What is an Account?
Accounts are at the foundation of financial accounting. Each business transaction increases or decreases balances in one account or another. The entire accounting concept is based on maintaining a chart of accounts, but what is an account?
An account is simply a record of all changes to a specific asset, liability, or equity item. You can think of an account like a notepad. Each accounting item has its own notepad that is used to document all of the increases and decreases to that item over time.
For instance, the asset account records all of the changes in assets over time like asset purchases and sales.
Accounts are typically named and numbered in order to categorize and keep track of them. Accounts can also have sub-accounts. For example, the vehicle account is a sub-account inside the main asset account.
All accounts are kept or recorded in the general ledger. You could think of this as a folder that you keep all of your account notepads in.
Types of Accounts
All accounting in the chart of accounts or general ledger fall into three main categories: asset, liability, or equity.
Asset accounts have a debit balance and represent the resources a company has at its disposal.
Liability accounts have a credit balance and represent the money that a company owes to other entities.
Equity accounts also have a credit balance and they represent the owners’ stake in the company.
There are many different ways to format or display an account, but the most common way is by using T-accounts. T-accounts format account balances by keeping the debits on the left side and the credits on the right. The overall account balance is then calculated at the bottom. T-accounts also have a title or heading that displays the name and number of the account.
Here is an example of a T-account.
Accounts can also be displayed as a listing of transactions in the general ledger. In other words, the cash account might just have a list of all the transactions that affected the cash account during that period.
Although the list format ultimately works, T-accounts and similar reports are much easier to read and use. T-accounts are also helpful in the accounting cycle before preparing trial balances.