Now we have a brief overview of financial statements, we are left with the task of knowing how to categorize transactions so they appear in the right financial statement. When you categorize transactions, they are grouped into 2 main financial statements or reports namely:
- The Balance Sheet
-
The Profit & Loss Statement
Previously, we talked of the elements of the financial statements. Now we will turn our attention to what elements belong in the balance sheet and profit and loss statement. Knowing the difference will help you better choose which account to use when categorizing transaction.
The balance sheet statement reports on the assets, liabilities and equity account. The accounting equation shows the relationship between these elements.
The profits and loss statement reports on the revenues, expenses, gains and losses of a business.
Recognizing Asset Transactions
An asset, is a resource controlled by the business. The major characteristics of assets are as follows:
- A probable future benefit: this means that there is expectation of some future monetary value. If Uncle Joe owes you money for lemonade he bought today, the amount he owes you is an asset because you expect to collect in the future.
- The business controls the resource and the benefit: unless the business has control it cannot be considered an asset of the business. If a business leases a vehicle, the vehicle cannot be considered an asset to the business if the business does not control or have exclusive rights to the vehicle.
- The event or transaction bringing about the benefit must have occurred: For instance if I agree to purchase a piece of equipment next month, the equipment is not an asset to me just yet.
- The asset must be measured in monetary terms: you have to be able to assign a value to the asset. The value of loyal customers are hard to determine so in generally it will not appear on the balance sheet.
Once an asset has been recognized on the books of a business, it will continue to be considered an asset until the benefits are exhausted or the business disposes of the asset. Also, assets does not have to be a tangible items: There are also intangible assets like patents and copyrights.
Asset Accounts
Detailed information of the elements of the financial statement is kept in records called accounts. For instance, a business usually maintains more than one asset, so dumping every asset into one account will not tell much about the business. An informative statement will have different categories for each asset like cash, equipment, inventory, etc.
Here are some accounts you can use to categorize asset transactions:
| Account |
Definition |
| Cash | Currency, checks, balances in checking and saving account, money orders, certificate of deposit, and any other item that is payable on demand |
| Accounts Receivable | Expected future cash from current or past sales. Accounts receivables arise from allowing customers to buy now and pay later |
| Inventory | Goods finished and ready for sale |
| Prepaid Expenses | Future benefits arises from prepaying for an expense. For example if you pay your insurance premiums 12 months in advance, the prepayment is an asset to you as you still have unused benefits. |
| Supplies | Items used in the business. Supplies are often bought in bulk and not immediately consumed. The unconsumed portion is an asset to the business. When an asset is consumed it is expensed to supplies expense. |
| Land | Land |
| Buildings | Buildings |
| Computers and Equipment | Computers and equipment |
Classification of Assets
Assets are further classified into long and short term.
Long term assets
Long term assets: are assets that will produce future benefits more than a year from now or a business operating cycle.
Long term assets are often referred to as fixed asset. Fixed assets are defined according to the purpose they were acquired for. For example if you buy a vehicle for marketing in the balance sheet it will be labelled “Marketing Vehicle” on the balance sheet. Fixed assets are held with the intention of generating future revenue. Examples of fixed assets are land, building, computer and equipment, etc.
Short term assets
On the other hand, short term assets produce future benefits less than a year/ operating cycle. An operating cycle is the average time it takes a business to convert inventory to accounts receivable and finally into cash.
Short term assets are also referred to as current assets. Current assets are expected to be converted to cash (or use up related benefits) over a relatively short period. The most common type of current assets are cash, accounts receivable and inventory.
In the next article, I will talk about liabilities.