, but have
only $5,000 of equity. The Balance Sheet equation is:
Assets = Liabilities + Owner's Equity

We can see how this equation works with our example: $30,000 Asset
= $25,000 Liability + $5,000 Owner Equity.

Types of Equity Accounts and Their Various

Names
There are three types of Equity accounts that will meet the needs of
most small businesses. These accounts have different names
depending on the company structure, so we list the different account
names in the chart below.

Contribution (Money Invested): There are times when company

owners must invest their own money into the company. It may be
start-up capital or a later infusion of cash. When this occurs,
a Capital or Investment account is credited. See the first row in the
table below.

Distribution or Draw (Money Withdrawn): If a business is profitable,

the owners often want some of the profit returned to them. To track
this activity, a Draw or Distribution account is debited. This is the only
Equity account (non-contra) that receives debits. See the second row
in the table below.

Accumulation from Prior Years: To tracks a company's Net Income

as it accumulates over the years, Retained Earnings or Owner's
Equity is credited. On the first day of the fiscal year, most accounting
programs automatically credit this account with the previous year's
Net Income. See the third row of the table below.
NOTE: Most single-owner companies enter journal entries to "close
out" the Contribution and Draw accounts to Retained Earnings on the
last day of the fiscal year. Partnerships, however, may choose not to
close out these accounts so that a permanent record of partner activity
is maintained.

Sole Subchapter S
Partnership
Proprietor Corporation
Partner A
Owner's Capital
Paid in
Investment - Contribution,
Capital - or -
Money invested or - Partner B
Capital
Capital Capital
Contribution
Contribution Contribution,
etc.
Partner A Draw,
Money
Owner's Draw Partner B Draw, Distribution
withdrawn
etc.
Owner's Partner A
Cumulative
Equity - or - Equity, Retained
Earnings (less
Owner's Partner B Earnings
$$ withdrawn)
Capital Equity, etc.

Income or Revenue
Income is money the business earns from selling a product or service,
or from interest and dividends on marketable securities. Other names
for income are revenue, gross income, turnover, and the "top line."
Net income is revenue less expenses. Other names for net income
are profit, net profit, and the "bottom line."

Income is "realized" differently depending on the accounting method

used. Accrual basis accounting counts the revenue as soon as an
invoice is entered into the accounting system. Cash basis
accounting does not count the revenue until the invoice is paid.
Income accounts are temporary or nominal accounts because their
balance is reset to zero at the beginner of each new accounting
period, usually a fiscal year. Most accounting programs perform this
task automatically.

Expenses

Expenses are expenditures, often monthly, that allow a company to

operate. Examples of expenses are office supplies, utilities, rent,
entertainment, and travel.

Like revenue accounts, expense accounts are temporary accounts

that collect data for one accounting period and are reset to zero at the
beginning of the next accounting period. Most accounting programs
perform this task automatically.

A unique type of Expense account, Depreciation Expense, is used

when purchasing Fixed Assets. Costly items, such as vehicles,
equipment, and computer systems, are not expensed, but
are depreciated or written off over the life expectancy of the item. A
contra-account, Accumulated Depreciation, is used to offset the Asset
account for the item. Please see your Accountant for help with the
depreciation of Assets.