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What Are Accounts? - Definition and Use to Categorize Transactions

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  • 0:38 How Are Accounts Classified?
  • 1:09 Asset Accounts
  • 1:55 Liability Accounts
  • 2:28 Owner's Equity Accounts
  • 2:52 How Transactions…
  • 5:02 Lesson Summary
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Lesson Transcript
Instructor: Rebekiah Hill

Rebekiah has taught college accounting and has a master's in both management and business.

Everything in this world is made up of parts. Accounting is no different. The numerous parts that exist in the accounting world are called accounts. In this lesson, you will learn what accounts are, how they are classified, and what they do.

What Is An Account?

Have you ever put together a jigsaw puzzle? Personally, I enjoy it. I find a good deal of satisfaction in the ability to take all these pieces and put them together to make a final picture. When I think about the role of accounts in accounting, it reminds me of a puzzle. Each account is one small part of the entire picture. What exactly is an account? The textbook definition of an account is that it is a place to record transactions that occur within a business, but to me, an account is just a piece of the puzzle.

How Are Accounts Classified?

There are three main categories of accounts that are used in accounting. They are assets, liabilities, and owner's equity accounts. Assets are things that a company owns. Liabilities are things that a company owes. Owner's equity is the amount of money that an owner invests into the business. Every single financial transaction that occurs in a business falls into one of these three categories. It's the job of an accounting professional to decide what category that is.

Asset Accounts

Asset accounts are broken down into two subcategories: current assets and noncurrent assets. Current assets are those assets that will be used up or sold within one year. Cash is a current asset. Another current asset is accounts receivable, which is what others owe to you. Another example of a current asset is prepaid expenses. Prepaid expenses are expenses that have been paid in advance and will be expensed out throughout the year. Inventory and supplies are two other examples of current asset accounts. Noncurrent assets, also called long-term assets, are things that a business has that will not be used up or turned into cash within a year. Examples of noncurrent assets are land, buildings, and equipment.

Liability Accounts

Like asset accounts, liability accounts are also broken down into current and noncurrent subcategories. Current liabilities are bills or any other debt obligation of a company that is due within one year. Payroll expenses, utility bills, and short-term loans are good examples of current liabilities. Noncurrent liabilities are debt obligations that will extend for longer than 12 months. Payments on big ticket items, such as machinery, land, and buildings, are good examples of noncurrent liabilities.

Owner's Equity Accounts

The final type of account classification that is used in accounting is owner's equity, oftentimes just called equity. Equity accounts are further broken down into the owner's capital account, which is where his direct investment is categorized, and stockholder's equity, which is where any equity that comes from the sale of stocks or bonds and any investments by stockholders is categorized.

How Transactions Affect Accounts

Before you can start to put the accounting puzzle together, there is one more piece of information that you need to know. The most common form of accounting that is used today is called double-entry accounting. Double-entry accounting states that for every one transaction, two or more accounts will be affected. Now let's look at a few examples to see how all this works.

1. Bob's Auto Repair is a pretty busy place. Since Bob services all makes and models of vehicles, he must keep a number of different parts in stock. Each week, Bob places an order for stock inventory from Bill's Auto Emporium and charges them to his charge account. This week, his order totaled $2,540.67.

When Bob's bookkeeper analyzes this transaction, what accounts will be affected? For this transaction, there will be both an asset and a liability account that is affected. The asset account will be inventory, which will have a balance increase of $2,540.67. The liability account that will be affected will be accounts payable, which will have an increase in the same amount.

2. A few weeks later, Bob pays his bill at Bill's Auto Emporium in the amount of $9,972.34. What accounts are affected in this transaction? Once again, this transaction affects an asset and a liability account. The asset account, cash, will have a decrease in its balance of $9,972.34. The liability account, accounts payable, will also have a decrease in its balance in the same amount.

As you can see using Bob's Auto Repair as an example, every transaction does affect at least two accounts. Once all transactions for an accounting period have been analyzed and recorded, then it's time to put the pieces of the puzzle together. The end result is a picture of the true financial health of the company.

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