Accounts #
There are five types of accounts.
Assets. (+) #
Asset accounts represent something the owner has. A canonical example is banking accounts.
Another one is a “cash” account, which counts how much money is in your wallet. Investments are also assets (their units aren’t dollars in this case, but rather some number of shares of some mutual fund or stock). Finally, if you own a home, the home itself is considered an asset (and its market value fluctuates over time).
Liabilities. (-) #
A liability account represents something the owner owes.
The most common example is a credit card. Again, the statement provided by your bank will show positive numbers, but from your own perspective, they are negative numbers. A loan is also a liability account. For example, if you take out a mortgage on a home, this is money you owe, and will be tracked by an account with a negative amount. As you pay off the mortgage every month the negative number goes up, that is, its absolute value gets smaller and smaller over time (e.g., -120,000 -> -117,345).
Expenses. (+) #
An expense account represents something you’ve received, perhaps by exchanging something else to purchase it.
This type of account will seem pretty natural: food, drinks, clothing, rent, flights, hotels and most other categories of things you typically spend your disposable income on. However, taxes are also typically tracked by an expense account: when you receive some salary income, the amount of taxes withheld at the source is recorded immediately as an expense. Think of it as paying for government services you receive throughout the year.
Income. (-) #
An income account is used to count something you’ve given away in order to receive something else (typically assets or expenses).
For most people with jobs, that is the value of their time (a salary income). Specifically, here we’re talking about the gross income. For example, if you’re earning a salary of $120,000/year, that number is $120,000, not whatever amount remains after paying for taxes. Other types of income includes dividends received from investments, or interest paid from bonds held. There are also a number of oddball things received you might record as income, such the value of rewards received, e.g., cash back from a credit card, or monetary gifts from someone.
Equity. (-) #
The account that receives those previously accumulated incomes is called “Previous Earnings”.
It lives in a fifth and final type of accounts: Equity. We did not talk about this type of accounts earlier because they are most often only used to transfer amounts to build up reports, and the owner usually doesn’t post changes to those types of accounts; the software does that automatically, e.g., when clearing net income.The account type “equity” is used for accounts that hold a summary of the net income implied by all the past activity. The point is that if we now list together the Assets, Liabilities and Equity accounts, because the Income and Expenses accounts have been zero’ed out, the sum total of all these balances should equal exactly zero. And summing up all the Equity accounts clearly tells us what’s our stake in the entity, in other words, if you used the assets to pay off all the liabilities, how much is left in the business… how much it’s worth.