Every accounting item belongs to one of five groups: asset, liability, equity, income or expense. Two questions are enough to sort an item, so you do not have to memorise long lists.
This lesson is part of SPM Accounting foundations. The next lesson, applying the accounting equation, shows how these groups move together.
What are the two questions?
First ask: does the business own it or owe it? Things owned with future benefit are assets. Things owed to outsiders are liabilities. What belongs to the owner is equity.
Second, if it is about the period’s performance, ask: did it come in from earning, or go out from running the business? Earnings are income. Costs of running the business are expenses.
Worked example: ten items in Kedai Runcit Aminah
| Item | Group | Why |
|---|---|---|
| Cash in the drawer | Asset | The business owns it |
| Shelves and a cold drink fridge | Asset | Owned, used over a long period |
| Packets of rice in stock | Asset | Owned, to be sold |
| Amount a customer has not yet paid | Asset (receivable) | Expected to be collected |
| Amount owed to a wholesaler | Liability (payable) | Must be paid to an outsider |
| A bank loan for the fridge | Liability | Must be repaid |
| Aminah’s capital | Equity | The owner’s claim |
| Sales of rice and drinks | Income | Earned from trading |
| Shop rent for the month | Expense | Cost of running the shop |
| Electricity bill for the month | Expense | Cost of running the shop |
The equation for the shop at one moment is assets = liabilities + equity. Income and expenses change equity over the period, since income increases it and expenses reduce it.
The mistake that loses marks
The common slip is to treat the owner taking money or goods for personal use as an expense. That is drawings, which reduce equity directly and are not a cost of running the business.
Another slip is to record the purchase of a fridge as an expense because money left the business. The fridge will serve the shop for years, so it is an asset, and the cost is spread over its life later through depreciation.
Check yourself
Classify each item for a tailor’s shop: (a) a sewing machine bought for RM2 400; (b) RM300 fabric rolls still unsold; (c) wages paid to an assistant; (d) money owed to the fabric supplier; (e) RM150 taken by the owner for personal use.
Answer
(a) Asset: owned, benefits the shop over a long period.
(b) Asset: inventory, owned and to be sold.
(c) Expense: cost of running the business in the period.
(d) Liability: a payable owed to an outsider.
(e) Drawings: reduces equity, not an expense. Equity is the owner’s claim, and this is the owner taking some of it.
What to study next
Go on to applying the accounting equation to see these groups change with each transaction. Practise classification and entries with the debit-credit transaction trainer, and look up any term in the accounting glossary.
For a teacher to drill classification on your own items, see online one-to-one Accounting tuition.