What do liabilities include

Assets, Liabilities, Equity, Revenue, and Expenses

This Accounting Basics tutorial discusses the five account types in the Chart of Accounts. We define each account type, discuss its unique characteristics, and provide examples.

Having a good understanding of these account types is a prerequisite to reading financial reports and posting transactions in the accounting system. So let's begin!

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Account Type Overview

The five account types are:   Assets, Liabilities, Equity, Revenue (or Income) and Expenses. To fully understand how to post transactions and read financial reports, we must understand these account types. We'll define them briefly and then look at each one in detail:

  • Assets: tangible and intangible items that the company owns that have value (e.g. cash, computer systems, patents)
  • Liabilities: money that the company owes to others (e.g. mortgages, vehicle loans)
  • Equity: that portion of the total assets that the owners or stockholders of the company fully own; have paid for outright
  • Revenue or Income: money the company earns from its sales of products or services, and interest and dividends earned from marketable securities
  • Expenses: money the company spends to produce the goods or services that it sells (e.g. office supplies, utilities, advertising)

Assets

Assets can be defined as objects or entities, whether tangible or intangible, that the company owns that have economic value.

Tangible assets are physical entities that the business owns such as land, buildings, vehicles, equipment, and inventory.

Intangible assets are things that represent money or value; things such as Accounts Receivables, patents, contracts, and certificates of deposit (CDs).

Assets are also grouped according to either their life span or liquidity - the speed at which they can be converted into cash. Current assets are items that are completely consumed, sold, or converted into cash in 12 months or less. Examples of current assets include accounts receivable and prepaid expenses.

Fixed assets are tangible assets with a life span of at least one year and usually longer. Fixed assets might include machinery, buildings, and vehicles. Fixed assets are typically not very liquid. And because of their higher costs, assets are not expensed, but depreciated, or "written off" over a number of years according to one of several depreciation schedules.

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Liabilities

Liabilities are the debts, or financial obligations of a business - the money the business owes to others. Liabilities are classified as current or long-term.

Current liabilities are debts that are paid in 12 months or less, and consist mainly of monthly operating debts. Examples of current liabilities may include accounts payable and customer deposits.

Current liabilities are usually paid with current assets; i.e. the money in the company's checking account. A company's working capital is the difference between its current assets and current liabilities. Managing short-term debt and having adequate working capital is vital to a company's long-term success.

Long-term liabilities are typically mortgages or loans used to purchase or maintain fixed assets, and are paid off in years instead of months.

Equity

Equity is of utmost importance to the business owner because it is the owner's financial share of the company - or that portion of the total assets of the company that the owner fully owns. Equity may be in assets such as buildings and equipment, or cash. Equity is also referred to as Net Worth.

For example, if you purchase a $30,000 vehicle with a $25,000 loan and $5,000 in cash, you have acquired an asset of $30,000, but have only $5,000 of equity. The Balance Sheet equation is:

Assets = Liabilities + Owner's Equity

We can see how this equation works with our example: $30,000 Asset = $25,000 Liability + $5,000 Owner Equity.

Types of Equity Accounts and Their Various Names

There are three types of Equity accounts that will meet the needs of most small businesses. These accounts have different names depending on the company structure, so we list the different account names in the chart below.

Contribution (Money Invested): There are times when company owners must invest their own money into the company. It may be start-up capital or a later infusion of cash. When this occurs, a Capital or Investment account is credited. See the first row in the table below.

Distribution or Draw (Money Withdrawn): If a business is profitable, the owners often want some of the profit returned to them. To track this activity, a Draw or Distribution account is debited. This is the only Equity account (non-contra) that receives debits. See the second row in the table below.

Accumulation from Prior Years: To tracks a company's Net Income as it accumulates over the years, Retained Earnings or Owner's Equity is credited. On the first day of the fiscal year, most accounting programs automatically credit this account with the previous year's Net Income. See the third row of the table below.

NOTE: Most single-owner companies enter journal entries to "close out" the Contribution and Draw accounts to Retained Earnings on the last day of the fiscal year. Partnerships, however, may choose not to close out these accounts so that a permanent record of partner activity is maintained.

 Sole ProprietorPartnershipSubchapter S Corporation
Money investedOwner's Investment - or -
Capital Contribution
Partner A Capital Contribution,
Partner B Capital Contribution, etc.
Paid in Capital - or -
Capital Contribution
Money withdrawnOwner's DrawPartner A Draw,
Partner B Draw, etc.
Distribution
Cumulative Earnings (less $$ withdrawn)Owner's Equity - or -
Owner's Capital
Partner A Equity,
Partner B Equity, etc.
Retained Earnings

Income or Revenue

Income is money the business earns from selling a product or service, or from interest and dividends on marketable securities. Other names for income are revenue, gross income, turnover, and the "top line."

Net income is revenue less expenses. Other names for net income are profit, net profit, and the "bottom line."

Income is "realized" differently depending on the accounting method used. When a business uses the Accrual basis accounting method, the revenue is counted as soon as an invoice is entered into the accounting system.

If the Cash basis accounting method is used, the revenue is not realized until the invoice is paid.

Income accounts are temporary or nominal accounts because their balance is reset to zero at the beginner of each new accounting period, usually a fiscal year. Most accounting programs perform this task automatically.

Expenses

Expenses are expenditures, often monthly, that allow a company to operate. Examples of expenses are office supplies, utilities, rent, entertainment, and travel.

Like revenue accounts, expense accounts are temporary accounts that collect data for one accounting period and are reset to zero at the beginning of the next accounting period. Most accounting programs perform this task automatically.

A unique type of Expense account, Depreciation Expense, is used when purchasing Fixed Assets. Costly items, such as vehicles, equipment, and computer systems, are not expensed, but are depreciated or written off over the life expectancy of the item. A contra-account, Accumulated Depreciation, is used to offset the Asset account for the item. Please see your Accountant for help with the depreciation of Assets.


We hope this article on the five account types in accounting has been helpful. Check out some of our other popular tutorials, such as All About Your Credit Score! and Social Security Retirement Benefits Guide. Cheers!

Disclaimer:: Keynote Support is providing general information in a highly readable format as a service to the visitor. We have made every effort to provide information accurate as to the date of this article. Every customer environment and each transaction is unique, so please use the information and examples in this article only as a guide. In addition, the reader cannot infer from this article that Keynote Support is providing financial or accounting advice. Consult with a financial or accounting professional for assistance with your unique requirements.

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