Account Types Explained: Assets, Liabilities, Equity, Revenue, Expenses

Account types

Account types are the five categories every account belongs to: assets, liabilities, equity, revenue, and expenses. An account types choice is made once, when the account is created, and every entry, report, and ratio built on that account inherits it.

The type is the most important field on an account and the one most people fill in last. The name is what you read. The type is what the software reads. It decides which side of an entry makes the balance grow, which statement the balance appears on, and whether the balance carries into next year or starts again at zero. Get the type right and the rest of the chart mostly takes care of itself.

Structure

The five types come from the accounting equation. Assets equal liabilities plus equity. That equation describes what the business has and who has a claim on it, and it must hold after every transaction. Revenue and expenses are the two ways equity changes through operations, so the expanded form of the equation reads: assets equal liabilities plus equity plus revenue minus expenses.

Each type answers one question about a balance.

• Assets are what the business owns or is owed: cash, receivables, inventory, equipment.
• Liabilities are what the business owes to others: unpaid bills, loans, customer deposits, taxes collected but not yet remitted.
• Equity is what is left for the owner after liabilities are subtracted from assets: money put in, profit left in, draws taken out.
• Revenue is what the business earned from customers in the period.
• Expenses are what the business used up to earn that revenue in the period.

The first three types are permanent. Their balances carry forward from year to year, and together they make up the balance sheet. The last two are temporary. Their balances measure one period, roll into equity at year end, and start again from zero. Together they make up the income statement.

In a chart of accounts the type usually shows up twice: once as an explicit field, and once in the first digit of the account number. Assets start with 1, liabilities with 2, equity with 3, revenue with 4, and expenses with 5 and up. The number is a convention. The type field is what the software enforces.

QuickBooks Online adds a second layer under the five: the detail type. Bank, Accounts Receivable, and Fixed Assets are all detail types of asset. Cost of Goods Sold sits under expense as a detail type and reports above gross profit. The detail type controls placement on the report. The five account types are still the categories underneath, and the entry rules below follow from them.

Recording

The type of an account decides which side of an entry increases it. Assets and expenses grow on the debit side. Liabilities, equity, and revenue grow on the credit side. The mechanics of debits and credits are covered on their own page; here the point is that the type is what selects the side.

The entry below records a customer paying a 5,000 deposit before any work is done. The cash is an asset, so it is debited. The deposit is not revenue yet, because nothing has been delivered. It is a liability, an obligation to either do the work or return the money, so Customer Deposits is credited. Figures are illustrative.

The second entry records the work being completed a month later. The obligation is gone, so the liability is debited down to zero. The revenue has now been earned, so Service Revenue is credited. This is the entry that moves 5,000 from the balance sheet to the income statement.

Now consider what happens if Customer Deposits had been created as an Income type instead of a liability. Entry 1 would have posted the 5,000 straight to revenue. The month would show profit on work not yet done. Entry 2 would have nothing to move. And the balance sheet would be missing a 5,000 obligation that still exists. The entries would balance either way. The type is the only thing that made the difference.

Reporting

Each type has one home on the statements. Assets, liabilities, and equity make up the balance sheet, which shows position at a point in time. Revenue and expenses make up the income statement, which shows performance over a period. The two statements meet at net income, which is revenue minus expenses, and which flows into equity on the balance sheet.

The balance sheet excerpt below shows the position at the end of the first month, after Entry 1 and before Entry 2. The deposit is a liability, in the highlighted row, and it will leave the balance sheet when the work is delivered.

Both highlighted rows come from Entry 1. Cash went up by 5,000 and liabilities went up by 5,000, so the two totals still agree. Had the deposit been typed as income, the liability row would not exist, equity would be 5,000 higher through an inflated profit, and the balance sheet would still balance. A wrong type does not break the arithmetic. It moves a balance to the wrong statement and leaves no trace.

The same principle runs the other way for costs. Equipment typed as an expense shows up on the income statement in the month it was bought, and profit collapses for one month and recovers the next. Equipment typed as an asset stays on the balance sheet and reaches the income statement gradually through depreciation. Same purchase, same cash, two different pictures of the business, and the type is the only thing that differs.

Insight

A type is a decision about which questions the books can answer. When a balance is typed wrong, the reports still balance and the software still runs. What breaks is the meaning of the number. The questions below are the ones that stop having an answer.

The five types are the same in every business. What differs by industry is which accounts sit inside each type and how finely they are split, and that is what the industry guides built on this foundation cover. To check whether every account in your own chart carries the type its balance deserves, run the chart through the optimizer.

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