On Account
Definition
General Definition:
On account refers to a partial payment made towards settling an outstanding obligation. This kind of payment reduces the amount due but does not eliminate the obligation entirely.
Finance Definition:
In finance, on account often implies transactions made on credit terms, signifying a purchase where the payment is anticipated to occur after the product or service is delivered. These transactions are typically synonymous with an ‘open account,’ as they are not secured by any promissory note.
Examples
- Partial Payment: A business owes $10,000 to a supplier and makes a payment of $4,000 “on account,” reducing the outstanding balance to $6,000.
- Open Account: A retailer purchases goods from a wholesaler valued at $15,000 “on account,” agreeing to pay within 30 days, without a signed promissory note.
Frequently Asked Questions (FAQs)
What does “on account” mean in accounting?
“On account” in accounting denotes a payment towards an outstanding bill or an agreed-upon credit period for the settlement of a purchase. The term implies the remaining balance is still owed.
How does “on account” differ from a cash transaction?
In a cash transaction, payment is made immediately upon receipt of goods or services. In an “on account” transaction, payment is deferred to a later date, indicating a credit purchase.
Is “on account” synonymous with “open account” in finance?
Yes, these terms are often used interchangeably. Both imply a credit relationship where payment is expected after delivery, and there is no supporting promissory note or immediate payment requirement.
Can individuals use “on account” transactions?
While businesses commonly use “on account” transactions for goods and services, individuals might also engage in similar arrangements, such as with utilities or credit card purchases.
What impact does an “on account” transaction have on financial statements?
For the buyer, it increases accounts payable until payment is made. For the seller, it increases accounts receivable until the payment is received.
- Accounts Payable: The amount a business owes to its suppliers for goods or services received but not yet paid for.
- Accounts Receivable: The amount due to a business from customers who have purchased goods or services on credit.
- Credit Terms: The conditions under which credit is extended to a buyer, including the timing and amount of payment.
- Promissory Note: A financial instrument involving a written promise by one party to pay another party a definite sum of money either on-demand or at a specified future date.
Online References
Suggested Books for Further Studies
- “Accounting Made Simple: Accounting Explained in 100 Pages or Less” by Mike Piper
- “Financial Accounting, 10th Edition” by Walter T. Harrison Jr., Charles T. Horngren, and C. William Thomas
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
Fundamentals of “On Account”: Accounting Basics Quiz
### What does "on account" typically refer to in business transactions?
- [x] Partial payment of an obligation or credit terms for a purchase.
- [ ] Payment in full at the time of purchase.
- [ ] Documentation by a promissory note.
- [ ] Cash payment upon delivery.
> **Explanation:** "On account" in business transactions usually refers to either a partial payment towards an obligation or purchases made under credit terms where payment is deferred.
### What type of accounting entry would increase accounts payable?
- [ ] Receiving cash payment for goods sold.
- [ ] Issuing a promissory note.
- [x] Purchasing goods "on account."
- [ ] Settling a debt in full.
> **Explanation:** Purchasing goods "on account" increases accounts payable, representing the amount owed to suppliers.
### What is the effect of an "on account" transaction on a purchaser's balance sheet?
- [x] Increases accounts payable.
- [ ] Decreases cash balance.
- [ ] Increases fixed assets.
- [ ] Decreases accounts receivable.
> **Explanation:** An "on account" transaction signifies a credit purchase, thus increasing accounts payable on the purchaser's balance sheet.
### How would a seller record a sale "on account"?
- [ ] Debit Cash, Credit Sales Revenue
- [x] Debit Accounts Receivable, Credit Sales Revenue
- [ ] Debit Sales Revenue, Credit Accounts Payable
- [ ] Credit Sales Revenue, Debit Cash
> **Explanation:** The proper accounting entry for a sale "on account" involves debiting accounts receivable and crediting sales revenue, indicating an amount due from the customer.
### When can an "on account" transaction be settled?
- [ ] Immediately upon delivery.
- [ ] After the goods are used.
- [x] At the end of the credit term.
- [ ] When the promissory note is due.
> **Explanation:** An "on account" transaction is generally settled at the end of the established credit term.
### What does an increase in accounts receivable indicate for a business?
- [ ] Greater cash inflow.
- [ ] More liabilities.
- [x] More sales on credit.
- [ ] Reduced revenue.
> **Explanation:** An increase in accounts receivable indicates that a business has more credit sales, meaning customers owe more money for goods or services.
### What is an "open account"?
- [ ] An account with no transactions.
- [ ] An account paid on delivery.
- [x] A credit arrangement without a promissory note.
- [ ] A fully settled account.
> **Explanation:** An "open account" is a credit arrangement where goods or services are provided without requiring immediate payment or a promissory note.
### What financial term refers to the amount a business owes suppliers for credit purchases?
- [ ] Accounts Receivable
- [ ] Cash Equivalents
- [ ] Inventory
- [x] Accounts Payable
> **Explanation:** Accounts payable represents the amount owed to suppliers for purchases made on credit.
### How is a partial payment of a debt referred to in accounting terms?
- [x] On account.
- [ ] On credit.
- [ ] In full.
- [ ] Settled.
> **Explanation:** A partial payment of a debt in accounting terms is often referred to as "on account."
### What accounting entry is made when a partial payment is made on account?
- [ ] Reduce inventory.
- [x] Debit accounts payable, credit cash/bank.
- [ ] Debit sales revenue.
- [ ] Credit accounts receivable.
> **Explanation:** When a partial payment is made on account, accounts payable are debited (reduced), and cash or bank is credited (reduced).
Thank you for diving into the concept of “On Account.” Keep exploring more financial terminology to strengthen your business acumen!
