What Does Account Mean?
What is the definition of account? There are five main types of accounts used in an accounting system. Each of these are represented in the expanded accounting equation. Assets = Liabilities + Owner’s Equity + Revenues – Expenses.
5 Types of accounts
Although businesses have many accounts in their books, every account falls under one of the following five categories:
- Revenue (or income)
Familiarize yourself with and learn how debits and credits affect these accounts. Then, you can accurately categorize all the sub-accounts that fall under them.
Let’s take a look at an example of each
Assets are resources that the company can use to generate revenues in current and future years. Asset accounts have a debit balance and are always presented on the balance sheet first.
Liabilities represent the debt obligations that the company owes to creditors. This can include bank debt as well as notes from owners. Liability accounts have a credit balance and appear below assets on the balance sheet.
Equity accounts represent the owner’s stake in the business. Equity is often called net assets because it shows the amount of assets that the owners actually own after the creditors have been paid off. You can calculate this by flipping the accounting equation around to solve for equity instead of assets.
Revenue and expense accounts are technically both temporary equity accounts, but they are significant enough to mention separately. Revenue accounts track the income generated by the business. These items have a credit balance and increase total equity.
Assets are the physical or non-physical types of property that add value to your business. For example, your computer, business car, and trademarks are considered assets.
Some examples of asset sub-accounts include:
- Petty Cash
- Accounts Receivables
Although your Accounts Receivable account is money you don’t physically have, it is considered an asset account because it is money owed to you.
Again, debits increase assets and credits decrease them. Debit the corresponding sub-asset account when you add money to it. And, credit a sub-asset account when you remove money from it.
Let’s look at an example. You sell some inventory and receive 500. You put the 500 in your Checking account. Increase (debit) your Checking account and decrease (credit) your Inventory account.
Expenses are costs your business incurs during operations. For example, office supplies are considered expenses.
Examples of sub-accounts that fall under the expense account category include:
- Cost of Goods Sold (COGS)
Remember that debits increase your expenses, and credits decrease expense accounts. When you spend money, you increase your expense accounts.
Let’s say you spend 1,000 on rent. You pay for the expense with your Checking account. Increase your Rent Expense account with a debit and credit your Checking account.
Liabilities represent what your business owes. These are expenses you have incurred but have not yet paid.
Types of business accounts that fall under the liability branch include:
- Payroll Tax Liabilities
- Sales Tax Collected
- Credit Memo Liability
- Accounts Payable
Accounts payable (AP) are considered liabilities and not expenses. Why? Because accounts payables are expenses you have incurred but not yet paid for. As a result, you add a liability, or debt.
Credit liability accounts to increase them. Decrease liability accounts by debiting them.
You buy 500 of inventory on credit. This increases your Accounts Payable account (credit). And, it increases the amount of inventory you have (debit). Your journal entry might look something like this:
Equity is the difference between your assets and liabilities. It shows you how much your business is worth.
Here are a few examples of equity sub-accounts:
- Owner’s Equity
- Common Stock
- Retained Earnings
Again, equity accounts increase through credits and decrease through debits. When your assets increase, your equity increases. When your liabilities increase, your equity decreases.
You invested in stocks and received a dividend of 500. To reflect this transaction, credit your Investment account and debit your Cash account.
Last but not least, we’ve arrived at the revenue accounts. Revenue, or income, is money your business earns. Your income accounts track incoming money, both from operations and non-operations.
Examples of income sub-accounts include:
- Product Sales
- Earned Interest
- Miscellaneous Income
To increase revenue accounts, credit the corresponding sub-account. Decrease revenue accounts with a debit.
Say you make a 200 sale to a customer who pays with credit. Through the sale, you increase your Revenue account through a credit. And, increase your Accounts Receivable account through a debit.