ASSET ACCOUNTS

Assets can be subdivided into many accounts , depending on their nature and assumed holding
periods. The general categories of asset accounts are as follows, along with the accounts
commonly used within each category:

Current assets

 Cash. Includes bills and coins on hand, such as petty cash.

 Bank deposits. Includes cash kept in depository accounts.
 Marketable securities. Includes both debt and equity securities, as long as they can be
liquidated within a short period of time.

A marketable security is an easily traded investment that is readily converted into cash, usually

because there is a strong secondary market for the security. Such securities are typically traded
on a public exchange, where price quotes are readily available. The tradeoff for the high level
of liquidity is that the return on marketable securities is usually low.

Marketable securities are recorded as a current asset, since they have a maturity of less than one
year. This is of some importance when calculating the current ratio, since marketable securities
are included in the numerator of that calculation, and make a business look more liquid.
Examples of marketable securities are: Banker's acceptances, Certificates of deposit,
Commercial paper, Treasury bills.

A conservatively-run business may place a large proportion of its excess cash in marketable
securities, so that it can easily liquidate them if there is a sudden need for cash. A tightly-
managed treasury department that has a clear understanding of expected  cash flows may pursue
higher-return investments which typically require longer maturities, and so will invest a smaller
proportion of excess cash in marketable securities.

 Trade accounts receivable. Only includes receivables from the organization's customers.
Accounts Receivable is an asset that arises from selling goods or services to someone on credit.
The receivable is a promise from the buyer to pay the seller according to the terms of the sale.
This is an unusual asset because it isn’t an asset at all. It is more of a claim to an asset. The
seller has a claim on the buyer’s cash until the buyer pays for the goods or services .

Trade receivables are amounts billed by a business to its customers when it delivers
goods or services to them in the ordinary course of business. These billings are typically
documented on formal invoices, which are summarized in an accounts receivable aging
report. This report is commonly used by the collections staff to collect overdue
payments from customers. In the general ledger , trade receivables are recorded in a
separate accounts receivable account, and are classified as current assets on the balance
sheet if you expect to receive payment from customers within one year of the billing
date.

1
 To record a trade receivable, the accounting software creates a debit to the accounts
receivable account and a credit to the sales account when you complete an invoice.
When the customer eventually pays the invoice, the accounting software records the cash
receipt transaction with a debit to the cash account and a credit to the accounts
receivable account.

 Other accounts receivable. May include an array of miscellaneous receivables,

especially advances to employees and officers.
 Notes receivable. Includes notes from other parties. A common source is accounts
receivable that have been converted into notes.  A note is a written promise to repay money. A
company that holds notes signed by another entity has an asset recorded as a note. Unlike
accounts receivable, notes receivable can be long-term assets with a stated interest rate.
 Prepaid expenses. Includes any prepaid amounts that have not yet been consumed, such
as prepaid rent, insurance premiums, and advertising. Prepaid expenses, like prepaid insurance,
are expenses that have been paid in advanced. Like accounts receivable, prepaid expenses are
assets because they are a claim to assets. If six months worth of insurance is paid in advance,
the company is entitled to insurance (a service) for the next six months in the future .

A prepaid expense is an expenditure that is paid for in one accounting period, but for which
the underlying asset will not be entirely consumed until a future period. An example of a
prepaid expense is insurance, which is frequently paid in advance for multiple future
periods; an entity initially records this expenditure as a prepaid expense, and then charges it
to expense over the usage period. Thus, if a company prepays $2,400 of insurance that will
cover a one-year period, the initial entry is to the prepaid expense (asset) account, with $200
of this amount being charged to expense in each of the following 12 months, until the entire
asset has been consumed.

A prepaid expense is listed within the current assets section of the balance sheet until the
prepaid item is consumed. Once consumption has occurred, the prepaid expense is removed
from the balance sheet and is instead reported in that period as an expense on the income
statement. If the total ending balance in the prepaid expenses account is quite small, it may
be aggregated with other assets and reported within an "other assets" line item on the
balance sheet.

When the amount of a prepaid expense is immaterial, the accountant may choose to
immediately charge it to expense. Doing so is more efficient than initially recording it as an
asset and then charging it to expense with multiple journal entries over a period of time.

 Other current assets. Includes any minor items not readily classified into one of the
preceding accounts. For example: Supplies - Many companies have miscellaneous assets that
are entire in product production that are too small and inexpensive to capitalize. These assets
are expenses when they are purchased. A good example is car factory’s bolts. It’s difficult to
account for each bolt as it is used in the assembly process, so they are just expensed.

Inventory

2
 Inventory consists of goods owned a company that is in the business of selling those goods. For
example, a car would be considered inventory for a car dealership because it is in the business
of selling cars. A car would not be considered inventory for a pizza restaurant looking to selling
it delivery car .

 Raw materials inventory. Includes materials that must be converted into their final form
through a production process.
 Work-in-process inventory. Includes goods that are in the process of being converted
into salable items.
 Finished goods inventory. Includes items that have been manufactured and are now
ready for sale.
 Merchandise inventory. includes goods that were purchased from suppliers in a ready-
for-sale condition.

Fixed assets

 Buildings. Includes the constructed or purchased cost of all buildings owned by the firm.
 Computer equipment. May include not only computer equipment, but also the cost of
more expensive software packages.
 Furniture and fixtures. Includes all furniture owned by the business.
 Land. Includes the cost of all land owned by the business. This account is not
depreciated.
 Leasehold improvements. Includes the cost of all improvements made to property being
leased by the company as the lessee.

A leasehold improvement is a customization of rental property. Examples of leasehold

improvements are new carpeting, cabinetry, lighting, and walls. A tenant may want to invest
in leasehold improvements in order to adjust the characteristics of office or production space
to its specific needs. The landlord may pay for these improvements in order to improve
future lease rates for the rental property.

In accounting, a leasehold improvement is considered an asset of the tenant if the tenant

paid for it, the investment exceeds the capitalization limit of the tenant, and the
improvements will be usable for more than one reporting period. If so, the tenant records the
investment as a fixed asset and amortizes it over the lesser of the remaining term of the lease
or the useful life of the improvement. Upon termination of a lease, all leasehold
improvements become the property of the landlord.

 Machinery. Includes the cost of production equipment, conveyors, and so forth.

 Office equipment. Includes the cost of such office equipment as printers and copiers.
 Vehicles. Includes all vehicles, forklifts, and related equipment owned by the business.
 Accumulated depreciation. Represents the cumulative total of all depreciation charged
against fixed assets. This is a contra account.

3
 Accumulated depreciation is the total depreciation for a fixed asset that has been charged to
expense since that asset was acquired and made available for use. The accumulated depreciation
account is an asset account with a credit balance (also known as a contra asset account); this
means that it appears on the balance sheet as a reduction from the gross amount of fixed assets
reported.

The amount of accumulated depreciation for an asset will increase over time, as depreciation
continues to be charged against the asset. The original cost of the asset is known as its gross
cost, while the original cost of the asset less the amount of accumulated depreciation and any
impairment is known as its net cost or carrying amount.

The balance in the accumulated depreciation account will increase more quickly if a business
uses an accelerated depreciation methodology, since doing so charges more of an asset's cost to
expense during its earlier years of usage.

When the asset is eventually retired or sold, the amount in the accumulated depreciation account
relating to that asset is reversed, as is the original cost of the asset, thereby eliminating all
record of the asset from the company's balance sheet. If this derecognition were not completed,
a company would gradually build up a large amount of gross fixed asset cost and accumulated
depreciation on its balance sheet.

Calculating accumulated depreciation is a simple matter of running the depreciation calculation

for a fixed asset from its acquisition date to its disposition date. However, it is useful to spot-
check the calculation of the depreciation amounts that were recorded in the general ledger over
the life of the asset, to ensure that the same calculations were used to record the underlying
depreciation transaction.

For example, ABC International buys a machine for $100,000, which it records in the
Machinery fixed asset account. ABC estimates that the machine has a useful life of 10 years and
will have no salvage value , so it charges $10,000 to depreciation expense per year for 10 years.
The annual entry, showing the credit to the accumulated depreciation account, is:

After 10 years, ABC retires the machine, and records the following entry to purge both the asset and
its associated accumulated depreciation from its accounting records:

Intangible assets

4
 Broadcast licenses. Includes the cost to obtain broadcast licenses.
 Copyrights, patents, and trademarks. Includes the costs incurred to obtain these assets.
 Domain names. Includes the cost to acquire Internet domain names.
 Goodwill. Is comprised of the acquisition cost of an entity, less the fair value of all
identifiable assets.
 Accumulated amortization. Represents the cumulative total of all amortization charged
against intangible assets. This is a contra account

Accumulated amortization is the cumulative amount of all amortization expense that has been charged
against an intangible asset. The concept can also be intended to apply to all amortization that has been
charged to-date against a group of intangible assets. Amortization is used to indicate the gradual
consumption of an intangible asset over time. It is nearly always calculated on a straight-line basis. The
typical amortization entry is a debit to amortization expense and a credit to the accumulated amortization
account. Accumulated amortization is recorded on the balance sheet as a contra asset account, so it is
positioned below the unamortized intangible assets line item; the net amount of intangible assets is listed
immediately below it.

It is not common to report accumulated amortization as a separate line item on the balance sheet. More
typical presentations are to include accumulated amortization in the accumulated depreciation line item,
or to present intangible assets net of accumulated amortization on a single line item.

The cost of an intangible asset that has not yet been charged to amortization expense is called net of
accumulated amortization, and is calculated as the original cost of an intangible asset, minus its
accumulated amortization. When an intangible asset is terminated, the associated amount of accumulated
amortization is also removed from the balance sheet. Accumulated amortization differs from accumulated
depreciation in that accumulated amortization is associated with intangible assets, while accumulated
depreciation is associated with tangible assets.

LIABILITIES AND EQUITY ACCOUNTS

Current liabilities

 Accounts payable (payables or trade payables): any companies purchase inventory on credit
from vendors or supplies. When the supplier delivers the inventory, the company usually has 30 days to pay
for it. This obligation to pay is referred to as payments on account or accounts payable. No written contract
needs to be in place. The promise to pay can either be oral or even implied .

Accounts payable is the aggregate amount of one's short-term obligations to pay suppliers for products
and services that were purchased on credit. If accounts payable are not paid within the payment terms
agreed to with the supplier, the payables are considered to be in default, which may trigger a penalty or
interest payment, or the revocation or curtailment of additional credit from the supplier. The term can
also refer to the department that processes payables.

When individual accounts payable are recorded, this may be done in a payables subledger, thereby
keeping a large number of individual transactions from cluttering up the general ledger. Alternatively, if
there are few payables, they may be recorded directly in the general ledger. Accounts payable appears
within the current liability section of an entity's balance sheet.

Accounts payable are considered a source of cash, since they represent funds being borrowed from
suppliers. When accounts payable are paid, this is a use of cash. Given these cash flow considerations,

5
 suppliers have a natural inclination to push for shorter payment terms, while creditors want to lengthen
the payment terms.
From a management perspective, it is of some importance to have accurate accounts payable records, so
that suppliers are paid on time and liabilities are recorded in full and within the correct time periods.
Otherwise, suppliers will be less inclined to grant credit, and the financial results of a business may be
incorrect . 

Other types of payables that are not considered accounts payable are wages payable and notes
payable. The reverse of accounts payable is accounts receivable, which are short-term
obligations payable to a company by its customers.

 Accrued liabilities
Since accounting periods rarely fall directly after an expense period, companies often incur
expenses but don’t pay them until the next period. These expenses are called accrued liabilities.
Take utilities for example. The current month’s utility bill is usually due the following month. Once
the utilities are used, the company owes the utility company. These utility expenses are accrued and
paid in the next period.
An accrued liability is an obligation that an entity has assumed, usually in the absence of a
confirming document, such as a supplier invoice. The most common usage of the concept is when a
business has consumed goods or services provided by a supplier, but has not yet received an invoice
from the supplier. When the invoice has not arrived by the end of an accounting period, the
accounting staff records an accrued liability; this amount is usually based on quantity information in
the receiving log and pricing information in the authorizing purchase order. The purpose of an
accrued liability entry is to record an expense or obligation in the period when it was incurred.
Examples of accrued liabilities are:
Accrued interest expense. A company has a loan outstanding, for which it owes interest that has
not yet been billed by its lender at the end of an accounting period.
Accrued payroll taxes. A business incurs a liability to pay several types of payroll taxes when it
pays compensation to its employees.
Accrued pension liability. A company incurs a liability to pay its employees at some point in the
future for benefits earned under a pension plan.
Accrued services. A supplier provides services to a company, but has not billed the company by
the end of an accounting period, because it takes time to compile billings from the time sheets of
its employees.
Accrued wages. A company owes wages to its hourly employees at the end of an accounting
period, for which it is not scheduled to pay them until the next period.
Non-current liabilities

 Debt
Debt is an amount owed for funds borrowed. The lender agrees to lend funds to the borrower
upon a promise by the borrower to pay interest on the debt, usually with the interest to be paid at
regular intervals. A person or business acquires debt in order to use the funds for operating
needs or capital purchases. In a business, debt may also be used as the source of funds for
buying back shares in the business or to acquire another organization.

6
 Debt may be secured by an entity's other assets, which will become the lender's property if the
entity cannot pay back the debt. Alternatively, the debt may be unsecured. Debt may also be
guaranteed by a third party, such as an owner or a corporate parent.

A lender may impose certain covenants as part of a debt agreement, such as a requirement that a
current ratio of at least 2:1 be maintained, or that no dividends be paid as long as the debt is
outstanding. If the borrower breaches a covenant, the lender is permitted to call the loan, thereby
forcing its immediate repayment by the borrower.

The debt is commonly divided into two types:

Bonds Payable – Many companies choose to issue bonds to the public in order to finance future
growth. Bonds are essentially contracts to pay the bondholders the face amount plus interest on the
maturity date. Bonds are almost always long-term liabilities.

Notes Payable – A note payable is a long-term contract to borrow money from a creditor. The most
common notes payable are mortgages and personal notes.

 Unearned Revenue – Unearned revenue is slightly different from other liabilities because it
doesn’t involve direct borrowing. Unearned revenue arises when a company sells goods or
services to a customer who pays the company but doesn’t receive the goods or services. In
effect, this customer paid in advance for is purchase. The company must recognize a liability
because it owes the customer for the goods or services the customer paid for.

 Other liabilities

Equity

 Common stock
Common stock is an ownership share in a corporation that allows its holders voting rights at
shareholder meetings and the opportunity to receive dividends. If the corporation liquidates,
then common stockholders receive their share of the proceeds of the liquidation after all
creditors and preferred stockholders have been paid. This low level of liquidation preference can
present a danger of lost funds when an investor owns the common stock of a business that is in
financial difficulties. However, if a business is highly profitable, most of the benefits accrue to
the common stockholders.

In many states, law requires that a par value be assigned to each share of common stock. Par
value is technically the legal price below which a share of stock cannot be sold. In reality, par
value is routinely set at the minimum possible amount, and is not even required under the
incorporation laws of some states. Thus, par value is irrelevant in most cases.

The dollar amount of common stock recognized by a business is stated within the equity section
of the company balance sheet. The amount of common stock that a business records is split
between the common stock account and the additional paid-in capital account; the sum total
recorded matches the price at which the company sold shares to its investors.

7
 Retained earnings
Retained earnings are the profits that a company has earned to date, less any dividends or other distributions
paid to investors . This amount is adjusted whenever there is an entry to the accounting records that impacts a
revenue or expense account. A large retained earnings balance implies a financially healthy organization. The
formula for ending retained earnings is:

Beginning retained earnings + Profits/losses - Dividends = Ending retained earnings

A company that has experienced more losses than gains to date, or which has distributed more dividends than
it had in the retained earnings balance, will have a negative balance in the retained earnings account. If so,
this negative balance is called an accumulated deficit .

The retained earnings balance or accumulated deficit balance is reported in the stockholders' equity section of
a company's balance sheet.

A growing company normally avoids dividend payments, so that it can use its retained earnings to fund
additional growth of the business in such areas as working capital , capital expenditures , acquisitions, research
and development, and marketing. It may also elect to use retained earnings to pay off debt, rather than to pay
dividends. Another possibility is that retained earnings may  be held in reserve in expectation of future losses,
such as from the sale of a subsidiary or the expected outcome of a lawsuit.

As a company reaches maturity and its growth slows, it has less need for its retained earnings, and so is more
inclined to distribute some portion of it to investors in the form of dividends. The same situation may arise if
a company implements strong working capital policies to reduce its cash requirements.

When evaluating the amount of retained earnings that a company has on its balance sheet, consider the
following points:
Age of the company. An older company will have had more time in which to compile more retained earnings.
Dividend policy. A company that routinely issues dividends will have fewer retained earnings.
Profitability. A high profit percentage eventually yields a large amount of retained earnings, subject to the two
preceding points.
Cyclical industry. When a business is in an industry that is highly cyclical, management may need to build up
large retained earnings reserves during the profitable part of the cycle in order to protect it during downturns.
Working capital definition
Working capital is the amount of an entity's current assets minus its current liabilities. The result is
considered a prime measure of the short-term liquidity of an organization. A strongly positive working
capital balance indicates robust financial strength, while negative working capital is considered an indicator
of impending bankruptcy. The operational efficiency, credit policies and payment policies of a business have
a strong impact on its working capital.

A 2:1 ratio of current assets to current liabilities is considered healthy, though the ratio can vary by industry.
The ratio may also be reviewed on a trend line, with the intent of spotting any declines or sudden drops that
could indicate liquidity problems.

As an example of the calculation of working capital, a business has $100,000 of accounts receivable,
$40,000 of inventory, and $35,000 of accounts payable. Its working capital is:

8
$140,000 Current assets - $35,000 Current liabilities = $105,000 Working capital