Account – Meaning and types

Meaning of account:

An Account is a record of summarized business transaction for a person, asset or gain/ loss. Each company keeps a record of its business transactions so that at the end of the period it may be able to know its financial position.

For a public limited company in India, it is mandatory to disclose its annual accounts in form of financial statements. It is done for the sake of investors and other stakeholders, who are also interested in relevant information related to expenditure and revenue of the firm.

Every account has two sides known as debit and credit. When a transaction takes place, it either increases debit side or decreases credit side and vice – versa. Here, it should be kept in mind that both sides of an account always remain equal.

 

Types of account:

Accounts can be divided in three parts based upon the nature of transaction:

Types of accountPersonal A/c

Personal accounts are related to any person or organisation.

Example:

Ram a/c, XYZ ltd a/c etc.

Real A/c

These are the accounts which are related to any asset like property, good, furniture etc.

Example:

Cash a/c, bank a/c, etc.

Nominal A/c

Nominal accounts are related to expenses, gains and loss.

Example:

Rent a/c, salaries a/c, discount a/c etc.

Meaning and types of asset

Before reading about the different types of asset, it is advisable to know the meaning of asset.

Meaning of asset:

In context of a company, an asset is a resource having some economic value which can be measured. Assets are used to increase the cash-flows for a firm. Therefore, these are bought for the purpose of adding value to a firm.

Different types of asset:

There are 7 major types of asset which falls under 3 main categories:

Convertibility: Liquid, Current and fixed assets

Physical Existence: Tangible and intangible assets

Usage: Operating and non-operating assets

Types of asset

On the basis of convertibility:

There are 3 main types of asset under this category:

Meaning of current assets:

Current asset refer to those assets which can be converted into cash within a short period of time. These assets are used to pay off short term debt obligations of a company. In other words, the main purpose of having current assets is to pay off current liabilities.

Example of current assets:

Below is a complete list of these assets:

  • Cash and bank balance,
  • Accrued interest,
  • Stores and spare parts,
  • Loose tools,
  • Stock in trade,
  • WIP,
  • Accounts receivable etc.

Treatment of current assets:

These assets are shown on the assets side on a balance sheet as highlighted in below image:

Total amount of these assets, given on the balance sheet, is also used to calculate working capital for a company. Working capital is used to pay off day to day expenses of a company.

Read about: Difference between liquid assets and current assets

Meaning of fixed assets:

Fixed assets are used to generate income for a business enterprise over a longer period of time. These assets are not purchased for the purpose of selling them to business customers or its end users. This characteristic differentiates fixed assets from current assets.

It should be noted that in some countries like India, these assets also include intangible assets like goodwill of the firm, patents, trademark etc.

Example of fixed assets:

A common list of these assets includes:

  • Land & buildings,
  • Leasehold premises,
  • Railway sidings,
  • Plant & machinery,
  • Furniture,
  • Patents and trademarks,
  • Live stock,
  • Vehicles etc.

Treatment of fixed assets:

Fixed assets are an important part of a company’s balance sheet and are shown on the asset side. The figures given on the balance sheet are net values of these assets.

Fixed assets

Net value means values which remained after deducting depreciation.

Meaning of liquid assets:

These assets are considered more liquid than current assets in sense that they can be converted into cash within a very short time (90 days).

Example of liquid assets:

  • Cash,
  • Bank balance,
  • Accounts receivable etc.

Liquid assets are assumed to be converted into cash at any point of time. That’s the reason why inventory (as it is difficult to convert, when needed) and prepaid expenses (cannot be converted into cash at all) are not considered as liquid assets.

On the basis of physical existence:

There are 2 main types of asset under this category:

Meaning of tangible assets:

As the name suggests, these are the assets which can be seen and touched.

Example of tangible assets:

  • Property,
  • Plant,
  • Equipment,
  • Furniture,
  • Machinery etc.

Meaning of intangible assets:

Unlike tangible assets, intangible assets can be seen or touched but have business value.

Example of intangible assets:

  • Patents,
  • Copyright,
  • Goodwill,
  • Trade secrets,
  • Permits,
  • Corporate intellectual property etc.

On the basis of usage:

There are 2 main types of asset under this category:

Meaning of operating assets:

These are the assets which are used to perform day to day activities in an organization.

Example of operating assets:

  • Cash
  • Stock
  • Building
  • Machinery
  • Equipment
  • Patents
  • Copyrights
  • Goodwill etc.

Meaning of non-operating assets:

These assets are not used in day to day operation but they still generate revenue.

Example of non-operating assets:

  • Short-term investments,
  • Marketable securities,
  • Vacant land,
  • Interest income from a fixed deposit etc.

Current ratio – Meaning & formula

Current ratio is one of the liquidity ratios, shows the relationship between current assets and current liabilities of a firm. Current ratio indicates a firm’s commitment to meet its short-term debt obligations.

If the value of this ratio is greater than 1, then it indicates that the company is in position to pay its current liabilities by liquidating its current assets. A value of lesser than 1 indicates that the company can not pay its current liabilities by liquidating all of its current assets.

This ratio is also known as ‘working capital ratio’.

Formula for the calculation of current ratio:

This ratio is calculated by dividing the amount of current assets by current liabilities as shown below

current ratio

Example:

Let’s suppose XYZ ltd reports total current assets of INR 80,000 at the end of financial year 2015 – 16 and current liability of INR 75,000.

Working capital ratio (for the financial year 2016 – 17) = 80,000 / 75,000 = 1.07

This shows that company is in position to pay its current liabilities.

Net sales – Meaning & Formula

Net sales (also known as net revenue) is the actual amount of sales done by a company in a given period of time. It is the amount of sales left after subtracting the amount of sales return, discount and allowances for damaged goods from gross sales.

The amount of net revenue is shown on the income statement of company. This value is used to calculate gross profit, operating profit and net profit for a company.

Formula for the calculation of net sales:

Net sales = Gross sales – (Sales return + Discount on sales + Allowance for damaged and missing goods)

Example:

Let’s suppose, XYZ ltd reports gross sales of INR 1,00,000, sales return of INR 10,000, discount on sales of INR 15,000 and allowance of INR 12,000 for financial year 2016 – 2017.

Net revenue for XYZ ltd for the financial year 2016 – 2017

= 1,00,000 – (10,000 + 15,000 + 12,000) = INR 63,000.

 

Operating profit – Meaning & Formula

Operating profit is the excess of net revenue over COGS and operating expenses of a company. Operating expenses include selling, general and administrative expenses. These expenses are not directly associated in production of goods or services.

It refers to that amount of profit which is remained after deducting both direct and indirect expenses however, accounts for interest and taxes. For this reason, it is also known as EBIT (Earnings before interest and tax).

Formula for the calculation of operating Profit:

EBIT is the difference between gross profit and operating expenses of a company. Therefore, the formulas which can be used in calculation are:

Net revenue – (COGS + Operating expenses)

Or

Gross profit – Operating expenses

Cost of goods sold (COGS) = Opening stock + Purchases – Closing stock

Example:

From the figures given in income statement of XYZ ltd, EBIT can calculated as:

operating profit

 

Gross profit = 75,000

Operating expenses = 22,000

Operating profit = 75,000 – 22,000 = 53,000

 

 

 

 

 

This figure is used in the calculation of net profit and operating profit margin.