Accounting heads are the fundamental principles of accounting to identify the debits and credits of a transaction. Accounting heads segregate the monetary transactions of a business into five blocks i.e.: Assets, Liabilities, Equity, Expenses, and Revenue. Every transaction has debits and credits and they must be equal in value (Debit = Credit). All transactions may have one or more heads of account and they will be treated/ recorded in the books accordingly (Treatment given below).
An asset is any resource that can be ‘Owned’ or ‘controlled’ by a business entity to generate future economic benefits(Profits).
As defined above, any resource owned or controlled by a business that generates economic benefits (Profits) is called an asset. Assets usually have an estimated useful life and are revalued accordingly to their fair value or market value. Assets are also depreciated over their useful life or other methods. In accounting, assets are classified into two major categories: Tangible assets and intangible assets. Tangible and intangible assets are further divided into sub-classes known as current assets, & non-current assets.
Current assets include:
- Cash or cash equivalents
- Bank balance
- Inventory / Closing Stock
- Prepaid expenses
- Debtors / Accounts receivable.
- Advance payments, etc.
Non-current/ Fixed assets Include:
- Long-term investments
- Right of use, etc.
When assets are increased it is recorded in the Debit balance of accounting records. However, when an asset decreases it is recorded in the credit balance of accounting records. shown in illustration 1.1 below
Expenses are the cost of carrying on business operations to generate economic benefits.
An expense is an outflow necessary to carry on business activities. Expenses can be fixed or variable. A fixed expense is independent of the level of output/production/sales e.g. Rent, Manager’s salary, support department costs, etc. On the contrary, a variable expense is a rely on the level of business activity e.g raw material, merchandise inventory, labor wages, etc.
Examples of expenses
- Cost of Goods Sold
- Salaries and Wages
- Rental Expenses
- Repair and Maintenance
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Expenses are recorded/ booked on the debit side of the books, and when expenses are decreased they are booked on the credit side of accounting books. See illustration 1.2 below.
3). Revenue / Income:
Revenues are inflows of money resulting in by carrying on business activities by selling goods, services, and products.
Revenue is the income generated by the operational activities of the business. Income can be classified as sales, gain on disposal of fixed assets, discount received from vendors, etc. Revenue is the gross income of a business and profit is calculated by subtracting all the expenses from revenue (Profit=Revenue- Expenses).
- Gain on disposal of assets
- Interest income
- Discount received
- Exchange rate gain
When a business earns some revenue. This revenue is recorded in the credit balance of accounting records and when a business bears some losses, then these losses are recorded in the Debit balance of accounting records.
Liabilities are the financial obligations contracted by the business for a specified period and have a cost which is known as interest.
When a business enters into any debt, it is said to be a liability of the business. Liabilities can be long-term and short-term. Long-term debts are generally entered for the rapid growth of the business. While short-term debts are entered to manage cash flows of day-to-day business activities. Debts are entered for the specific time period as may be agreed between the parties. Liabilities often come with interest payable which is generally accrued on a per-annum basis. The payment schedule for principal and interest depends upon the parties entering the loan agreement.
Long term liabilities
- Bank Loan
- Lease Obligation
- Notes Payable
- Accounts Payable
- Accrued Expenses
- Interest Payable
These loans are recorded in the credit balance of accounting records. However, when these loans are repaid then they are recorded in the Debit balance of accounting records.
Owner’s Equity is the net investment of the entrepreneur in the business. It is calculated by Investment + business profits – Owner’s withdrawals = Owner’s Equity.
It is the overall monetary stake of the business owner/ entrepreneur in the business. When a business makes profits it increases the investment (and vice-versa). Owner’s withdrawals such as salary, interest, or other drawings are subtracted from the owner’s equity and any additional investment is added to reach the Owner’s Equity. It is also known as net Assets i.e Total Assets – Total Liabilities = Owner’s Equity.
- Capital Account
- Partner current/ capital Accounts
- Share capital
- Share premium
- Revaluation reserve
- General reserve
When equity/ capital is increased through business activities or by investments. This increase is recorded in the credit balance of accounting records. However, when capital decreases by withdrawals or losses, then this is recorded in the debit balance of accounting records.