Classification of Accounts

Business activities can be reflected in any one of the five broad categories of financial statement elements: assets, liabilities, owners’ equity, revenue, and expenses.

Within these financial statement elements are sub-classifications referred to as accounts, which provide individual records of increments and decrements in specific assets, liabilities, components of shareholders’ equity, revenue, or expenses.

Relationship Between Financial Statement Elements and Accounts

A company’s financial statements are constructed using the five elements.

Assets are regarded as the economic resources that a company has, liabilities represent creditors’ claims on these resources, while owners’ equity is the residual claim on the resources. These three elements are reported on the statement of financial position or balance sheet.

Revenues are the inflows of economic resources to a company, while the expenses represent the outflows of economic resources or increments in liabilities. These two elements are reported on the statement of comprehensive income or profit & loss statement.

The amounts recorded in individual accounts are summarized and grouped within each financial statement element. Unlike the elements, however, there is no universal standard set of accounts which is applicable to every company. A company, therefore, has to select the accounts and account groupings which can summarize the volumes of its accounting data. Such data is critical in the preparation of a company’s financial statements. In addition, the decisions a company makes are premised upon the data.

Common accounts recorded as assets include:

• cash and cash equivalent;
• accounts receivable;
• inventory; and
• property, plant and equipment

Common accounts recorded as liabilities include:

• accounts payable;
• current and deferred tax liabilities; and
• bonds payable

Common accounts recorded as owners’ equity include:

• paid-up capital;
• reserves; and
• retained earnings

Common accounts recorded as revenue include:

• sales;
• gains from trading; and
• investment income

Common accounts recorded as expenses include:

• cost of goods sold;
• depreciation; and
• interest expense

The accounts used in a company’s accounting system are set out in its chart of accounts, which provides more details than the financial statements.

Some accounts are used to offset other accounts known as contra accounts. Examples of contra accounts include allowance for bad debt (which offsets the accounts receivable account), accumulated depreciation (which offsets the property, plant and equipment account), and sales and returns allowances (which offsets the revenue account).

Question

In which of the following elements, would the tax payable account be recorded?

A. Assets

B. Liabilities

C. Owners’ equity

Solution

The correct answer is B.

Tax payable is recorded in the “liabilities” element on the financial statements.

Reading 22 LOS22b:

Explain the relationship of financial statement elements and accounts, and classify accounts into the financial statement elements