Classification of Accounts

Before proceeding with the debit-credit analysis of additional types of transactions, considerations will be given to the customary categories or classes of accounts that compare a ledger. The exact nature and composition of the most common accounts will also be explained.

Assets

Any physical thing (tangible) or right (intangible) owned that has a money value are an asset. Assets are frequently presented on the balance sheet as two distinct groups: (1) current assets and (2) fixed assets. Theses two categories and the most common individual accounts in each are discussed in the paragraphs that follow.

Current Assets

Cash and other assets that may reasonable be expected to be realized in cash or sold or consumed usually within a year or less through the normal operations of the business are called current assets. In addition to cash, the assets in this group usually owned by a service business are bills receivable, debtors, supplies and prepaid expenses.

Cash is any medium of exchange that a bank will accept at face value; it includes bank deposit, currency, cheques, bank drafts and postal orders. Bills receivable are claims against debtors evidenced by a written promise to pay a bearer. Debtors are claims, less formal than bills that arise from sales of services or merchandise on credit. Prepaid expenses are advance payments of expenses such as subscriptions, insurance premiums, vehicle tax, etc.

Fixed Assets

Tangible assets used in the business that are of a relatively fixed or permanent nature are called fixed assets or plant assets. Such assets, with the exception of land wear out or depreciate with the passage of time. The amount of depreciation for an accounting period cannot be determined with the same degree of certainty that applies to the expiration of insurance or of other prepaid expenses; consequently the cost of the fixed assets is recorded in one account and the accumulated depreciation is recorded in another account. Typical titles of fixed assets accounts are Plant and Machinery, Equipment, Building and Land. Equipment may be further classified by functions, with separate accounts entitled Delivery Equipment, Store Equipment, and Office Equipment.

Liabilities

Liabilities are amounts owed to outsiders (creditors). They are divided into two principal classes: (1) Current Liabilities (2) Long-term Liabilities.

Current Liabilities 

Liabilities that will be due within a short time usually one year or less) and that are to be paid out of current assets are called current liabilities. The most common liabilities in this group are creditors and bills payable, which are exactly like their debtors and bills receivable counterparts except that the debtors-creditor relationship is reversed. Other current liability accounts commonly found in the ledger are Accrued Salaries, Accrued Interest and Accrued Taxes.

Long-term Liabilities 

Liabilities that will not be due for a comparatively long time (usually more than one year) are called long-term liabilities or fixed liabilities. As they come within the one-year range and are to be paid, such liabilities become current. If the obligation is to be renewed rather than paid at maturity, however, it would continue to be classed as long-term. When payment of a long-term debt is to be spread over a number of years, the installments due within one year from a balance sheet date is classed as a current liability.

The most common liability in this group is long-term loans. These loans may have been obtained against a mortgage of property or covered by debentures.

Capital

Capital is the term applied to the owner’s equity in the business. It is a residual claim against the assets of the business after the total liabilities are deducted. Other commonly used terms for capital are owner’s equity, proprietorship and net worth.

Income

Income is the gross increase in capital attributable to business activities. It results from the sale of merchandise, the performance of services for a customer or a client, the rental of property, the lending of money, and other business and professional activities entered into for the purpose of earning income. More specific terms employed to identify the source of income include sales, fees, commissions, fares earned and interest income. If an enterprise has several different types of income, a separate account should be maintained for each.

Expenses

Costs that have been consumed in the process of producing income are expenses or expired costs. The number of expense categories and individual expense accounts maintained in the ledger varies with the nature and the size of an enterprise. A large business with authority and responsibility spread among many employees may use an elaborate classification system and hundreds of accounts as an aid in controlling expenses. For a small service business of the type assumed here for illustrative purposes, a modest number of expense accounts are satisfactory.