Part 4 – Types of Accounts
The Different Types of Accounts
Now that we understand how to increase and decrease different accounts, we can talk about the meaning of the different account types. This is where we actually start to understand accounting.
All accounts fit into 5 overarching account types: assets, liabilities, equity, expenses, and Income. So, we know, from before, how debits/credits increase/decrease account values… or we at least printed out the diagram from the “Seriously, what is a Debit and a Credit… I mean… Seriously?” section. We are learning these 5 account types so that we know what category to place each account in, and how to increase or decrease the account.
Within these 5 overarching account types, there are further account type specifications. I call these the underling account types… actually I just made that term up right now ‘cause I needed a good way to describe their position. Here are the things to know about underling account types:
- They are important so that you understand why an account fits into one of the 5 overarching categories.
- If you read 2 different accounting books, they will both agree on the 5 overarching accounts. However, you will get some different, but similar, underling account types. Depending on your industry, software, etc… you may use different underling account types. Neither accounting book would be wrong, but the thing to remember is that everything I write is correct and everyone else is wrong.
- When you’re setting up an account and you know the overarching account, but don’t know what the underling account is… don’t worry too much. It’s good to setup the account correctly, but as long as you have the overarching account right, the bottom line of your financial statements will be the same.
The 5 overarching account types are described below:
An asset is basically something that a company owns and uses for the benefit of the company. Think of an asset as something of value that the company owns. The following are asset underling account types:
- Bank Accounts – If I need to explain to you why they are valuable, then you need to stop reading this.
- Accounts Receivable (A/R) – This is an account to track money that is owed to you. A/R is different than a loan you make to someone (which is a note receivable… also an asset.) Once you sell a good or service, you are owed money. Accounting considers the money you are owed to be as good as collected. So, A/R is an asset that you hold… It’s the future collection of money… A/R is kind of like a trust fund that you don’t have access to yet.
- Fixed Asset – A fixed asset is something of value that you will have for a long time, typically over a year. This includes your property, equipment, furniture, etc… Fixed assets are usually depreciable, which sucks… because I hate explaining depreciation.
- Current Asset – Current assets are assets that will be converted to cash quickly, usually within a year. This includes inventory, prepaid expenses (hold on, I’ll talk about that in a sec), undeposited funds (money you collected, but haven’t deposited yet), etc…
- Bank Accounts and A/R are actually current assets, I differentiate them because they are important to track and monitor separately.
- A prepaid expense is one of those tricky, intangible, ideas. Prepaid expenses aren’t used in cash accounting, but they are one of the gems that make accrual accounting sooo much better. Let’s say you get an electricity bill for $100. For some reason, you decide to overpay and send in a check for $150… I don’t know, maybe you’re drunk or something. The $50 you overpaid is now an asset because it’s a prepaid expense.
Yes, this is still an intangible idea. It can be better understood by saying that you purchased the right to use $50 of electricity in the future. The right of future use of electricity is an asset. Once that $50 of electricity is used, the $50 becomes an expense.
A liability is money that you owe… basic. The following are liability underling account types:
- Accounts Payable (A/P) – This is an account to track money that you owe. Yes, that is the same definition I gave you for all liabilities… think of A/P as an account to track any bill you receive. A/P is different than your mortgage (which is a long term liability.) When you receive a good or service, you owe money. Accounting considers the money you owe to be as good as paid.
- Let’s you receive an electricity bill, but haven’t paid it yet. That bill represents an A/P liability because you owe that money.
- Liability (Current Liability) – Current liabilities are liabilities that will typically be paid within one year. I say “Typically” very loosely. Since this is property management accounting, if the account isn’t an A/P account and it isn’t a mortgage/loan, it’s a current liability. So, here’s some examples: accrued property tax (you owe property tax every month, but are only billed twice a year… so you can track the liability each month if you’re an accounting superstar… I am not an accounting superstar.), tenant prepaid rent, security deposits, etc…
- Yes, I am going to explain how to deal with prepaid rent and security deposits later. These 2 items are so important to me for 2 reasons:
- They are so important!
- Almost no accounting program handles these correctly. When I test other property management software programs to see what they are doing, this is the biggest part that gets me so frustrated with them… I should be happy that they do it wrong, but I get so unbelievably frustrated… and I’m not even using their software to do any actual management!
- Tenant prepaid rent and security deposits are 2 things that make Total Management the greatest thing on earth. I can’t even begin to explain how easy and accurately Total Management handles these items. If you’re currently using Total Management, you can read about these items for fun; since you have no reason to need to understand themJ.
- Long Term Liability – Basically, your mortgage… moving on…
Equity (Owners’ Equity)–
Not gonna lie, this isn’t an easy one. Luckily, if you’re doing basic bookkeeping, you won’t really have to deal with this. Equity accounts track the value of the portion of the company that is owned by one or more people. If a company has more than one owner, each owner may be tracked in their own individual account. That takes a lot of work and I let my accountant do that… I just track all owners in 1 equity account.
Here’s an easy way to understand an equity account: Let’s say you wake-up in the morning and want to know the value of your Microsoft stock. You grab the newspaper, pour some Folgers in your cup, and look at the stock value (this example takes place in 1990.) The value of your stock is basically the same as looking at your equity account for Microsoft.
This is an easy one. If you are paying money and you are not paying down a liability (security deposit, mortgage, etc…), the money you are paying is an expense… pretty much, all of your bills use an expense account. The only underling account type I care about here is called other expense. I only use this underling account when I have an expense that I want to track separately… I’m lying, I’ve never used this account type in my life. However, some people set their donations expense account as an other expense account. This just helps to set aside donations in order to see the actual expenses that were incurred in the pursuit of income.
This one isn’t bad either. If you are charging a tenant for a good/service, the charge is income. One thing I’ll clear up later, in an example, is how to do the bookkeeping when you keep or make a withholding against a security deposit. The deposit you are keeping is actually income, even if it is used to pay for an expense… don’t worry, the expense you’re concerned about offsets the income and they cancel each other out, so you’re not actually paying taxes on that security deposit income. The only underling account type I care about here is called other income. This one I actually use periodically. If I make money on a good or service that doesn’t really have to do with property management, I use an other income account… nope… lying again. I just checked my books and I have no entries in any other income accounts. I was sure I did, but nope.