After the financial transaction occurs and is proven by direct and indirect documents, as previously explained, then it is analyzed in order to identify the accounts that have been affected by the financial transaction that occured.
In this lesson, we are going to explain the first and second points, while the third and fourth points will be explained in the next lesson.
The account can be defined as the record or the container that contains all the financial movements that have affected it after analyzing the financial transaction, For example, if the company makes a transaction for the sale of goods amounting to USD 1,000 and that value is received in cash , then when we analyze the financial transaction, we will find out that it contains two accounts, an account for sales, which increased by USD 1,000, and the cash account, which also increased by USD 1,000, and from that we conclude the following:
There are several classifications of accounts, the most widely-accepted classification of which is that accounts are categorized into five groups as follows:
The assets account for all economic resources and properties which the company owns, and are divided into several sections as follows:
Liabilities represent all the debts and amounts owed by the company, and are categorized as follows:
Owner's equity is the accounts that represent the liabilities of the company towards the owners of the enterprise (company), such as the capital account, Owner Withdrawals account, retained earnings account, etc.
Revenue is the accounts that arise at the time of selling goods or providing a particular service to others, such as computer hardware sales or revenue from providing consulting services.
Expenses are the accounts which arise when the company gets services from others, to help it practice its business activity and achieve its objectives, such as electricity, telephone, internet, advertising expenses and other expenses.
The following balances appeared in the Trial Balance of Al-Amal Trading Company at 31/12/2015 as follows:
| Cash | Printing Revenue | Electricity Expenses |
|---|---|---|
| Furniture and decorations | Short-term loans | Al-Amal Enterprise (receivables) |
| Al-Tafaol Company (payables) | Capital | Bank |
| Owner Withdrawals | Translation Revenue | Copyrights |
| Salaries & Wages | Hardware | Telephone Expenses |
Match each account with the group to which it belongs, based on what has been explained above.
Answer:
| Account Name | Group |
|---|---|
| Cash | Current Assets |
| Printing Revenue | Revenue |
| Electricity Expenses | Expenses |
| Furniture and decorations | Fixed Assets |
| Short-term Loans | Short-term Liabilities |
| Al-Amal Enterprise (receivables) | Current Assets |
| Al-Tafaol Company (Payables) | Short-term Liabilities |
| Capital | Owner's Equity |
| Bank | Current Assets |
| Owner Withdrawals | Owner's Equity |
| Translation Revenue | Revenue |
| Copyrights | Intangible Assets |
| Salaries & Wages | Expenses |
| Hardware | Fixed Assets |
| Telephone Expenses | Expenses |
The relationship among the five key accounts can be represented by the following equation:
| the company's resources(Assets) | = | Liabilities towards others (liabilities) + liabilities towards owners (Owner's equity) |
that means:
| Assets | = | Liabilities + Owner's equity |
Owner's equity equals the following:
| Owner's equity | = | Capital – Owner Withdrawals + (revenue – expenses) |
Hence, the equation in its final form becomes as follows:
| Assets | = | Liabilities + (capital – Owner Withdrawals + revenue – expenses) |
This equation is called the balance sheet equation, or the accounting equation, which states that the balance sheet contains two sides, one of which represents assets, and the other represents liabilities and Owner's equity. Both sides must be equal when any financial transaction occurs. When any financial transaction occurs, it will affect either the assets side only or the liabilities and Owner's equity side only, or both sides, while maintaining the balanced of the balance sheet.