Keeping Track of Transactions – Setting Up Your Accounts
Every accounting system needs accounts, and every account will fit into one of the standard account categories (such as assets or revenues). When you start out in business, it can be difficult to anticipate every single account you are ever going to need. Instead of trying to do that, it’s better to focus on core accounts that are common to virtually every business. Then you can add on the more specialized accounts you need to run your company.
FACT
There’s a standard system for numbering the different types of accounts, and it’s embedded into virtually all packaged accounting software. As long as you follow the standard numbering convention, your reports will print correctly. If you choose to make up your own account numbering system, you may have to reset every report within the program.
When talking about accounts, you tend to use their names: cash, postage expense, payroll. In the accounting system, though, you will assign distinct numbers to each account. The combination of the number and the name serves as a unique identifier for each account and can help avoid recording transactions in the wrong accounts. Once you have all your accounts named and numbered, you will list them in account number order; that listing is known as the chart of accounts, and it will come in handy when you are getting started.
Similar and Different Accounts
Almost every company uses the same standard accounts for its assets and liabilities. The differences mainly come in with equity, revenues, costs, and expenses, because these are more dependent on the type of business you have.
Your equity setup depends entirely on your business structure. Sole proprietors have a single capital account and owner withdrawal accounts; the withdrawal accounts are often split out into personal categories, so owners can track things such as personal deductible expenses and estimated income tax payments more easily. Partnerships have one capital account and at least one withdrawal account for each partner, so there will be at least two of each of those accounts. Corporations’ equity is completely different, made up of at least one stock account and an account called retained earnings.
Question?
Do I have to deal with sales taxes?
That depends on the laws in each state where you do business. In some states, only products are taxable; others impose sales tax on services as well. Many states have varying sales tax rates for different types of items. Check with the state sales tax office in any state where you have sales to learn its requirements.
Revenue accounts should match your major products or services. Some- times, revenues are also broken down into taxable and nontaxable sales to make things easier when it comes time to file your sales tax return. Your cost accounts will match your revenue accounts; if your product revenues are split up, your cost accounts will be, too. As for expenses, some are com- mon to every business (such as phone and electricity), while others may be unique to your industry (waiting room magazines, for example).
Assigning Account Numbers
Even among the same types of accounts, there’s a method to the numbering scheme. In the asset section (where the numbers all start with 1), cash always comes first; if you have three cash accounts, those would be your first three listed accounts. Then come other current assets, in their order of liquidity. Accounts receivable would come before inventory, for instance. After you’ve numbered all current assets, start on the fixed assets; most of the time, the first entry here gets number 150. Each fixed asset is listed separately and usually alphabetically. The final entry in the fixed-asset group will be the accumulated depreciation account. If you have intangible assets, they come next, followed by their accumulated amortization account.
Account numbers for liabilities (which start with 2s) work basically the same way. Current liabilities come first, usually starting with accounts payable. When you switch to long-term liability numbering, start with account number 250 to show a clear segregation; that will be useful as you begin to add accounts, because it will be easier to figure out where they go. The specific equity accounts (all starting with 3) differ based on your business entity, but the numbering scheme remains the same. You start with the capital itself, whether it’s a partner’s capital account or total shares of stock out- standing. That is followed with drawing or dividend accounts, then prior and current earnings.
Your revenue accounts will start with 4s. Depending on your type of business, you may have several revenue accounts, or merely one. If you sell both services and products, you have to separate them for accounting purposes. However, you may want to further break down sales for your own tracking purposes; for example, taxable and nontaxable, or clothing and accessories. Cost accounts (which start with 5s) track your sold inventory, no matter what kind of products you sell. If you’ve decided to split up your sales accounts, you may want to mirror them with the connected product cost accounts. Expenses (which all start with 6s) are often just listed in alphabetical order, allowing enough room in between to insert new categories as necessary.
A Sample Chart of Accounts
A complete chart of accounts could fill several pages, so here you will see more of a skeleton version to give you the basic idea. This setup is for a retail company that sells two products only: hammers and nails. The company is set up as a sole proprietorship.
| Account Number | Account Name | Account Type |
|---|---|---|
| 100 | Cash | Asset |
| 110 | Accounts Receivable | Asset |
| 120 | Inventory—Hammers | Asset |
| 121 | Inventory—Nails | Asset |
| 130 | Prepaid Expenses | Asset |
| 150 | Fixed Assets | Asset |
| 180 | Accumulated Depreciation | Asset |
| 200 | Accounts Payable | Liability |
| 210 | Payroll Taxes Payable | Liability |
| 220 | Sales Taxes Payable | Liability |
| 250 | Long-Term Loan Payable | Liability |
| 300 | Rob Smith, Capital | Equity |
| 350 | Rob Smith, Withdrawals | Equity |
| 400 | Sales—Hammers | Revenue |
| 401 | Sales—Nails | Revenue |
| 450 | Sales Returns | Revenue |
| 500 | Cost of Goods Sold—Hammers | Cost |
| 501 | Cost of Goods Sold—Nails | Cost |
| 610 | Accounting & Legal | Expense |
| 615 | Advertising | Expense |
| 630 | Depreciation | Expense |
| 640 | Insurance | Expense |
| 645 | Interest | Expense |
| 660 | Payroll | Expense |
| 661 | Payroll Taxes | Expense |
| 670 | Rent | Expense |
| 675 | Repairs & Maintenance | Expense |
| 680 | Utilities | Expense |
Most companies will have more accounts than this, and some of these basic accounts may be split out in a more meaningful manner. For example, you may have three cash accounts: cash on hand (also known as petty cash), regular checking, and payroll checking. Those would require three separate accounts in your chart.