LESSON 8: TYPES OF MAJOR ACCOUNTS

Learning Objectives

At the end of this lesson, the learners should be able to:

1. identify the account as assets, liabilities, capital, income or expenses

2. cite an example of each type of account
3. prepare a chart of accounts

Elements of Financial Statements

Financial statements portray the financial effects of transactions and other events by
grouping them into broad classes according to their economic characteristics. Theses
broad classes are termed the elements of financial statements. The elements directly
related to the measurement of financial position in the balance sheets are assets,
liabilities and equity.

The elements directly related to the measurement of performance in the income

statement are income and expenses. The statement of changes in financial position
usually reflects income statement elements and changes in the balance sheet
elements.

Recognition of the elements of financial statements

Recognition is the process of incorporating in the balance sheet or income statement

an item that meets the definition of an element and satisfies the criteria for
recognition. An item that meets the definition of an element should be recognized if it
is probable that any future economic benefit associated with the item will flow to or
from the enterprise and the item has a cost or value that can be measured with
reliability.

Measurement of the elements of financial statements

Measurement is the process of determining the monetary amounts at which the

elements of the financial statements are to be recognized and carried in the balance
sheet and income statement. A number of these are used to different degrees and in
varying combinations in financial statements.

Historical cost: assets are recorded at the amount of cash or cash equivalents paid or
the fair value of the consideration given to acquire them at the time of their
acquisition. Liabilities are recorded at the amount of proceeds received in exchange for
the obligation or in some circumstances at the amounts of cash or cash equivalents
expected to be paid to satisfy the liability in the normal course of business.

Current Cost: assets are carried at the amount of cash or cash equivalents that would
have to be paid if the same or an equivalent asset was acquired currently. Liabilities
are carried at the undiscounted amount of cash or cash equivalents that would be
required to settle the obligation currently.

Realizable Value: Assets are carried at the amount of cash or cash equivalents that
could currently be obtained by selling an asset in an orderly disposal.

Settlement Value: liabilities are carried at the undiscounted amounts of cash or cash
equivalents expected to be paid to satisfy the liabilities in the normal course of
business.

Present Value: assets are carried at the present discounted value of the future net
cash inflows that the item is expected to generate in the normal course of business.
Liabilities are carried at the present discounted value of the future net cash outflows
that are expected to be required to settle the liabilities in the normal course of
business.

Financial Position

Also known as the balance sheet. This statement includes the amounts of the
company’s total assets, liabilities, and owner’s equity which in totality provides the
condition of the company on a specific date. (Haddock, Price, & Farina, 2012).

Permanent Accounts

As the name suggests, these accounts are permanent in a sense that their balances
remain intact from one accounting period to another. (Haddock, Price, & Farina, 2012)
Examples of permanent account include Cash, Accounts Receivable, Accounts
Payable, Loans Payable and Capital among others. Basically, assets, liabilities and
equity accounts are permanent accounts. They are called permanent accounts
because the accounts are retained permanently in the SFP until their balances become
zero. This is in contrast with temporary accounts which are found in the Statement of
Comprehensive Income (SCI). Temporary accounts unlike permanent accounts will
have zero balances at the end of the accounting period.

Contra Assets

Contra assets are those accounts that are presented under the assets portion of the
SFP but are reductions to the company’s assets. These include Allowance for Doubtful
Accounts and Accumulated Depreciation. Allowance for Doubtful Accounts is a contra
asset to Accounts Receivable. This represents the estimated amount that the company
may not be able to collect from delinquent customers. Accumulated Depreciation is a
contra asset to the company’s Property, Plant and Equipment. This account represents
the total amount of depreciation booked against the fixed assets of the company.
Assets

Asset is a resource controlled by the entity as a result of past events and from which
future economic benefits are expected to flow to the entity (IASB Framework). The
primary criterion for asset recognition is that the expenditure will result in economic
benefits flowing to the owner in future reporting periods. Another criterion used for
asset recognition is that there must be an objective way to measure the asset. Yet
another criterion for asset recognition is the materiality of the expenditure

Current vs. Non-Current Assets

Current Assets are assets that can be realized (collected, sold, used up) one year after
year-end date. Examples include Cash, Accounts Receivable, Merchandise Inventory,
Prepaid Expense, etc.

Non-current Assets are assets that cannot be realized (collected, sold, used up) one
year after year-end date. Examples include Property, Plant and Equipment
(equipment, furniture, building, land), long term investments, etc.

Tangible vs. Intangible Assets

Tangible Assets are physical assets such as cash, supplies, and furniture and fixtures.

Intangible Assets are non-physical assets such as patents and trademarks

Current Assets

Cash are any medium of exchange that a bank will accept for deposit at face value. It
includes coins, currency, checks, money orders, bank deposits, and drafts.

Cash Equivalents are short term, highly liquid investments that are readily convertible
to known of cash and which are subject to an insignificant risk of changes in value.

Short term investments are the investments made by the company that are intended to
be sold immediately

Notes Receivable is a written pledge that the customer will pay the business a fixed
amount of money on a certain date.

Accounts Receivables are claims against customers arising from sales of services or
goods on credit. This type of receivable offers less security than a promissory note.

Inventories are asset which are held for sale in the ordinary course of business; in the
process of production for such sale; or in the form of materials or supplies to be
consumed in the production process or in the rendering of services.

Supplies are items purchased by an enterprise which are unused as of the reporting
date.
Prepaid Expenses are expenses paid for by the business in advance. It is an asset
because the business avoids having to pay cash in the future for a specific expense.
These include insurance and rent. These prepaid items represent future economic
benefits – assets – until the time these start to contribute to the earning process;
these, then, become expenses.

Accrued Income is revenue earned but not yet collected

Non-Current Assets

Long term Investments are the investments made by the company for long-term
purposes

Property, Plant and Equipment are tangible assets that are held by an enterprise for
use in the production or supply of goods and services or for rental to others or for
administrative purposes and which are expected to be used during more than one
period. Included are such items as land, building, machinery and equipment,
furniture and fixtures, motor vehicles and equipment.

Accumulated depreciation is a contra account that contains the sum of the periodic
depreciation charges. The balance in this account is deducted from the cost of the
related asset – equipment or buildings – to obtain book value.

Intangible assets are identifiable, nonmonetary assets without physical substance held
for use in the production or supply of goods or services, for rental to others or for
administrative purposes. These include goodwill, patents, copyright, licenses,
franchises, trademarks, brand names, secret processes, subscription lists and non-
competition agreements.

Liabilities

Liabilities are a present obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outflow from the enterprise of resources
embodying economic benefits (IASB Framework). First criterion, the outflow of
resources embodying economic benefits (such as cash) from the entity is probable.
The other criterion, the cost / value of the obligation can be measured reliably.

Current vs. Non-Current Liabilities

1. Current Liabilities are liabilities that fall due (paid, recognized as revenue)
within one year after year-end date. Examples include Accounts Payable,
Utilities Payable and Unearned Income.
2. Non-current Liabilities are liabilities that do not fall due (paid, recognized as
revenue) within one year after year-end date. Examples include Notes Payable,
Loans Payable, Mortgage Payable, etc.
Current Liabilities

Accounts Payable represents the reverse relationship of the accounts receivable. By

accepting the goods or services, the buyer agrees to pay for them in the near future.

Notes payable is the business entity is the maker of the note; the business entity is the
party who promises to pay the other party a specified amount of money on a specified
future date.

Accrued Expenses is an amounts owed to others for unpaid expenses. This account
includes salaries payable, utilities payable, interest payable and taxes payable.

Unearned Revenues is when the business entity receives payments before providing its
customers with goods and services, the amounts received are recorded in the
unearned revenue account (liability method). When the goods or services are provided
to the customer, the unearned revenue is reduced and income is recognized.

Current portion of long term debt are portions of mortgage notes, bonds and other long-
term indebtedness which are to be paid within one year from the balance sheet date.

Non-Current Liabilities

Long-term Note Payables are promissory notes due to be paid over periods extending
beyond one year from the balance sheet.

Mortgage Payable - account records long – term debt of the business entity for which
the business entity has pledged certain assets as security to the creditor. In the event
that the debt payments are not made, the creditor can foreclose or cause the
mortgaged asset to be sold to enable the entity to settle the claim.

Bonds Payable - Business organizations often obtain substantial sums of money from
lenders to finance the acquisition of equipment and other needed assets. They obtain
these funds by issuing bonds. The bond is a contract between the issuer and the
lender specifying the terms of repayment and the interest to be charged.

Equity or Owner’s Equity

Equity or Owner’s Equity represents the owner's investment in the business minus
the owner's draws or withdrawals from the business plus the net income (or minus the
net loss) since the business began.

Capital is used to record the original and additional investments of the owner of the
business entity. It is increased by the amount of profit earned during the year or is
decreased by a loss.

Withdrawals are recorded in the drawing or withdrawal account rather than directly
reducing the owner’s equity account
Income summary is temporary account used at the end of the accounting period to
close income and expenses. This account shows the profit or loss for the period before
closing to the capital account.

Financial Performance

Income is the increase in economic benefits during the accounting period in the form
of inflows of cash or other assets or decreases of liabilities that result in increase in
equity. Income includes revenue and gains.

Expenses are decreases in economic benefits during the accounting period in the form
of outflows of assets or incidences of liabilities that result in decreases in equity.

Chart of Accounts

 A chart of accounts is a listing of the accounts used by companies in their

financial records.
 The chart of accounts helps to identify where the money is coming from and
where it is going.
 The chart of accounts is the foundation of the financial statements.

The following are the steps in the preparation of a basic chart of accounts:

1. Create two columns.

2. Prepare the assets first, then liabilities, then equity, then revenue and
expenses.
3. List all assets, liabilities, equity, revenue and expenses account in the first
column.
4. On the second column, choose an account code (discretion of the company).
5. On the third column, write the description for each account on when to use it.
 An example of a chart of accounts is given below:

Account Account Code Description

*may vary
Assets
Cash 1000 Use for actual cash transactions
Accounts Receivable 1200 Use for customers who will pay in the future
Inventory 1300 Use for items held for sale
Prepaid Expenses 1400 Use for expenses paid in advance
Supplies 1500 Use for items to be used in the future
Office Equipment 1600 Use for equipment that are used in the office
Store Equipment 1700 Use for equipment that are used in the store
Land 1800 Use for land used in operations
Liabilities
Accounts Payable 2000 Use for the debts of the company
Notes Payable 2100 Use for promissory notes issued by the
company
Salaries Payable 2200 Use for salaries to be paid in the future
Capital
Owner’s, Capital 3000
Owner’s, Withdrawal 4000
Service Revenue 5000 Use for earnings
Salaries Expense 6000 Use for salaries incurred, regardless of
payment
Utilities Expense 6100 Use for electricity and water expenses
incurred