Types of Accounts

Steps to analyze the financial transaction

1. Identifying the accounts affected by the financial transaction.
2. Identifying the type of account and whether it is among the assets, liabilities, owner's equity, revenue or expenses..
3. Identifying the debit and credit account.
4. Preparing the accounting entry.

In this lesson, we are going to explain the first and second points, while the third and fourth points will be explained in the next lesson.

Definition of the account

The account can be defined as the record or the container that contains all the financial movements that have affected it after analyzing the financial transaction, For example, if the company makes a transaction for the sale of goods amounting to USD 1,000 and that value is received in cash , then when we analyze the financial transaction, we will find out that it contains two accounts, an account for sales, which increased by USD 1,000, and the cash account, which also increased by USD 1,000, and from that we conclude the following:

• Accounts are extracted after the financial transaction is analyzed.
• Each financial transaction involves at least two accounts, one of which is called debit, and the other is called credit.

Classification of Accounts

There are several classifications of accounts, the most widely-accepted classification of which is that accounts are categorized into five groups as follows:

Assets (Property):

The assets account for all economic resources and properties which the company owns, and are divided into several sections as follows:

Current Assets (Short-Term)

Current assets represent the assets owned by the company in the form of cash or which are expected to be converted into cash within the upcoming fiscal period, such as cash on hand and at bank, accounts receivable [receivables], goods, notes receivable (Bills of exchange)… etc.

Fixed Assets (Long-Term)

Fixed assets are the assets owned by the company for the purpose of helping it to practice its activity and to be used them for several years or for several subsequent fiscal periods. They are not purchased with the intent of immediate resale, such as buildings, machinery, equipment, furniture, etc.

Intangible Assets (Long-Term)

Intangible assets are assets owned by the company and are lacking the tangible physical substance, such as the Goodwill, Trademark, Patents…etc.

Other Assets

Other Assets represent the other accounts of a debit nature (Normal Debit Balance), which appear on the assets side of the balance sheet, because they represent assets of the company, such as the prepaid expenses account and the accrued revenue account.

Liabilities:

Liabilities represent all the debts and amounts owed by the company, and are categorized as follows:

Current liabilities(Short-Term)

Short-term liabilities are debts which the company is required to pay off within the upcoming fiscal period (less than a year), such as accounts payable, short-term loans, notes payable (Bill of Exchange) etc.

Non-current liabilities(Long-Term)

Long-term liabilities are debts which the company is required to pay off within the upcoming fiscal periods (more than a year).

Other Liabilities

Other Liabilities represent the other accounts of a credit nature (Normal Credit Balance), which appear on the liabilities side of the balance sheets, because they represent debts on the company, such as the accrued expenses account, the deferred revenue account.

Owner's Equity

Owner's equity is the accounts that represent the liabilities of the company towards the owners of the enterprise (company), such as the capital account, Owner Withdrawals account, retained earnings account, etc.

Revenue (Sales):

Revenue is the accounts that arise at the time of selling goods or providing a particular service to others, such as computer hardware sales or revenue from providing consulting services.

Expenses

Expenses are the accounts which arise when the company gets services from others, to help it practice its business activity and achieve its objectives, such as electricity, telephone, internet, advertising expenses and other expenses.

The Accounting Equation:

The relationship among the five key accounts can be represented by the following equation:

the company's resources(Assets) = Liabilities towards others (liabilities) + liabilities towards owners (Owner's equity)

that means:

Assets = Liabilities + Owner's equity

Owner's equity equals the following: 

Owner's equity = Capital – Owner Withdrawals + (revenue – expenses) 

Hence, the equation in its final form becomes as follows: 

Assets = Liabilities + (capital – Owner Withdrawals + revenue – expenses) 

This equation is called the balance sheet equation, or the accounting equation, which states that the balance sheet contains two sides, one of which represents assets, and the other represents liabilities and Owner's equity. Both sides must be equal when any financial transaction occurs. When any financial transaction occurs, it will affect either the assets side only or the liabilities and Owner's equity side only, or both sides, while maintaining the balanced of the balance sheet.