Examining Liability and Equity Accounts for Your Business
In addition to an Assets section, the balance sheet for a business includes sections for reporting accounts relating to Liabilities and Equity. The Liabilities section is divided into two categories: current liabilities and long-term liabilities.
Liability accounts in a balance sheet
The Liabilities section of the balance sheet comes after the Assets section and shows all the money that your business owes to others, including banks, vendors, contractors, financial institutions, or individuals. Like assets, you divide your liabilities into two categories on the balance sheet:
Current liabilities: All bills and debts you plan to pay within the next 12 months. Accounts appearing in this section include Accounts Payable (bills due to vendors, contractors, and others), Credit Card Payable, and the current portion of a long-term debt.
Long-term liabilities: All debts you owe to lenders that will be paid over a period longer than 12 months. Mortgages Payable, Loans Payable, and Bonds Payable are common accounts in the long-term liabilities section of the balance sheet.
Most businesses try to minimize their current liabilities because the interest rates on short-term loans, such as credit cards, are usually much higher than those on loans with longer terms. You should always look for ways to minimize your interest payments by seeking longer term loans with lower interest rates than you can get on a credit card or short-term loan.
Equity accounts in a balance sheet
Every business has investors. Even a small mom and pop grocery store requires money upfront to get the business on its feet. Investments are reflected on the balance sheet as equity. The line items that appear in a balance sheet’s Equity section vary depending upon whether or not the company is incorporated. (Companies incorporate primarily to minimize their personal legal liabilities.)
If you’re preparing the books for a company that isn’t incorporated, the Equity section of your balance sheet should contain these accounts:
Capital: All money invested by the owners to start up the company as well as any additional contributions made after the start-up phase. If the company has more than one owner, the balance sheet usually has a Capital account for each owner so that their individual stakes in the company can be tracked.
Drawing: All money taken out of the company by the company’s owners. Balance sheets usually have a Drawing account for each owner in order to track individual withdrawal amounts.
Retained Earnings: All profits that have been reinvested into the company.
For a company that’s incorporated, the Equity section of the balance sheet should contain the following accounts:
Stock: Portions of ownership in the company, purchased as investments by company owners.
Retained Earnings: All profits that have been reinvested in the company.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
