Module 3 – Principles of Accounting

Name: __________________________________________________ Date Submitted: ___________

Subject Code : Actg 1 Descriptive Title : Principles of Accounting

Module Content: The Five Major Accounts

Learning Competencies:
 Identify and define the various accounts used in accounting for business transactions
 Identify the normal balance of an account
 Define, identify, and classify accounts according to the five major types.
 Describe the Chart of Accounts and explain its purpose

Introduction

In the previous module, you have learned the different elements of financial statements and
these are assets, liabilities, equity, income and expense. Some examples of each element are cash,
accounts receivable, accounts payable and notes payable. In accounting, these examples are known
as account. Learning the preparation of accounting journal entries require adequate knowledge of the
different account titles used in accounting.
In this module, you will be able to identify and define the various account titles used in
accounting for business transactions and its normal balances, discuss the five major account and
describe and know the importance of a chart of accounts.

What is an account?

An account is a specific example of a certain element of

financial statements. It is a unique record for each type of asset,
liability, equity, income and expense. It is a form where a
business records an increase or decrease of a specific asset,
liability, equity, income or expense. It helps businesses in
recording, classifying and summarizing financial transactions and
events. The parts of an account are Left Side (Debit) and the
Right Side (Credit).

Types of Accounts

Since an account is a specific example of an element of financial statements, there are many
accounts the company may have, depending on the need of the business. It depends upon the
management as to what to be set up for recording and reporting different transactions. These
accounts are grouped as follows:
1. Real accounts - These are permanent accounts with balances carried forward to the next
accounting period. These include assets, liabilities, and capital accounts.
2. Nominal accounts - These are temporary accounts with balances closed at period-end.
These include income, expenses, and drawing accounts.
3. Contra account - It can be a real or nominal account with a balance that opposes the
normal balance of related account; hence, it must be deducted from the account to which
it is related. It can be a contra asset, contra liability, contra income, and contra expense.
4. Adjunct accounts - These can be a real or nominal account with a balance that is added
to the account to which it is related.

Major Accounts: Definition, Classifications, and Examples

The major accounts in accounting are assets, liabilities, owner’s equity, revenues, and
expenses. Though revenues and expenses are under owner's equity account, they are shown
separately because they are the main income statement accounts. So, effectively, there are five
major accounts.
Assets can be classified further into two. These are current assets and noncurrent assets.
Current assets are those reasonably expected to be realized in cash within one year from the
reporting date or the normal operating cycle, whichever is longer. If an asset cannot be classified as
current, then its rightful classification is noncurrent asset. If future economic benefits of the asset
exceed one year, then the operating cycle of the business is the basis for the asset classification.
Operating cycle is the average time it takes the business to turn the cash used in the business to
cash received from selling goods or rendering services.
Examples of asset accounts include:
 Cash – is a generic account. Some companies that engage in simple transactions usually
use this account, which could either be on hand or in the bank. However, for a company
to be more effective in directing its business, cash can be made more specific. The
following are the specific names of cash used in academic field, as well as in the industry:
o Cash on Hand – denotes to money or cash substitutes representing the collection of
the company awaiting deposit to the company’s depository bank
o Cash in Bank - denotes to the money of the company that is in in the bank awaiting
payment
o Cash in Fund - denotes to money placed in a specific fund for a specific purpose (e.g.
Petty Cash Fund)
o Cash equivalents – refer to short –term investments made by the company.
 Investment in trading securities-This asset pertains to stocks or bonds acquired by an
individual or company with the intention of trading them for profit.
 Accounts receivable - This refers to open accounts which represent the amount of
money owed by the customers to the business.
 Notes receivable- This represents the amount of money owed by the customer or
debtors to the business evidenced by a promissory note.
 Inventories - These are assets held tor sale in the ordinary course of business, in the
process of production for sale or in the form of materials or supplies to be consumed in
the production process or in the rendering of services.
 Unused supplies - These are supplies which remain unused at the end of the accounting
period.
 Prepaid rent - This refers to an advance payment made by the business to cover for
future rental payments.
 Equipment - Manual or automated machines used in the business; they include
photocopying equipment, computers, laptops, ring binders, laminating machines, delivery
vehicles, and vans, among others.
 Furniture and fixtures - These are tables, chairs, filing cabinets, and display racks,
among others.
 Building This refers to the physical structure owned and used by the business to conduct
its business operations.
 Land-This refers to the physical site owned by the business where the building is situated.
It is not subject to depreciation.
 Allowance for doubtful accounts -This is a contra-asset or a valuation account which
refers to the portion of accounts receivable that is estimated to be uncollectible at the end
of a particular accounting period.
 Accumulated depreciation This is a contra-asset or a valuation account which refers to
the aggregate portion of the total cost of property, plant, and equipment that has been
charged to depreciation expense

Liabilities are present obligations of the entity to transfer an economic resource as a result
of past events. Simply put, these represent claims against the assets of the business. These are what
the business owes. These are called liabilities because they represent the current obligation of the
business, which arose from past transactions or events, and require an outflow of resources
embodying economic benefits.
Liabilities can be classified further into two. These are current liabilities and noncurrent
liabilities. Current liabilities are those reasonably expected to be settled by payment of cash, delivery
of goods, or performance of service within its normal operating cycle or within one year from the
reporting date, whichever is longer. Therefore, noncurrent liabilities are obligations reasonably
expected to be paid in cash beyond one year.
Examples of liability accounts include:
 Accounts payable - This refers to open accounts which represent the amount of money
owed by the business to creditors or suppliers.
 Notes payable - This represents the amount of money owed by the business to the
supplier or creditor evidenced by a promissory note
 Loan payable - This represents the amount of money borrowed by the business from
third party creditors.
  Mortgage payable -This represents the amount of money borrowed by the business
from a bank or a lending institution that is secured by collateral.
 Unearned Revenues (or Advances from Clients) - Cash collected by the business in
advance for a service or good that is yet to be rendered or delivered.

The owner’s equity is the residual interest in the assets of the entity after deducting all its
liabilities. It is the net difference between total assets and total liabilities. It represents ownership and
its terminology changes depending on the form of business organization. If it is a sole proprietorship
form of business organization, owner’s capital account is used and this is classified under owners’
equity or equity. The owner’s capital account is increased by the additional contribution of the owner
and recognition the net income of the business and decreased by withdrawals of the owner and
recognition of the net losses of the business.

Revenues are the earnings arising from the main line of operations of the business.
Revenues result from rendering of services or selling of goods. Income results from increases in
assets, or decreases in liabilities, that result in increases in equity, other than those relating to
contributions from holders of equity claims.
Examples of revenue accounts include:
 Service revenue - This refers to the earnings made by any business that is into
rendering services. The term "revenue is used and not "income to distinguish that such an
earning arises from the main line of operations of the business.
 Interest income - This represents interests credited by the bank to the account of the
business arising from bank deposits. Notice that the term "income' was used since earning
interests from bank deposits is not the main line of operations of the business.
 Sales-This represents the earnings made by any business that is into selling goods or
merchandise
 Professional fees- This represents earnings made by professionals or experts from
rendering services to their clients. Professionals include lawyers, doctors, and certified
public accountants, among others. Thus, this can be considered as a revenue account or
an expense account. To distinguish between the two, a company's chart of accounts
can have both professional fees income and professional fees expense.

Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity,
other than those relating to distributions to holders of equity claims.
Examples of cost and expenses accounts include:
 Utilities expense. This refers to costs associated with the usage of electricity, water, and
communication for a particular accounting period.
 Salaries expense - This refers to costs incurred associated with the services rendered
normally by permanent and full-time employees who are paid on a regular basis, usually
monthly.
 Taxes and licenses expense - This represents c incurred to register business, to acquire
the right to operate, and to settle taxes.
 Supplies expense - This refers to the amount of supplies that was used during a particular
accounting period.
 Doubtful accounts expense - This refers to the amount of accounts receivable that is
estimated as uncollectible and is recognized as an expense in the current accounting
period.
 Depreciation Expense - this refers to the allocated portion of the cost of property, plant,
and equipment charged to expense in the current accounting period.

Normal Balances and T-account

A normal balance is the usual balance of
an account assuming proper accounting has been
made. The T-Account is a visual aid used by
accountants to illustrate the effect of financial
transactions. From the name itself, T-account is
like a big letter “T”. The left side of the T is the
debit while the right side is the credit side. A T-
account is a simplified form of an account. Figure
1.1 shows the normal balance of each element of
financial statement illustrated using the T-account.
 Chart of Accounts

A chart of accounts is a listing of all the accounts and is usually tailored to the operations of
the business. It functions as a guide to the accountant or bookkeeper in ensuring uniformity and
consistency in the use of all the accounts in recording business transactions. Using a chart of
accounts would reduce the confusion as to the choice of account titles and permits to be used
uniformly in recording routine transactions. Most of the time, it is prepared in a manner such that the
five main or major accounts are grouped and organized. As such, at the earliest possible time, the
business should anticipate all specific accounts it may use in its lifetime that will be included in the
list. Moreover, businesses also assign a range of numbers (block) to major accounts to accommodate
additional specific accounts that may be created or might arise in the future. The table below is an
illustrative example of chart of accounts.

Account Account
Account Title Account Title
Number Number
Assets Income
101 Cash 401 Sales revenue
102 Accounts Receivable 411 Sales returns and allowances
103 Inventories 412 Sales discounts
104 Prepayments
111 Land Expenses
112 Building 501 Purchases
121 Accumulated Depreciation - Building 502 Purchase returns and allowances
503 Purchase discounts
Liabilities 511 Salaries Expense
201 Account Payable 512 Rent Expense
202 Notes Payable 513 Transportation Expense
203 Unearned Income 514 Depreciation Expense
515 Interest Expense
Owner's Equity
301 Owner's Capital
302 Owner's Drawings

EVALUATION
Read and answer the questions below. Write your answer in a separate sheet.

1. What is the effect of investments on the equity of the owner?

2. Why is it that there is a decrease effect on both liabilities and capital when a loan is
being paid?
3. Why is it that the total assets remain unchanged when supplies are purchased for
cash?
4. What are the two (2) elements that will have a decrease effect on capital?
5. What are the examples of secondary income and non-cash expenses?

References:
Ballada, Win, Ballada, Susan, Basic Accounting. DomDane Publishers & Made Esasy Books. 2018
Tan, Lorenzo G. et al, Fundamentals of Accounting 1. F&B Educational Inc.,2018.
Frias, Solita A, Pefianco, Erlinda C., Fundamentals of Accountancy, Business and Management: A
Textbook In Accounting 1. Phoenix Publishing House, 2020.
Ong, Flocer Lao. Fundamentals of Accountancy, Business And Management 1. C&E Publishing, Inc. 2016