Once a transaction has been identified, the transaction needs to be analyzed to understand which part of the balance sheet or income statement the transaction impacts. Each transaction is analyzed to identify 1) which specific areas (accounts) are impacted, 2) if the transaction creates a benefit (asset) or an obligation (liability) to the company, 3) the direction (increase or decrease) of impact, and 4) the quantum or amount of impact.

What are Accounts?

An account is a page/file/place in the accounting system that is used to record, compile, sort, and summarise a specific category or type of transactions.

Let me explain what an account is using an analogy. You can think of an account as a file in your office. You use a file to keep a specific category of papers together. For example, you may have a file where you keep all your rent invoices. You may have another file where you keep all your food invoices. And a third file where you keep all your fuel expenses. Similarly, a cash account is a place in your accounting system that records all the cash-related transactions. A rent expense account is a place that records all the rent expense transactions placed in that account.

You can also think of an account as a bin in your warehouse. If the warehouse deals with clothing, you will put all shirts in one place (a bin). You will put all trousers in another bin and all socks in another bin. This way, whenever you need a shirt, you pull it out of the shirt bin. When you get a new stock of T-shirts you put it into the T-shirt bin. Similarly, you put socks into another bin, and when you need socks you take them out of that bin. Each bin will have only one category of clothing.

Similarly, an account will store only one kind of transaction. If you have a wage payables account, you will put all wage payables-related transactions into that account. All property, plant, and equipment transactions will go into another account called the property, plant, and equipment account. All inventory transactions will go into another account called the inventory account.

So, to summarise, an account is a file or a bin-like place which stores all transactions of one specified category. Here is a list of accounts that we can start with. Remember, these are just files that organize all your transactions, so you can have many more accounts and name them as you deem fit.

Note: A customer account is an account that stores all transactions related to that customer.

Types of Accounts

Now that you know what an account is, you should learn about the different types of accounts. The first classification of accounts you need to know and identify are:

1. Asset Accounts
2. Liabilities Accounts
3. Shareholders Equity Accounts
4. Revenue accounts
5. Expense accounts

There are other classifications which we will deal with when required.

Asset Accounts

An asset is anything that provides a current or future economic value to a business. All accounts that deal with assets are categorized as asset accounts.

Asset accounts include the cash and cash equivalents account, the inventories account, the accounts receivable account, the property, plant, and equipment account, the goodwill account, etc.

Liabilities Accounts

A liability is any financial obligation that a business has to anyone else. Liabilities include an obligation to pay a person, a business, or any organization at any point in the future. Liabilities are settled by paying, or transferring economic benefits such as money, goods or services.

For example, if someone has worked for the company or provided a service to the company, the company owes them an obligation to pay for the service. This is a liability to the company. If the company borrows money from a bank, the company has an obligation to return the money as per the contract.  This is a liability to the company.

There are two types of liabilities: 1) Liabilities to shareholders who are owners of the company, and 2) liabilities to others who are not shareholders. All accounts that deal with liabilities to outsiders who are not shareholders are categorized as liability accounts.

Liability accounts include accounts payable, notes payable, long-term debt, tax payables, lease obligations, etc.

Shareholders Equity Accounts

All accounts that deal with liabilities associated with shareholders are categorized as shareholders’ equity accounts.

Shareholders’ equity accounts include common stock, additional paid-in capital, treasury stock, retained earnings, minority interest, etc.

Revenue accounts

Accounts related to sales or revenues are called revenue accounts. Examples of revenue accounts include sales revenue, ancillary services revenue, etc.

Expense accounts

An expense is any cost incurred to generate revenues. This includes any expenses paid or unpaid. Accounts related to expenses are called expense accounts. Examples of expense accounts include the cost of goods sold, rent expenses, wage expenses, insurance expenses, taxes, interest expenses, marketing expenses, R&D expenses, etc.

Balance Sheet vs. Income Statement Accounts

You can categorise accounts based on where they appear in a financial statement. Accounts that refer to balance sheet-related items are called balance sheet accounts. Accounts that appear in an income statement are called income statement accounts.

Balance sheet accounts

All accounts that appear on a balance sheet are called balance sheet accounts. Since all asset accounts, liability accounts, and shareholder equity accounts appear on the balance sheets, these are balance sheet accounts. Examples of balance sheet accounts include the cash and cash equivalents account, inventories account, accounts receivable account, property, plant, and equipment account, goodwill account, accounts payable account, notes payable account, long-term debt account, stockholders’ equity account, retained earnings account, etc.

Income Statement Accounts

Revenue accounts and expense accounts go into the income statement. These accounts appear in an income statement are therefore called income statement accounts. Examples of income statement accounts include revenue account, cost of goods sold, rent expenses, wage expenses, insurance expenses, taxes, interest expenses, marketing expenses, R&D expenses, etc.

Size and Direction

We also need to understand the size of the transaction we are studying in monetary terms. That is, we need to know the dollar amounts by which our company’s financial obligations change. In addition we need to know the direction of change – is it an increase or a decrease in that specific account?

So after we identify and understand which accounts are impacted, the type of accounts these are, we observe the dollar change in the accounts and if there has been an increase or decrease.

Transaction Analysis Table

After we identify and understand which accounts are impacted, the type of accounts these are, if the impacted account increased or a decreased, and by how much, we can place this information in the transaction analysis table on our website or balance sheet equation template. Steps involved are:

Step 1: Identify all the accounts that are impacted.

Step 2: Specify the type of account the identified accounts in step 1 are (Assets/Liabilities/Shareholders’ Equity).

Step 3: Identify if the accounts increase in value or decrease in value.

Step 4: Specify the amount by which the accounts’ values increase or decrease by.

We can illustrate transaction analysis with an example. Let’s say we pay $1,000 to purchase inventory. We record this transaction in a transaction analysis template below.

Here is what the process looks like step by step:

1. We know that the cash account and the inventory account are impacted. So we list these accounts in the accounts column.
2. We know both cash and inventory are resources that benefit the company and therefore are categorized as asset accounts. So we specify that these accounts are assets in the type column in the above table.
3. We know cash goes down because we pay cash to purchase the inventory, and therefore, cash decreases. We also know that our inventory account goes up because we have purchased inventory.
4. The amount of increase and decrease is $1,000.

A few things to point out:

Note 1: Every transaction must impact at least two accounts. This is where the term double-entry book-keeping comes from.

Note 2: A transaction can impact more than two accounts.

Note 3: At all times, the accounting equation must be true. A = L+SHE. We elaborate on this in the following section.

Note 4: The opening balances of income statement accounts at the beginning of a period always start at zero as they are temporary accounts.

Note 5: The opening balances of balance sheet accounts is carried forward from the end of the previous accounting period. They could start at zero if the company is new or the account is new.

Illustration: Analyzing Transactions

We will analyze each of the transactions of our hypothetical company in this section. Please note that we simply follow the four steps outlined in the last section.

1. Mark invested $20,000 to start a business in exchange for 1,000 shares on January 15^th.
   • Cash received.
   • Shares issued.
2. The business borrowed $30,000 from ABC bank at an interest rate of 10% per year on January 1^st.
   • Cash received.
   • Debt created.
3. Equipment worth $25,000 was purchased by the company in exchange for cash on January 4^th.
   • Equipment received.
   • Cash paid.
4. Inventory worth $40,000 of inventory was purchased by the company on 60 days credit on January 6^th.
   • Inventory received.
   • Cash paid.
5. Three customers walked into the store to enquire about prices and products on January 12^th.
   • No Financial Impact.
6. The company sold $10,000 worth of inventory for $30,000 on 30 day credit on January 15^th.
   • Inventory given.
   • Receivables created.
7. The company paid wages of $5,000 on January 31^st.
   • Wages recorded.
   • Cash paid.
8. The company’s rent for the month of January was $2,000 was paid on January 31^st.
   • Rent expenses recorded.
   • Cash paid.
9. The company’s equipment would last for 5 years and use the straight-line depreciation method to account for depreciation expenses.
   • Depreciation expenses recorded.
   • Accumulated depreciation increases.
10. The company acknowledges that interest for a month is accrued.
    • Interest Expenses
    • Interest payable