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What is an account? This at first glance should be easy to understand but is actually sneakily complex.
It’s like asking the question what does fish taste like? Wait before you blurt out an answer, think about it…
There are millions of different types of fish out there, and they are discovering more every year. Each fish tastes a little different.
Are you sure you know what fish taste like?
Something so seemingly simple can be so complex.
The same could be said for what an account is. There are so many different accounts out there it can be difficult to accurately describe its features. But we will give it a go…
Definition and Explanation of Account:
Account is the individual record of an asset, a liability, a revenue, an expense or capital, in a summarized manner. For example, the individual record of sales is ‘sales account’. In the same way there are so many accounts which are opened in the ledger like salary account, machinery account, furniture account etc. How many accounts there should be in the ledger of a business? It depends upon the nature and size of the business.
Generally one full page is fixed in the ledger for each account. But it depends, how many times the changes take place in that particular account. Some accounts are very busy accounts like cash account, bank account and sales account. Obviously for such accounts one page for each will not be enough and so, they need more pages in the ledger to be fixed. In some accounts, changes take place only once or twice in a year, so only one page will be enough. e.g. machinery account, capital account, loan account etc.
There are two types of changes that may take place in an account, e.g. either there will be increase or there will be decrease. Take the example of cash (an asset), either there is inflow of cash or there is outflow of cash. To record these two types of changes, every account (a page) is divided in two sides. Increase is recorded on one side and decrease is recorded on the other side. The specimen of an account (a ‘T’ form of an account) is shown below:
When a change takes place in an account, either it will be recorded on the left side (debit side) or on the right side (credit side). Amounts recorded on the left side of an account, regardless of the account title, are called debits, and the account is said to be debited. Amounts recorded on the right side of an account are called credits, and the account is said to be credited. Now keeping in mind the concept of double change in every business transactions, we can say that every business transaction affects a minimum of two accounts and every change (in a particular transaction) is recorded in a separate account. Now question arises, how the changes are recorded in different accounts? It depends upon the rules of debiting and crediting which have been discussed on rules for debits and credits page.
For example, furniture is purchased for $20,000 on cash basis. This is a business transaction and it has brought two changes.
- Increase in furniture by $20,000 (an asset).
- Decrease in cash by $20,000 (an asset).
These two changes are recorded in two accounts: furniture account and cash account in the following way:
When an amount of $20,000 is recorded on the debit side (left side) of furniture account, it is said that furniture account is debited and when an amount of $20,000 is recorded on the credit side (right side) of cash account, it is said that cash account is credited. When an asset increases the account of that asset is debited and when an asset decreases the account of that asset is credited. Click here to read a detailed article about rules of debit and credit.
What is Accounts Receivable? Definition of Accounts Receivable, Accounts Receivable Meaning
Description: The word receivable refers to the payment not being realised. This means that the company must have extended a credit line to its customers. Usually, the company sells its goods and services both in cash as well as on credit.
When a company extends credit to the customer, the sale is realised when the invoice is generated, but the company extends a time period to the customers to pay the amount after some time. The time period could vary from 30-days to a few months.
Account Receivables (AR) are treated as current assets on the balance sheet. Let’s understand AR with the help of an example. Suppose you are a manufacturer M/S XYZ Pvt Ltd and you manufacture tyres.
A customer gives you an order of Rs 1,00,000 for 100 tyres. Now, when the invoice is generated for that amount, sale is recorded, but to make the payment the company extends the credit period of 30-days to the customer.
Till that time the amount of Rs 1,00,000 becomes your account receivable because the customer will pay that amount before the period expires. If not, the company can charge a late fee or hand over the account to a collections department.
Once the payment is made, the cash segment in the balance sheet will increase by Rs 1,00,000, and the account receivable will be decreased by the same amount, because the customer has made the payment.
The amount of account receivable depends on the line of credit which the customer enjoys from the company. Usually, this is offered to customers who are frequent buyers.
What is a Real Account? – Definition | Meaning
Definition: A real account is a permanent account in the general journal that does not close at the end of a period. In other words, these accounts stay open allowing their balances to accumulate and carry over to the next period for the company’s lifetime.
What Does Real Account Mean?
What is the definition of real account? Real accounts reflect the current and ongoing financial status of a company because they carry their balance forward into the next accounting period. These accounts are typically reported on the balance sheet at the end of the year as assets, liabilities, or equity.
These account balances change throughout the accounting period. Management can review the extent of these changes by comparing initial and final balance of each account. The final balance will become reported on the balance sheet at the end of the period and will be carried over to the next period becoming the initial balance for the next accounting period.
The relationship between real and nominal accounts is that a change in one of them might derive in a change on the other. This means that if a nominal account increases or decreases it will increase or decrease a permanent account.
Let’s illustrate this concept with an example.
Young Motors Co. is a startup company that produces motorcycles. Today is the first day of the company and its owners contribute the following things:
- Cash: $30,000
- Inventory: $25,000
- Fixed Assets: $50,000
The company has no liabilities. After a few months of operations, the company has the following:
- Revenues: $25,000
- Cost of goods sold: $10,000
- Rent: $5,000
- Other Expenses: $1,500
The accounting period started on January 1 and it will end on December 31.
At the end of the period, the revenues, cost of goods sold, rent, and other expenses are reported on the income statement as an $8,500 net income. These accounts are then closed with year-end closing entries to the retained earnings account leaving the company with the following permanent accounts that will carry over into the next period:
- Cash: $50,000
- Inventory: $15,000
- Fixed Assets: $50,000
- Retained Earnings: $115,000
Define Real Accounts: Real account means a general journal account that isn’t closed at the end of the year
What is Accounts Payable? Definition of Accounts Payable, Accounts Payable Meaning
Description: Accounts Payable is a liability due to a particular creditor when it order goods or services without paying in cash up front, which means that you bought goods on credit. Accounts Payable as a term is not limited to companies. Even individuals like you and me have Accounts Payable.
We consume electricity, telephone, broadband and cable TV network. The bills get generated towards the end of the month or a particular billing period. It means that the service provider gave you some service and sends the bill which needs to be paid by a certain date or else you will default. This becomes Accounts Payable.
Let’s also understand from a company’s point of view. You are a company A who purchases goods from company B on credit. The amount raised needs to be paid back in 30 days.
Company B will record the same sale as accounts receivable and company A will record the purchase as accounts payable. This is because company A has to pay company B.
Under the accounting (Accrual) methodology, this will be treated as a sale even though money has not exchanged hands yet. The accounts department needs to be extremely careful while processing transactions relating to Accounts Payable.
Here, time is the essence considering it is a short term debt which needs to be paid within a specific period of time. Along with that accuracy is the key, which involves the amount that needs to be paid along with the name of the supplier. Accuracy is important because it will impact the company’s cash position.