Accounts are simply records of any transaction that has increased or decreased the total balance of an asset, liability or equity item.
Accounting is the process of documenting financial transactions of a business into those accounts. The accounting procedure comprises of summarizing, analyzing, and reporting the transactions, to external agencies, tax collectors and regulating entities.
Accounts are the backbone of financial accounting. Each transaction done by a firm increases or decreases the total balance in one account to another. To understand the format of accounts, we need to go through a few concepts for a better understanding.
Primary Accounting Methods
There are two main accounting approaches, The accrual basis and the cash basis. The accrual basis is a method which involves the recording of income items when they are earned, and files deductions when expenses are induced. Whereas, the cash basis of accounting records sales when cash is collected and records expenses when cash is paid.
Examples of Accrual basis are accounts receivables and account payables. While on the other hand, the examples of the cash basis are purchasing a good or service on cash, paying the electricity bill for money.
Assets and Liabilities
Assets are the items owned by a company, which provide future economic benefit. Liabilities are those goods or services owed by a business to another business, which have to be paid back in the given time period.
Assets bring value to your business and increase your company’s equity, while liabilities decrease your company’s capital and equity. The more your assets surpass your liabilities, the better the financial stability of the company. However, if you find yourself with more liabilities compared to assets, you might be on the verge of going bankrupt.
A few examples of assets are your cash, machinery owned by a business and the inventory available for sale. Examples of liabilities are loans, wages owed to workers and money owed to suppliers which are regarded as accounts payable.
Debit and Credit
In the double-entry bookkeeping system, debit and credit are two prime aspects of every financial transaction occurred between two companies. Debit is on the left-hand side of the column of an account which records an increase in assets, expenses and records the decrease in equity, income and liability, On the other hand, the credit side is on the right-hand side of the account column which records the increase in equity, liabilities and income, and reduces asset and expense accounts.
How do debit and credit help us in the construction of an account? It helps us by creating a balance between both the sides of the account which identifies the accuracy of the accounts.
Types of Accounts
Accounts are usually named and counted to identify and keep a record of them. Accounts also have sub-accounts. For example, Mr. John’s account is a sub-account of the accounts receivable account.
There are 3 accounts which make up the general ledger account. Asset, liability and equity accounts.
- Asset accounts. The asset account has a debit balance which shows the resources available to companies.
- Liability accounts. The liability account has a credit balance which records the money owed to other agencies.
- Equity accounts. The equity account displays the owner’s investment in the business, for example, the capital. The equity account’s balance is also stated on the credit side of the column.
Format of Accounts
Now that the basics have been explained, it will be easier to understand how accounts are arranged in a format. A simple account has three parts. First, the account title or account name. Second, the left side column for the debit side and third is the right side of the column for the credit side.
The most common way to format or display the accounts is through T-accounts.
The T-account is a graphical representation of a general ledger account. As explained earlier, the left side of the account shows the debit side and the right side of the account shows us the credit side. The total balance appears at the end of the account.
When making a T-account it is required to mention the date, description of account and the total amount for accuracy, and easy access of any specific transaction for the future.
According to the double-entry system, every financial transaction a debit entry should be made along with a credit entry to balance both sides of the account. Therefore, it is important to calculate the difference between the debit side and the credit side to show how one side of an accounting transaction is reflected through another account.
So, let’s say the debit side exceeds the credit side, the account has a debit balance, and if the credit side surpasses the debit side, it will result in a credit balance.
Running Balance Account Format
Sometimes, the T- Account is used in situations where the balances of the account are needed periodically, such as weekly, monthly, or annually. The format of the running balance is required to show the total balance after each transaction is recorded, but it is calculated similarly to a normal T-account.
Advantages of Accounting Format
The accounting format has many uses. Firstly, It shows us a clear representation of the transactions which take place in a business. For example, a business will always know whom they owe their money to and who owes them cash with the help of T-accounts.
Secondly, through the use of accounting formats, a company can easily make amends on transactions which have an error. For instance, if a Company A finds out that the accounts receivables of the firm are understated, they can easily identify the specific account they have made errors in and rectify the problem.
Thirdly, using an accounting format through the use of a t-account, helps a company analyze financial transactions through accounts rather than dates, which can be very hard to identify.
Lastly, it is very easy to manage the accounts in this format because it helps accountants calculate balances and easily differentiate between the debit and credit side entries.
Disadvantages of Accounting Format
Even though there are many benefits of this system, there are a few drawbacks of the format. Sometimes there may be complete omissions of transactions, which can never be traced because the double-entry system cannot detect if a transaction is missing.
The use of this system can be time-consuming and costly as an organization may require an additional accountant for bookkeeping, which may increase the costs of a business.
Although there are a few disadvantages of the accounting format, it is essential for most businesses, because these accounts help companies track their financial performances of previous years, and compare themselves with competitors, and in today’s fast-flowing competition this is the best system as it is very uncomplicated and data can be accessed in an instance.