The Account Title Indicative of Its Classification.—The account title or name should be so plain as easily to indicate its main classification. The two main classes of accounts are, as stated above, those relating to assets and liabilities, or property—things owned and things owed; and those relating to proprietorship—those showing the increases or decreases in net worth. The title of an account should clearly indicate whether the account belongs to the asset or liability class, or to the proprietorship class.

The accounts called Cash, Accounts Receivable, Mortgages Payable, Accrued Wages, clearly show assets and liabilities; while those entitled Sales, Rent Income, Wages, Expenses, indicate factors affecting proprietorship.

The Meaning of Account Balances.—In the asset accounts the larger side, and therefore the balance of the account, is normally on the left, i.e., the balance of Cash, Land, Buildings, Furniture and Fixtures, Notes Receivable, and the like are normally left-side balances. It follows, therefore, that all entries showing the acquisition or increase of assets are made on the left side of their accounts, and all entries showing the disposal or decrease of assets are made on the right side of the accounts. Very seldom are the cancellations listed on the right side in excess of the assets listed on the left.

In the liability accounts the balance is normally on the right side because liabilities are subtraction items from the assets and should, therefore, normally be on the opposite side of the account. Notes Payable, Accounts Payable, Mortgages Payable, Interest Payable, Rent Payable, and the like, have normally right-side balances. It follows, therefore, that all entries showing the assumption of liabilities are made to the right side of the account, and all entries showing the cancellation of these liabilities are made on the left side. Rarely are liability cancellations in excess of the liabilities owed.

As will be explained in [Chapter XII], in the group of accounts indicating decreases in proprietorship, the balance, or larger side, is normally on the left; in the group showing increases in proprietorship the balance is normally on the right. The balances of the accounts, Wages, Salaries, Rent Expense, and all other expenses, are normally left-side balances. It follows, therefore, that entries showing the cost of such expenses to the business are made on the left side of suitably named expense accounts, and entries showing a reduction in the expenses are made on the right side. Items for wages, for example, are shown on the left side of the Wages account, and any subtractions because of overpayment or for other reasons, are shown on the right side of the account.

The balances of the accounts Sales, Rent Income, Interest Income, and other kinds of income, are normally right-side balances. From this it follows that entries showing income are made on the right side of a suitable account, and entries indicating a reduction or subtraction from the income shown are made on the left side of the account. For example, income from sales is shown on the right side of the Sales account, while any reduction of that income, as when goods are returned by customers, is shown on the left side.

Knowing, therefore, to what main class each account belongs—asset, liability, expense, or income—one always knows on which side the balance is normally, and also that the items on the opposite side are subtraction items. Subtraction can be shown in the account only by thus separating dissimilar items.

Relation of the Account to the Financial Statements.—The equation of the balance sheet is the equation of the ledger. The fundamental proprietorship equation is written in two ways:

The ledger (that is, the accounts in the ledger) is constructed in accordance with the second form of the proprietorship equation. In it are found all the accounts of the business, which are included under the classes Assets, Liabilities, and Proprietorship. Under Proprietorship are the subgroups: (a) Net Worth, or capital at the beginning of the period, and (b) Current Profit or Loss. The Current Profit or Loss is in turn shown by the two groups of accounts: (1) Income, and (2) Expense. This classification of the accounts and their relation to the balance sheet are illustrated graphically in the chart shown in [Form 2].