The first thing that comes to mind when one thinks about the business transaction in terms of accounting is accounts title. These are the building blocks of a whole accounting system. Every time an accountant posts some accounting entry in the system, these account titles are updated to reflect the impact of the transaction.
It’s important to note that two account titles are updated when an accountant posts entry in the accounting system. For instance, when the business buys goods from the supplier in cash, the impact of this transaction is that the cash goes out from the business, and goods come into the business.
So, we need to reflect this exchange of the cash and goods in the books of accounts. Hence, two account titles (cash and goods) are updated. Sometimes, there may be a need to update more than two account titles for one transaction. For instance, the business buys half goods in cash and half goods on credit.
Now, three account titles need to be updated that include inventory, cash, and trade payable. So, which account titles need to be updated depending on the nature of the transaction carried out by the business.
The list of the account titles can be found on the general ledger. So, every time an accountant updates account titles general ledger is updated. At the end of the period, when all of the account titles have been updated, a general ledger is finalized which is used to form the financial statement.
Further, it has been seen that small businesses have less account titles than large businesses. As soon as the operations of the business keep increasing number of account titles in their general ledger keep increasing. In addition to this, account titles are designed in line with industry-accepted practices.
An important thing to note is that account titles are assigned digits, making it easy to trace when forming a financial statement. This is because digits can be easily sorted and mapped with the help of a formula if you are preparing financial statements in excel.
Similarly, accounting software has an in-built mapping and essential chart of accounts, although a chart of accounts can be modified/added/deleted based on the requirements of the business.
These managed features of the account titles enable us to get financial reports in few clicks (which is one of the greatest reasons for the success of the automated accounting software.
Further, account titles are allocated in different statements based on their nature like balance sheet, income statement, and statement of comprehensive income, etc.
There can be millions of account titles, and their nature help to decide where these account titles should be mapped. For instance, if account title is related to assets and liability, it’s mapped in the balance sheet; if account title is related to revenue and expenses, these are mapped in the income statement.
Let’s go through some main account titles and understand where they need to be mapped in the financial statement.
List of Account Titles:
|Type of account
|Property, plant, and equipment
|Cash and bank balance
|Deferred tax liability
|Cost of sales
|Selling and distribution expenses
There can be unlimited account titles, and their usage is dependent on the sector of the business. That’s the reason when you set up the company in the accounting software; you are required to enter the sector of your business.
So, the accounting software can set up account titles in line with the sector of the business. In addition to this, specific account titles are mapped in the specific statements. Let’s discuss category-wise details of the account titles.
Accounts titles in the asset category
These account titles are updated when accounting transaction reflects something that is expected to provide current or future economic benefits. Acquisition of assets in the business is expected to increase revenue or decrease expenses.
For instance, if the business acquires some machinery as asset account is updated and this asset is expected to increase the revenue accounts, that will lead to the business’s profitability.
Accounts titles in the equity category
Account titles of the equity include share capital retained earnings and dividend accounts. These account titles are not expected to be frequently updated but on certain events like raise of equity or repurchase of the shares. For instance, the share capital account is updated for the raise/recall of share capital, retained earnings account is updated when the accounting period is closed, and the dividend is updated when announced.
Updates of these account titles require approval from the higher management of the company.
Accounts titles in the revenue category
The number of account titles in the revenue category depends on the number of revenue streams. If the business has a single stream of revenue, a single account title fulfills the need. In accrual accounting, these account titles are updated when the business receives an economic benefit, or it gets a right to receive economic benefits in the future. However, the time of update is different for cash-based accounting.
Accounts titles in the expense category
These account titles are updated when the following actions are reflected in the business transactions.
- Economic benefits of the business decrease during an accounting period. It occurs when an economic benefit outflows from a business or there is increase in the liability that will be settled when the economic benefit will outflow from the business.
- The transaction might reflect an increase in the liability or decrease in the assets. For instance, when the company incurs expenses, it has to pay cash, and an alternative is to increase the liability. As an increase in expense is debit in nature, and paying cash/increase liability is credit.
- A decrease in equity but other than withdrawal/dividend payment. An increase in expense accounts decreases the equity as all expenses are closed in the retained earnings. However, dividends and withdrawal do decrease the equity but are not expenses.
Example of expense transactions and how related account titles are updated
The business launches a marketing campaign for the $5,000 with the agency and pays $3,000 while agreeing to pay the remaining amount after three months. This accounting transaction reflects that business is incurring expenses, and economic benefit is flowing out from the business. In addition to this, the obligation arises, amounting to $2,000 that will be settled in the future.
Frequently asked questions
How to know which account titles need to be updated from specific accounting transactions?
When you read accounting transactions, there is a need to discover the impact of the accounting transaction on the main heads. For instance, if an economic benefit is increasing/decreasing. Something is being added that is expected to generate potential benefits in the future.
So, when you’ve discovered which major category/categories of accounts need to be updated, then have a look at the activity in the transaction to identify specific account titles that need to be updated. For instance, we need to update the cash account if it’s flowing out/in of the business.
What are the five types of accounts, and how are account titles classified?
Five types of accounts include assets, liabilities, equity, revenue, and expenses. Account titles are classified/mapped under different heads depending on their nature. For instance, cash is an asset and is classified under the asset category.
Does the method of accounting impact account titles?
Yes, the choice of the accounting method impacts the account titles. For instance, if there if the business follows cash-based accounting, there is no need for the liability accounts like accounts payable and long-term liability payable.
Can a single accounting transaction impact more than two account titles?
Yes, a single accounting transaction can impact more than two account titles. For instance, if the business purchases machinery for $30,000 and pays $20,000 in cash and agrees to pay the balance after six months.
So, this accounting transaction impacts three account titles that include PPE account title (purchase of machinery), cash account title (paid cash), and payable account title (increased liability).