Introduction to Accounting Module 1

MODULE 1

INTRODUCTION TO ACCOUNTING

ACCOUNTING DEFINED

Accounting is a service activity whose function is to provide quantitative information, primarily financial in
nature, about economic entities, that is intended to be useful in making economic decisions. In general
sense, Accounting is an information system that provides reports to stakeholders about economic activities
and condition of a business.

ROLE OF ACCOUNTING IN BUSINESS:

1. Help the owners or management make decisions.

2. Record and analyze business transactions.
3. Communicate financial information to all interested parties.

TYPES OF BUSINESS:

1. Service business – entities that provide services to customers (e.g. schools, insurance companies,
accounting or law firms, repair shops, transportation companies, etc.)
2. Merchandising business – entities that purchase products from other businesses and sell them to
customers, (e.g. retailers, wholesalers, groceries, department stores, hardwares, drugstores, etc.).
3. Manufacturing business – entities that convert raw materials into finished products which are sold
to customers. (e.g. manufacturer of food, clothing, medicines, toys, furniture, fixtures, equipment,
etc.)

TYPES OF OWNERSHIP STRUCTURE (Forms of Business Organization):

1. Proprietorship – is a business that is owned and operated by a single individual (the owner is called
proprietor).
2. Partnership – is a business that is owned by two or more individuals (the owners are called
partners).
3. Corporation – is a business whose capital is divided into shares of stock and is created by operation
of law. (the owners are called stockholders).
4. Cooperative – is a business that is exempt from taxation. (the owners are called members).

Characteristics of the Different Forms of Business Organization:

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BASIC ELEMENTS OF ACCOUNTING (Accounting Values):

Statement of Financial Condition Elements (Shows the Financial Condition of the Business)

1. Assets – economic resources that have values and owned by the business. Included in this element
are cash, receivables, inventory, land, building, machinery, furniture and equipment.
2. Liabilities – economic or legal obligations that a business owes to other businesses or individuals.
Included in this element are accounts payable, notes payable, loan payable, payables to government
and unpaid (accrued) expenses.
3. Owner’s Equity - is the owner’s interest in, or claim to, the assets of a business. It is the difference
between the amount of assets and amount of liabilities.

Statement of Comprehensive Income Elements (Shows the Results of Operations)

1. Revenues – inflows of assets resulting from the sale of goods or services. Revenues increase owner’s
equity.
2. Expenses – outflows of assets resulting from cash spent or liability incurred in order to produce
revenue. Expenses decrease owner’s equity.
3. Net Income (Loss) – the excess (deficit) of revenue over expenses for a given accounting period.
Net income increase owner’s equity while net loss decreases owner’s equity.

THE ACCOUNTING PROCESS (Functions of Accounting)

Accounting is a measurement and communication process designed to provide useful and timely financial
information. Its functions are the following:

1. Recording – this is more popularly known as BOOKKEEPING, which involves putting into records
the business transactions and events. This can be done manually, with the use of mechanical devices
or electronically, or with the use of computer.
2. Classifying– this involves the grouping of similar items together in order to make the recording of the
different transactions and events more systematic
3. Summarizing – this involves the preparation of financial statements.
4. Interpreting– this involves the analysis of financial statements (by developing financial ratios and
explaining their significance) for the benefit of the readers or users.

RECORDING OF THE BUSINESS TRANSACTIONS

THE ACCOUNTING EQUATION

The relationship between the three basic accounting elements of the Statement of Financial Condition –
Assets, Liabilities, and Owner’s Equity – can be expressed in the form of a simple equation known as the
Accounting Equation. All accounting information is recorded within the framework of the accounting
equation. The basic accounting equation is shown below:

Assets = Liabilities + Owner’s Equity

P500,000 = P200,000 + P300,000

or

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Assets - Liabilities = Owner’s Equity

P500,000 - P200,000 = P300,000

The equality of the accounting equation is always maintained for every transaction that is recorded. The
peso amount on the left side of the equation (called DEBIT) should always equal to the peso amount on the
right side of the equation (called CREDIT). If assets increase, liabilities and/or owner’s equity must increase
by the same amount. Conversely, if assets decrease, there will be a corresponding decrease by the same
amount in the liabilities and/or owner’s equity. An increase in an asset may also have a corresponding
decrease in another asset or an increase in a liability may also have a corresponding decrease in another
liability by an equal amount.

BUSINESS TRANSACTION

Business Transaction – is an economic event or condition that directly changes an entity’s financial
condition or directly affects its results of operations. An accounting transaction takes place when a business
exchanges a thing or things of value for another. Business transactions are recorded in terms of debit and
credit. DEBIT is the value received or paid for by the business while CREDIT is the value parted with or
given up by the business. This is called the dual effect of a transaction. This is illustrated in the next page.
Business transactions will affect the accounting elements but the equality of the accounting equation will be
maintained. The analysis of the effects of a transaction in the accounting elements is illustrated in page 5
(see expanded accounting equation).

FINANCIAL STATEMENTS

Accounting Period – the period at the end of which financial statements are prepared. The
accounting period usually covers one year because it jibes with the payment of the annual income
taxes.
Calendar Year – a 12-month period ending December 31.
Fiscal Year – 12-month period not ending December 31.
Natural Business Year – a 12-month period which ends at the time the business activity
is at this lowest.

Financial Statements – are accounting reports prepared at the end of an accounting period (usually one
year) that provide financial information regarding the transactions that have been recorded and summarized.
The principal financial statements which are the end-products of accounting are the:

Statement of Comprehensive Income – also called as the Statement of Comprehensive Income, is a

statement, which shows the revenue and expenses for a specified period of time. It shows the results of
operations..

Statement of Changes in Equity - is a statement, which shows the summary of changes in the owner’s
equity for a given period of time. This statement supplements the Statement of Financial Condition.

Statement of Financial Condition - is a statement which shows the assets, liabilities and owner’s equity
of the business as of a specific date. It shows the financial condition of the business.

Statement of Cash flows – is a summary of cash inflows and cash outflows for a specific period of time,
such as a month or a year.

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METHOD OF BOOKKEEPING

Every business transaction affects at least two accounts (items). When you record the peso amount of a
transaction in one account, you record that same amount in another account. This is done to keep both
sides of the accounting equation equal or in balance.

The “double-entry system” is used because you are recording the amount involved in a transaction twice.
The fact that each transaction has a dual effect on the accounting elements is the basis for the double-
entry method of bookkeeping.

Double-Entry Method of Bookkeeping – is a method of recording the business transactions in terms of

the dual effect on the accounting elements (i.e., assets, liabilities, owner’s equity, revenues and expenses).
In other words, the transactions are recorded in terms of the increase or decrease in the accounts that are
affected.

An Account – is an accounting device used to classify and store information about the increases and
decreases in a particular item.

THE T ACCOUNT

The T account, is so called because of its T shape. It is used to show the increase or decrease in an account
(item) caused by a transaction. It is a convenient tool to analyze and record the effect of a transaction in a
particular account (item).

The T account has a TOP, a LEFT SIDE and a RIGHT SIDE. On the Top of the T is the title or name of the
Account. Amounts recorded on the left side are called DEBIT amounts while amounts recorded on the right
side are called CREDIT amounts.

RULES OF DEBIT AND CREDIT

Debits and credits are used to record the increases and decreases in each account affected by a
business transaction. To understand how transactions are recorded in the books (called books of
accounts) in terms of debits and credits, one should know first which side are the different accounting
elements. The accounting equation below will determine which side are the different accounting
elements or which side is a particular account (item)
.

ASSETS = LIABILITIES + OWNER‘S EQUITY

The left side of the accounting equation has been traditionally called the DEBIT side (abbreviated DR)
while the right side of the accounting equation is called the CREDIT side (abbreviated CR). All the asset
accounts therefore, being on the left side are debits and all liabilities and owner’s equity accounts, being
on the right side are credits.

RULES OF ADDITION AND SUBTRACTION BY POSITION

Add on the same side and subtract on the opposite side.

Rules For Asset Accounts:

1. Add (increase) on the same side (debit).

2. Subtract (decrease) on the opposite side (credit).

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3. The normal balance for an asset account is a debit balance.

Asset Accounts
Debit Credit
Increase + Decrease –
Balance

Rules For Liability and Owner’s Equity Accounts:

1. Add (increase) on the same side (credit).

2. Subtract (decrease) on the opposite side (debit).
3. The normal balance for a liability or owner’s equity account is a credit balance.

USING THE T ACCOUNT

Being familiar with the rules of debit and credit for asset, liability, and capital accounts, these rules will be
applied by using an example problem.

TRIAL BALANCE

A Trial Balance – is a listing of all the balances of the different accounts (assets, liabilities, capital, revenues
and expenses), as of a given time. This is prepared at the end of each month. The total of all the accounts
with debit balances must equal with the total of all the accounts with credit balances. If not, then an error in
posting (recording in the T account) must have been committed.

Purposes of the Trial Balance:

1. To check the accuracy of posting (recording in the T accounts) by testing the equality of the
debits and credits.
2. It aids in locating errors in posting.
3. It serves as a basis in the preparation of the financial statements.

BUSINESS TRANSACTION FLOW

Source Journal Ledger Trial Financial

Documents to Entries to Accounts to Balance to Statements

Source Documents – are the different documents, business forms and papers (e.g. invoices, official
receipts, vouchers, memoranda, deposit slips, check stubs, cash register tapes, payroll time cards, etc.)
evidencing or supporting a transaction, which serve as the basis for recording in the books of accounts.

Books of Accounts – are the accounting books where business transactions are recorded. The
books of accounts consist of the GENERAL JOURNAL and the GENERAL LEDGER.

The General Journal – this is a two-column journal, which is called the book of original entry because this
is the first book where the business transactions are recorded.

The General Ledger - this is called the book of final entry because this is the book where the business
transactions are finally recorded. The ledger serves the same purpose as the T account but more formal
and detailed.

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After the transactions are recorded in the general journal in terms of debit and credit, the transaction will be
further recorded in the general ledger. The process of recording in the journal is called JOURNALIZING
while the process of recording in the general ledger is called POSTING.

THE GENERAL JOURNAL

Many kinds of journal are used in business. One of the most common is the two-column general journal. It
is an all-purpose journal in which all the business transactions may be recorded. Each entry made in the
general journal includes the following information, entered in this order:
1. The date of the transaction.
2. The name of the account debited as well the amount.
3. The name of the account credited as well as the amount.
4. A posting reference (PR) indicating the account number of the account.
5. A short explanation of the transaction.

Samples of entries in the General Journal

Jan. 1 J Cruz, the owner invested cash in the business, P 50,000

GENERAL JOURNAL

Date Description P.R Debit Credit

Jan. 1 Cash 101 5 0 0 0 0 00
J. Cruz, Capital 301 5 0 0 0 0 00
Initial investment

Jan. 2 Paid advertising expense, P 51,331.50

GENERAL JOURNAL
Date Description P.R Debit Credit
Jan, 2 Advertising Expense 501 5 1 3 3 1 50
Cash 101 5 1 3 3 1 50
Advertising exp. Paid.

NOTE: The account debited is on the extreme left (under the description column) while
the account credited is indented a little to the right. This is to distinguish the debit
entry from the credit entry. The short explanation below the credit entry is likewise
indented to the right to distinguish it from the credit entry.

CHART OF ACCOUNTS

Chart of Accounts – is a list of all account titles and their account (code) numbers used for journalizing
business transactions.

Order of Listing the Accounts – The accounts are normally listed in the order in which they appear in the
financial statements. The Statement of Financial Condition accounts first, in the order of assets, liabilities
and owner’s equity. The Statement of Comprehensive Income accounts are then listed in the order of
revenues and expenses.

Numbering (Coding) of the Accounts – An account number identifies the account. Account numbers may
have three, four or more digits. The number of digits to be used will vary depending on the nature and size
of the business. See samples in the next page.

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Sample Chart of Accounts (Service Business)

Statement of Financial Condition accounts Statement of Comprehensive Income accounts

100 - Assets 400 - Revenues

101 - Cash 401 - Service Income
102 - Accounts Receivable
103 - Unused Office Supplies 500 - Expenses
104 - Prepaid Rent 501 - Salary Expense
121 - Delivery Equipment 502 - Advertising Expense
122 - Accumulated Depreciation - 503 - Communication Expense
Delivery Equipment 504 - Office Supplies Expense
505 - Rent Expense
200 - Liabilities 506 - Insurance Expense
201 - Accounts Payable 507 - Miscellaneous Expense
202 - Salaries Payable 508 - Depreciation Expense

300 - Owner’s Equity

301 - Brandon Lopez, Capital
302 - Brandon Lopez, Drawing
303 - Income Summary

Sample Chart of Accounts (Merchandising Business)

Statement of Financial Condition Accounts Statement of Comprehensive Income Accounts

100 - Assets 400 - Revenues

101 - Cash 401 -Sales
102 - Notes Receivable 402 -Sales Returns & Allowances
103 - Accounts Receivable 403 -Sales Discounts
104 - Allowance for Impairment Loss
105 - Interest Receivable 500 - Cost of Sales
106 - Merchandise Inventory 501- Purchases
107 - Supplies Inventory 502- Freight-in
108 - Prepaid Insurance 503- Purchase Returns & Allowances
110 - VAT Input Tax 504- Purchase Discounts
121 - Delivery Equipment
122 - Accumulated Depreciation - 600 - Operating Expenses
Delivery Equipment
123 - Store Equipment 601- Sales Salary Expense
124 - Accumulated Depreciation - 602- Advertising Expense
Store Equipment 603- Commission Expense
125 - Office Equipment 604- Delivery Expense
126 - Accumulated Depreciation - 605- Misc. Selling Expense
Office Equipment 606- Depreciation Expense – Delivery Equipment
607 -Depreciation Expense - Store Equipment

200 - Liabilities 608-Depreciation Expense – Office Equipment

201 Accounts Payable 609 -Rent Expense
202 Notes Payable 610- Insurance Expense
203 Accrued Sundry Payable 611- Office Supplies Expense
210 VAT Output 612- Impairment Loss
211 VAT Payable 700 – Other Income
300 - Owner’s Equity 701 -
Interest Income 301 Mary Modern, Capital

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302 Mary Modern, Drawing 800 –Other

Expense 303 Income Summary 801 - Interest
Expense

NOTE: All Statement of Financial Condition accounts are called REAL ACCOUNTS and all Statement of
Comprehensive Income accounts are called NOMINAL ACCOUNTS.

THE GENERAL LEDGER

General Ledger is a book or file by a business where accounts are kept on separate pages or cards. In a
computerized accounting system, accounts are kept on magnetic tapes or disks but the accounts as a group
are still referred to as the ledger, or the ledger accounts. This is called the book of final entry because this
is where the transactions are finally recorded. This is the T account expanded and formalized as a book.

The traditional general ledger format is shown below. For each account, one ledger is opened. The
account title or name is written in the middle and the account number is written on the right hand corner
of the account name. The ledger has the following column headings:

Left Side (Debit Side) Right Side (Credit Side)

1. Date 1. Date
2. Participants 2. Participants
3. Posting reference (PR) 3. Posting reference (PR)
4. Amount of debit entry 4. Amount of credit entry

Account Name Account Number

Date Particulars PR Debit Date Particulars PR Credit

Opening Accounts in the General Ledger

Before the entries in the general journal can be posted to the general ledger, an account must be opened
for all the accounts listed in the chart of accounts.

A trial balance is prepared to check the accuracy of posting to the general ledger and to
prove the equality of the debits and credits. If the trial balance is imbalance, error/s in the recording
in the general journal as well as posting to the general ledger must have been committed and must
be located.

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However, a balanced trial balance (the total of the debit column is equal to the total of the
credit column) does not necessarily mean that no errors have been committed. The following errors
cannot be detected by the trial balance:

1) No entry was made for a given transaction.

2) A journal entry was not posted to the general ledger.
3) A journal entry was posted twice.
4) Incorrect accounts were used to record a given transaction.
5) Incorrect amounts were recorded for a given transaction.

If the trial balance does not balance, the following are the common mistakes or errors:

1. Error in addition or subtraction in the general ledger or error in addition in the trial balance
itself.
2. Error of transposition, which means that digits are incorrectly interchanged. (eg. P 890 is
recorded as P 980.
3 Slide error or transplacement error, which means error in placing the decimal point. (eg.
P 150.00 is recorded as P 15.00)

Short Cuts in Locating Error/s in the Trial Balance

If the total of the debit column in the trial balance is not equal to the total of the credit column,
the following procedures may be followed to detect the error/s:

1. Get the difference between the total debits and total credits.
2. A difference of 10, 100, 1,000, etc., would probably indicate a simple error in addition either in the
trial balance or the general ledger.
3. If the difference is divisible by two,(2), the error would probably be in posting to the wrong side
(i.e., a debit is posted on the credit side or vice versa).
4. If the difference is divisible by nine (9), the error would probably be an error in transposition
or error in transplacement.

Procedures to Correct Errors in Journalizing or Posting

1. Draw a straight horizontal-line through the error and insert the correct title or amount if the
entry is incorrect or the posting is incorrect.
2. Make a correcting entry. This will correct the wrong entry recorded.

Correcting Entry – an entry made in the general journal to correct an error discovered.

NATURE AND ACCOUNTING FOR MERCHANDISING BUSINESS

The revenue generating activities of a merchandising business involve the buying and selling of
merchandise (items bought for resale in its original form such as goods, groceries, books, appliances, drugs,
clothing, etc.). When the merchandise is sold, the revenue is reported as Sales and its cost is recognized
as expense called Cost of Goods Sold, which is subtracted from sales to arrive at the Gross Profit. Other
expenses are then deducted to arrive at the net profit. Unsold merchandise at the end of a given period is
called Merchandise Inventory.

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Sales – Cost of Goods Sold = Gross Profit – Operating Expenses = Net Profit

ACCOUNTING FOR PURCHASES OF MERCHANDISE

There are two methods of accounting or recording for merchandise purchases:

1. Periodic Inventory Method – Under this method every time a purchase of merchandise is
made, it is charged or recorded (debited) to an account called PURCHASES. When a sale is
made. A revenue account called SALES is recorded (Credited) At the end of a given period, an
inventory ( physical count of the goods unsold - called MERCHANDISE INVENTORY- END) is
made to determine the cost of goods sold. This ending inventory will then be carried forward to
the next period and will become the MERCHANDISE INVENTORY-BEGINNING. This method
of accounting is used by a merchandising concern.

2. Perpetual Inventory Method – Under this method, an account called MERCHANDISE

INVENTORY (instead of Purchases) is used to record acquisition of merchandise. When a sale
is made, two entries will be made; the first is to record the revenue account called sales and the
second is to record the cost by charging or debiting to an account called COST OF GOODS
SOLD. In this manner, the merchandise inventory account will have a running balance and there
is no need to make a physical count. If ever a physical count or an inventory will be made, it is
only for the purpose of checking the accuracy of recording but not for the purpose of determining
the ending balance of the merchandise inventory. This method is normally used by a
manufacturing concern.

In normal business practices, before purchases are made by the purchasing department, it will require an
approved Purchase Requisition before it is authorized to issue a Purchase Order for the requested
merchandise.

Purchase Requisition Form – is a written request form to buy a certain item or items. Purchase requisition
forms are generally pre-numbered consecutively to prevent misuse or loss.

Purchase Order Form – is a buyer’s formal order form indicating therein the merchandise requested in the
purchase requisition form. The pre-numbered purchase order and requisition forms will support the purchase
evidenced by an Invoice.

Purchase Discount – is a discount given to the buyer for early payment of a purchase made on credit.

Discount Period – is the period of time within which an invoice must be paid to be entitled to a discount.

Trade Discount - is a special discount (outright deduction) from the list price offered by a seller to buyers if
the order is in large quantity.

TERMS OF PURCHASES:

CASH OR COD (Cash on Delivery) – this means that payment is required at the time the merchandise is
delivered.

2/10, n/30 – this means that a 2% discount of the gross invoice price is allowed if payment is made within
10 days after the invoice date, and the gross price is due 30 days from the invoice date.

2/EOM, n/60 – this means that a 2% discount of the gross invoice price is allowed if payment is made up to
the end of the month and the gross price is due 60 days from the invoice date.

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2/10/EOM, n/60 – this means that a 2% discount of the gross invoice price is allowed if payment is made by
the 10th of the following month, and the gross price is due 60 days from the invoice date.

Credit Term – is the term when payment for the merchandise is to be made as agreed upon by the seller
and the buyer.

Credit Period – is the time in which the buyer is allowed to pay.

TRANSPORTATION COSTS:

Freight In – this represents the transportation costs and other costs incidental to the purchase of the
merchandise.

FOB Shipping Point – this means Free on Board up to the shipping point. Freight charges will be
shouldered by the seller up to the shipping point before loading to a common carrier. Once the goods are
loaded, the buyer will pay for the freight charges.

FOB Destination – this means Free on Board up to the point of destination. The seller will pay for the freight
charges up to the buyer’s destination.

Freight Collect – this means that the buyer is to pay the freight when the merchandise arrives. If the term
is FOB destination, the buyer can deduct the cost of the freight when paying the invoice.

Freight Prepaid – this means that the seller has paid the freight on the goods at the time of shipment. If the
term is FOB shipping point, the seller can collect the cost of the freight from the buyer.

PURCHASE RETURNS AND ALLOWANCES

Merchandise may not always be received in satisfactory condition or according to the previously agreedon
terms. The goods may be damaged or defective, or may have arrived too late. In such cases, the buyer may
return the shipment to the seller or agree to keep the shipment if granted an allowance.

Purchase Returns and Allowances – are reductions in the purchase price of merchandise bought,
resulting from merchandise returned to the seller or from the seller’s reduction in the original purchase price.

ACCOUNTING FOR SALES

The merchandise in stock will be sold and new items will be purchased to replace the items sold.
Merchandise sales are credited to the Sales account. Sales can be made on cash or credit basis under the
different terms similar to the terms of purchases discussed earlier. For every sale made, a 12% VAT Output
Tax is recorded. The difference between the VAT Output Tax and the VAT Input Tax (normally a credit
balance) represents the liability of the business to the government.

Sales Invoice - is a document that the seller gives to the buyer listing the items ordered as per the P.O.
(purchase order of the buyer), together with the quantity, price, description, value added tax, the terms, and
the total price of the items ordered.

Credit Memo – is a form used by the seller to notify the buyer that his account is credited (the amount is
reduced) for the return of defective merchandise or allowance for damaged merchandise.

Sales Discount – is a discount granted by the seller for early collection on a credit sale.

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Sales Returns and Allowances – are reductions in sales, resulting from merchandise being returned by the
customer or from seller’s reduction in the original sales price.

Freight Out – this represents the cost of transporting the merchandise sold from the seller’s place to the
buyer’s place which is to be shouldered b y the seller (business).

SALES AND RELATED ACCOUNTS:

Sales – this revenue account represents the merchandise sold to customers valued at selling price
whether for cash or on credit.

Sales Returns and Allowances – this represents the merchandise returned by customers or the
price adjustments allowed for damaged merchandise valued at selling price. This is to be
subtracted from sales.

Sales Discount – this represents the cash discounts granted by the seller to the customers for
early payments of their accounts.

Freight Out - This represents the cost of transporting the merchandise sold to the buyer’s place.
This is considered an expense of the seller.

PURCHASES AND RELATED ACCOUNTS:

Purchases – this represents the cost of merchandise purchased from vendors or suppliers
whether for cash or on credit.

Purchase Returns & Allowances – this represents merchandise returned to vendors or

suppliers or price adjustments for damaged merchandise valued at purchase cost.

Purchase Discount – this represents cash discounts granted by the suppliers to the buyers for
early payments of their accounts.

Freight In – this represents the cost of transporting the merchandise purchased up to the buyer’s
place. This is added to the cost of the merchandise purchased by the buyer.

Merchandise Inventory – this represents the unsold merchandise valued at cost as of a given date.

HOW TO COMPUTE THE GROSS PROFIT OF A MERCHANDISING BUSINESS

Sales P 150,000
Less: Sales Returns & Allowances P 2,000
Sales Discounts 3,000 5,000
Net Sales 145,000
Less: Cost of Goods Sold:
Mdse. Inventory – beg. 10,000
Add: Purchases P 100,000
Freight-in 4,000
Total 104,000
Less: Purchase Ret. & Allow. P 1,000
Purchase Discounts 5,000 6,000 98,000
Cost of Goods Available for Sale 108,000
Mdse. Inventory – end 18,000 90,000

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GROSS PROFIT P 55,000

Note: All the above figures are assumed figures.

TRIAL BALANCE of a MERCHANDISING BUSINESS

A trial balance is a list of accounts in the general ledger with balances. It provides a check on the accuracy
of the posting (recording in the general ledger) by showing the equality of the total debits and total credits.

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LIST OF ACCOUNTS
Asset: Something a business has or owns
Liability: Something we owe to a non-owner
Equity: Something we owe to the owners or the value of the investment to the owner
Revenue: Value of the goods we have sold or the services we have performed
Expenses: Costs of doing business

Assets: Assets are something you own or have and they are resources you expect to gain a benefit from in the
future. Depending on the nature of the business there are many things that can be classified as assets.
• Cash (refers to the business cash available but can also be a checking or savings account)
• Office Supplies or other prepaid expenses (any expenses the business pays in advance)
• Accounts receivable (amount we will receive from customers at a later date)
• Inventory (items we intend to sell later)
• Equipment (value of equipment purchased)
• Building (value of building purchased)
• Land (value of land purchased)

Liabilities: Liabilities are something that business owes to a non-owner (debt and business obligations).
Liabilities can easily be identified as the account will most often end in the word “payable” since it is something
we must pay someone in the future.
• Accounts Payable (bills the company must pay)
• Sales Tax Payable (sales tax obligations)
• Wages Payable (obligations to employees for work performed),
• Payroll Taxes Payable (obligations paid on a monthly or quarterly to state, local or federal agencies)
• Unearned Revenue (down payments received on work to be completed in the future)
• Mortgage Payable (for example mortgage on business property)
• Notes Payable (business financial obligations from signing a promissory note).

Equity: Equity accounts represent the value of the owner’s investment in the company. The Equity accounts
are different based on the type of company.
For sole-proprietorship and partnership, a Capital account is used to record the investment of the
owners and income earned by the company. A Withdrawal (or drawing) account is used when the owner takes
money out for personal use.
For corporations, a Common Stock account is used to record the investment of the owners. A Retained
Earnings account is used to record the earnings of a corporation and to record when earnings are given back to
the owners in the form of dividends.

Revenues represent the value of the goods or services provided. Thanks to the revenue recognition principle,
we record revenue when we actually do the work by performing a service or delivering a product. Examples of
revenue accounts include:
o Service Revenue (revenue from completing a service, could be specific like plumbing service revenue,
accounting service revenue, photography service revenue, etc.)
o Sales Revenue (value of products you sell)
o Interest Revenue (value of interest earned on investments or bank accounts)

Expenses are costs to the company and reflect the outflow of money. What matters is have we incurred or used
the expense. These expenses represent the all costs of doing business and are used in order to generate the

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revenue. Examples of expenses accounts include (notice how most expense accounts end in the word
“expense”):

• Cost of Goods Sold (what we paid for inventory we have sold)

• Utilities Expense (cost of utilities)
• Wages Expense (cost of employee’s earnings)
• Rent Expense (cost of renting office space or equipment)
• Supplies Expense (cost of supplies used)
• Insurance Expense (cost of insurance used)
• Advertising Expense (cost of advertising)
• Bank Fees Expense (cost of bank fees charged by the bank)

15