THE FIVE MAJOR ACCOUNTS AND PREPARING THE CHARTS OF ACCOUNTS

OBJECTIVES OF THE LESSON:

1. Familiarize the five major accounts.
2. Explain each of the five major accounts.
3. Appreciate the importance of these accounts in business decision making.
4. Prepare chart of accounts.

FIVE MAJOR ACCOUNTS

1. ASSETS - These are the resources owned by the business that will provide future benefits.

There are the two (2) classifications of assets:

A. Current Assets
B. Non- Current Assets

A. CURRENT ASSETS - Current assets are all assets which are expected to be realized within the ordinary course of
business, or a span of 12 months, whichever is longer (Florendo, 2016). Realization here only means that these assets
are expected to be converted into cash, sold, or disposed after a certain time, or through the passage of time.

Let us be acquainted with the terms related to Current Asset.

a. Cash- Cash is the most familiar of all assets and it is classified as a current asset. Not all cash includes money. Money
means everything composed of bills and coins, considered as legal tender (such as the Philippine Peso in the Philippines, or
legal tenders of other nations (such as the U.S. Dollar). Cash, on the other hand, also includes money in the form of bank
deposits in checking accounts and savings accounts. It can also include checks, such as those provided by customers in
payment for goods or services received. (Florendo 2016)

b. Accounts Receivable - amounts due from customers arising from credit sales or credit services. You and your friends
went to an internet café to play videogames. Suddenly your friend went offline because his time is out. Your friend asks you,
“Can I borrow money from you? I will pay you tomorrow.” Then you lend him money. Since you are receiving money from
your friend, in accounting terms, you have accounts receivable coming from your friend.

c. Short-term Investments - The short-term investments account contains the company’s investments in low-risk, highly
liquid assets such as bonds and stocks, which are expected to be liquidated in less than a year (Florendo, 2016). These are
investments made by the company that are intended to be sold immediately.

d. Notes Receivable - Just like accounts receivable, it is a promise to receive cash but unlike the latter, it is more formal. The
borrower can seek legal remedies to recover what has been lent. Because of its written nature (usually in the form of a
promissory note), the term or the maturity dates are longer compared to accounts receivable.

e. Inventories - Have you been to a warehouse? A grocery store? How about a sari-sari store? As you can see, there are lots
of products like diapers, candies, canned goods etc. hanging, on the shelves or on the counter. In accounting terms, these
products are inventory. Aside from the products for sale or goods available for sale, inventory also includes raw materials
and work-in- progress items.

f. Supplies - are items that are used to run the daily operations of a business. They are not necessarily a component of the
finished products that are sold to customers, but they play an essential role in the business function. Supplies are purchased
by an enterprise that is unused as of the reporting date, they serve as current assets until their use, and the they become
expenses. Examples: Office Supplies – papers, pens, inks, folders, staplers; Store Supplies – boxes, paper bags, strings,
napkins, straws; Utilities Supplies -
f. Prepayments/Prepaid Expenses- Advance payment for expenses. You bought a prepaid WIFI. You paid Php 1,399.00 for
1-month subscription. Remember, you still have not used the data. As long as your load balance or data is not yet depleted,
you are considered to have a prepayment in your list of assets. A prepayment is an amount simply paid in advance for goods
or services anticipated to be received by the entity in the future (Florendo 2016). Prepayments would end to be as such
when they are finally used up. This is applicable in the following examples like: • Rent – Prepaid Rent; • Utilities – Prepaid
Utilities Expense; • Insurance paid in advance – Prepaid Insurance

g) Accrued Income – is a revenue earned by a business for service performed or goods sold but payment or cash have not
yet collected.

B. NON-CURRENT ASSETS - Assets that do not meet the current asset classification are noncurrent assets. You must
remember that they don’t have to meet at least 12 months before their expected realization. These are assets that
cannot be collected, sold, and even used up to one year after year-end date.

Let us be acquainted with the terms related to Nonconcurrent Assets.

a. Long-term Investment - The investments that we are talking here are the company’s investments which you do not
expect to realize within 1 year. Investment accounts such as real estate, long-term notes, government treasury bills, and
funds that are set aside for long-term purposes. You might hear of SSS and GSIS from your parents. From your parents’
point of view, these are long-term investments because they will be able to recover these through pension when they
retired.

b. Fixed Assets or Property, Plant and Equipment - Why is it called fixed asset? These assets are the most tangible of all
assets. It is longest-serving assets a business/institution/company can have. They cannot be converted into cash since they
are regularly placed as means of production. Collectively, these fixed assets can also be called as property, plant and
equipment (PPE). The following are the examples of fixed assets:
a) Land
b) Land improvements
c) Buildings
d) Machineries
e) Equipment
f) Furniture and Fixtures

c. Intangible Assets - Unlike fixed assets, these intangible assets lack physical substance, yet they are realizable over long
period of time. Most likely, they are represented by written documents or certificates stating their description and
ownership status. Prime examples are:
a) Patents -rights granted for an invention
b) Copyright – rights that creators or authors have over their literary and artistic works
e) Trademark – word/s, symbol, design that distinguish product from other products

2. LIABILITIES - These are the rights of the creditors that represent the debt of the business. Have you tried to
borrow money from a friend or a classmate? If you borrow money, you have a responsibility or liability to return the
money borrowed in due time. It may be with interest or the principal amount only. Liabilities are the debts and
obligations of a business to another entity.

There are the two (2) classifications of liabilities:

A. Current Liabilities or Short-term Liabilities
B. Non- Current Liabilities or Long-term Liabilities

A. CURRENT LIABILITIES - These are company’s short-term financial obligations that are due within one year or within a
normal operating cycle of a business. These liabilities must be settled or paid out within 12 months. Current liabilities are
typically settled using current assts. Cash is not always involved in paying a liability, it can include conversion and/or
refinancing.

a. Accounts Payable - amounts due, or payable to, suppliers for goods purchased on account or for services received on
account. In accounts payable, the entity of the paying side is the borrower while in accounts receivable, the entity of the
receiving side is the creditors.

b. Notes Payable - amounts due to third parties supported by promissory notes. Just like in notes receivable, notes payable
are written promises of the borrower to pay a certain sum of money. Usually it arises from larger trade or business
transactions which it is so necessary for additional formality, but it can also arise from the regular borrowings of the entity.
It is the opposite of the notes receivable.

c. Accrued Expenses or Accrued Liabilities - Accrued liabilities or accrued expenses are all other accounts which the
company should pay, arising from the normal course of business. Throughout the operating cycle, it is very much possible
that the company has already received benefits from certain events yet has still been unable to pay for It (Florendo, 2016).
For example, you are building a house. You have four carpenters. These carpenters already finished building your kitchen,
although you already benefited from their services still you just paid them after a week. Another example is your postpaid
internet connection, water supply or electric supply. You enjoyed the benefits of these things within a month, yet you have
not paid them. Same goes with rent, taxes and insurance.

d. Unearned Income - is cash or payment collected in advance. The liability is the services to be performed or the goods to
be delivered in the future.

e. Other Payables - These are payables that can be paid within a year but do not fall on the classifications listed above. The
examples are dividends payable and interest payable, and payables arising from lawsuits.

B.NON-CURRENT LIABILITIES - are long-term financial obligations. By strict definition, these are liabilities which the entity
expects to settle after more than a year or have the legal or contractual capacity to defer payment accordingly (Florendo,
2016).

a) Loans Payable - is a contract wherein the owner of the property gives the right to use it to another party in exchange
for an interest payment and gives back the property at the end of their contract. It is documented by promissory note.
And in the case there is still a portion which is unpaid as of the date of a company's balance sheet, the remaining
balance on the loan is called a loan payable.

b) Mortgage Payable - is the liability of a property owner to pay a loan that is secured by property and from the
borrower’s point of view. The mortgage is considered as long-term liability. Some part of the debt that is payable within
the next 12 months is classified as a short-term liability. The remaining unpaid principal will be the total amount due of
the loan.

3. EQUITY / OWNER’S CAPITAL / STOCKHOLDER’S EQUITY - Owner’s Equity is the

residual interest of the owner from the business. This refers the rights of the owners in the business. This is the amount by
which the business assets exceed business liabilities. It can be derived by deducting liabilities from assets.

To illustrate the concept, assuming you want to start a business. The problem is you don’t have assets like materials,
equipment, raw materials etc. to start a business. Hence, you borrowed cash from a lending institution. Technically you and
the lending institution are the owners of the business. Since you have the obligation to pay for the loan, the lending
institution has a greater claim for the asset of the business. To know how much you own in your business, you must deduct
the amount that you need to pay for the lending institution from the total asset of your business.
Equity is called owner’s capital or owner’s equity in the case of a sole proprietorship or a partnership. It is called
shareholders’ equity or stockholders’ equity in the case of a corporation.
 Elements that comprised the Equity:
Capital/Investment - is the value of cash and other assets invested in the business by the owner of the business.
Drawing or Withdrawals – the amounts taken out of a business by the owner for personal use.
Income/Revenue-
Expenses-

4. INCOME - is the net of revenues and expenses. For example, a merchandiser’s income from its operations is its net
sales minus the cost of goods sold, minus its operating expenses. The equity will increase because of the result of income,
revenues, gains, or capital contributions. Revenues according to Joselito G. Florendo from his book Fundamentals of
Accountancy, Business and Management 1, are the amounts received by a business earned main operating activities as a
result of selling something or rendering a service. Revenues are recognized when incurred and when entity already incurs
the related expenses. For example, you are an online seller selling face shields. Your customer paid you in advance even
though the products is not yet delivered. Only when you already incurred the expenses while delivering the face shields and
after paying the supplier only then you can recognize your revenue. The cash that you received is called deferred revenue
and is considered a liability.

Revenues can be classified as follows:

1. Operating Revenue – These are the revenues originated from main business operations like sales, service revenue etc.
2. Non-operating Revenue – These are results of some activities like interest revenue, rent revenue of a business not
engaged in the renting industry) which do not originate from the main business operations.

Examples of revenue accounts are the following:

1. Sales Revenue – main source of revenue for business for selling products
2. Service Revenue – main source of revenue for business that renders services
3. Interest Revenue – revenue earned as a result of investment in debt securities or receivables from other entities
4. Dividend Revenue – revenue earned as a result of dividend declaration of a company where in a business has invested
stocks

Gains according to Joselito G. Florendo from his book Fundamentals of Accountancy, Business and Management 1, are
increases in equity as a result of non-recurring activities or the increase in value of investments. Non-recurring includes the
sale of company non-current asset. A gain is the result of a peripheral activity, such as a retailer selling one of its old truck. A
gain occurs when the cash amount (or its equivalent) received is greater than the asset’s book value.

5. EXPENSES are the amount that a company consumes or incurs so that it can operate to generate income for the
business. Just like revenues, it is a result of the day-to-day operation of the business but not necessarily that an expense will
be the amount of cash used up in a given period.

Examples of Expenses accounts are the following:

1. Cost of goods sold – when inventory is sold, the cost of goods sold reflects what the company incurred to make the
inventory sell (in manufacturing companies) or to buy them (in merchandising companies)
2. Utility Expense – it includes the water and electricity used by the company to be paid to the utility companies like NEECO
and Munoz Water District.
3. Depreciation Expense – is a cost or expense assigned to the use of fixed asset or property, plant and equipment, except
land.
4. Office Supplies Expense – a result of purchasing office supplies
5. Insurance Expense – it is a result of paying insurances
6. Salaries Expense – it is a result of recognizing the hard work of the employees by paying them salaries
7. Bad Debt Expense – an estimate of how much accounts receivable the company will not be able to collect
8. Interest Expense – When you borrow money, there is an interest that you must be paid that added to the principal
amount borrowed.

PREPARING CHART OF ACCOUNTS

The following is a sample lecture for setting up a 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

Instruction: Read each statement below. Choose the letter of your best answer. Write your
answer in a separate sheet of paper.
1. Which of the following is a disadvantage of owning a common stock?
a. Common stockholders have the rig