Long-term liabilities
Long-term liabilities include money due beyond the next 12 months. Companies use the following accounts to record long-term liability transactions:
Loans payable: This account tracks debts, such as mortgages or loans on vehicles, that are incurred for longer than one year.
Bonds payable: This account tracks corporate bonds that have been issued for a term longer than one year. Bonds are a type of debt sold on the market that must be repaid in full with interest.
Equity accounts
Equity accounts reflect the portion of the assets that isn't subject to liabilities and is therefore owned by a company's shareholders. If the company isn't incorporated, the ownership of the partners or sole proprietors is represented in this part of the balance sheet in an account called Owner's equity or Shareholders’ equity. The following is a list of the most common equity accounts:
Common stock: This account reflects the value of the outstanding shares of common stock. Each share of common stock represents a portion of ownership, and this portion is calculated by multiplying the number of outstanding shares by the value of each share. Even companies that haven't sold stock in the public marketplace, but have incorporated, list shareholders on the incorporation documents and list the value of their shares on the balance sheet. Each common stock shareholder has a vote in the company's operations.
Preferred stock: This account reflects the value of outstanding shares of preferred stock, which falls somewhere between bonds and shares of stock. Although a company has no obligation to repay the preferred shareholders for their investment, it does promise these shareholders dividends. If the company can't pay the dividends for some reason, they're accrued for payment in later years. Any unpaid preferred stock dividends must be paid before a company pays dividends to common stock shareholders. Preferred shareholders don't vote in the firm's operations. If the business is liquidated, preferred shareholders receive their share of the assets before common shareholders.
Retained earnings: This account tracks the profits or losses for a company each year. These numbers reflect earnings retained instead of being paid out as dividends to shareholders. They show a company's long-term success or failure.
Revenue accounts
At the top of every income statement is the revenue the company brings in. This revenue is offset by any costs directly related to it. The top section of the income statement includes sales, cost of goods sold, and gross margin. Below this section, and before the profit and loss section, are the expenses. In this section, I review the key accounts in the Chart of Accounts that make up the income statement (see Chapter 7).
Revenue
A company records all sales of products or services in revenue accounts. The following accounts record revenue transactions:
Sales of goods or services: This account tracks the company's revenues for the sale of its products or services.
Sales discounts: This account tracks any discounts the company offers to increase its sales. If a company is heavily discounting its products, either it may be competing intensely or interest in the product may be falling. A company outsider probably doesn't see these numbers, but if you're reading the reports prepared for internal management, this account gives you a view of how discounting is used.
Sales returns and allowances: This account tracks problem sales from unhappy customers. A large number here may reflect customer dissatisfaction, which could be the result of a quality-control problem. A company outsider probably doesn't see these numbers, but internal management financial reports show this information. A dramatic increase in this number is usually a red flag for company management.
Cost of goods sold
A company tracks the costs directly related to the sale of goods or services in cost of goods sold accounts. The details usually appear only on internally distributed income statements and aren't distributed to company outsiders. Cost of goods sold is usually shown as a single line item, but it includes the transactions from all these accounts:
Purchases: This account tracks the cost of merchandise a company buys. A manufacturing company has an extensive tracking system for its cost of goods that includes accounts for items like raw materials, components, and labor to produce the final product.
Purchase discounts: This account tracks any cost savings a company is able to negotiate because of accelerated payment plans or volume buying. For example, if a vendor offers a 2 percent discount when a customer pays an invoice within 10 days rather than the normal 30 days, the vendor tracks this cost saving in purchase discounts.
Purchase returns and allowances: This account tracks any transactions involving the return of any damaged or defective products to the manufacturer or vendor.
Freight charges: This account tracks the costs of shipping the goods sold.
Expense accounts
Any costs not directly related to generating revenue are considered expenses. Expenses fall into four categories: operating, interest, depreciation or amortization, and taxes. A large company can have hundreds of expense accounts, so I don't name each one. Instead, I give you a broad overview of the types of expense accounts that fall into each of these categories:
Operating expenses: The largest share of expense accounts falls under the umbrella of operating expenses, which include advertising, dues and subscriptions, equipment rental, store rental, insurance, legal and accounting fees, meals, entertainment, salaries, office expenses, postage, repairs and maintenance, supplies, travel, telephone, utilities, vehicle expenses, and just about anything else that goes into the cost of operating a business and isn't directly related to selling a company's products.
Interest expenses: Interest paid on a company's debt is reflected in the accounts for interest expenses — credit cards, loans, bonds, or any other type of debt the company may carry.
Depreciation and amortization expenses: I discuss how depreciation is calculated in “Depreciation and amortization,” earlier in this chapter. The process for amortization is similar. The depreciation and amortization accounts track the amount written off each year for any type of asset, and the income statement shows expenses related to depreciation and amortization in each individual year.
Taxes: A company pays numerous types of taxes. Sales taxes aren't listed in the expense area because they're paid by customers and accrued as a liability until paid. Taxes withheld from employee paychecks are also accrued as a liability and aren't listed as an expense. The types of taxes that are expenses for a company include the employer's half of Social Security and Medicare taxes, unemployment taxes and other related payroll taxes that vary depending on state, and corporate taxes, if the company has incorporated. Businesses that aren't incorporated don't have to
