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Call Now The chart of accounts is the foundation upon which a business is built. Learn how to craft your chart before you start your small business. You'll be sorry if you don't. No matter what product is to be sold or what service is to be offered, starting and operating a small business takes courage, fortitude, and lots and lots of planning. As an accountant catering to small business for 30 years or so, I can tell you that many entrepreneurs have the courage and the fortitude in abundance, but not nearly as many take the time to truly plan how their fledgling business is going to operate. One of the first, and also one of the most serious, accounting mistakes small businesses make is not creating a cogent, coherent, and practical chart of accounts. In fact, some people start a business without even knowing what a chart of accounts is. To put it bluntly, if you don't know what a chart of accounts is and why it is so important, you might want to reconsider your plans to start a business. SEE: Quick glossary: Accounting What is the chart of accounts? The chart of accounts is a numbered list of assets, liabilities, equity, revenues, and expenses that form the foundation for every transaction a business will make during its existence. It is the framework for all the bookkeeping, accounting, and tax reporting the company will be required to perform. Create a proper chart of accounts for your business before you transact any business--or you will regret that you didn't. You can download our two sample charts of accounts to help you get started. One is a basic example for a corporation and one is a basic example for a sole proprietorship. Enjoying this article? Download this article and thousands of whitepapers and ebooks from our Premium library. Enjoy expert IT analyst briefings and access to the top IT professionals, all in an ad-free experience. Join Premium Today Unfortunately, small business accounting and bookkeeping applications like QuickBooks do a poor job of explaining what a chart of accounts is and why it is so important. In fact, QuickBooks and the like seem to go out of their way to avoid any "accountant's lingo" in their setup process. This often leads to poorly constructed charts of accounts that must be corrected by a professional later. Budding small businesses can avoid this costly outcome by learning and following a few basic rules. The formula The double entry accounting system on which the basic chart of accounts is founded was created by Luca Pacioli in the 13th century, and it is the tried-and-true method for tracking business transactions the world over. The system is based on this simple equation: Assets = Liabilities + Equity This is the basic accounting equation underlying the financial statement known as the balance sheet, which is part one of the chart of accounts. Part two of the chart of accounts is the income statement (or profit-and-loss statement, if you prefer). This simple equation is: Profit (Loss) = Revenues - Expenses The basic chart of accounts Of course, your business is unique and may require modifications to the basic chart of accounts, but the general outline will remain the same. I am purposely avoiding some of the more complicated tenets laid out by generally accepted accounting principles (GAAP) regarding the chart of accounts and financial statements because it is too complicated for this article, but if you want to see the full details, I suggest you visit the Financial Accounting Standards Board (FASB) web page. Balance sheet The first two sections in a standard chart of accounts are for assets. The first section, usually represented by accounts numbered in the 100s, are cash and cash equivalent assets, like accounts receivables. Section two is for longer lasting and depreciable assets, like equipment, vehicles, and fixtures. These accounts are generally numbered in the 200s. Liabilities come next in the chart and include accounts payable, lines of credit, loans, mortgages, and payroll tax withholdings. (Yes, that is correct--part of what the company takes out of an employee's paycheck is a liability and not an expense.) These accounts are generally numbered in the 300s. The accounts in the 400s are reserved for the equity section of the balance sheet. Depending on how the business was created, accounts in this section could include owners' equity, retained earnings, accumulated adjustments, capital stock, and the current fiscal year's profit or loss. Income statement The income statement starts with accounts numbered in the 500s and includes sales, service income, or other forms of revenue generated by the operation of the business. The 600s are generally reserved for accounts that fall into the cost of goods sold category. This might include accounts for the materials, supplies, and labor needed to manufacture or produce the product a business is selling. It is important to note that this section may not be necessary if the business is selling a service that does not require materials, etc. The next section is for general operating expenses, which range from advertising to workers' compensation insurance to everything in between. This section, usually numbered in the 700s, is the most variable section of any chart of accounts and will differ greatly depending on the business. The last two sections are optional and may not apply to all businesses. The 800s are where you list non-business related income. This section is for things like interest, dividends, and rebates. On the flip side, the 900s are for non-business related expenses, like charitable donations. Follow the plan From a record-keeping perspective, the chart of accounts is the most important planning opportunity for any new small businesses. A proper chart of accounts will set the tone for success as the business goes forward. Conversely, a poorly executed chart of accounts will hinder success, create stress, require professional help to fix, and could ultimately lead to the downfall of the entire operation. Before you start any business, plan and codify your chart of accounts--you will never regret that you did, but you will always regret that you didn't.Starting a small business can be as simple as registering a trade name and selling a service or product. Although specific details on business licensing and entity formations vary by state and industry, one common process required by all businesses is an accounting system. An accounting system is a compilation of monetary transactions entered into a ledger that is used to record financial records. Choose the specific software you will use to set up your accounting system. Accounting software like QuickBooks or Peachtree comes with pre-defined charts of accounts for various industries. Spreadsheet software such as Microsoft Excel or Open Office Calc does not have a built-in chart of accounts, so you must create one manually. Review your business model and financial statement reporting needs to assist in finding the best-suited chart of accounts. The chart of accounts is a list of the assets, liabilities, equity, income and expenses. Users of spreadsheet software can get a sample chart of accounts from www.Netmba.Com. After creating the chart of accounts, consider numbering the accounts. Although numbering is not required, it serves a purpose, and it is to help you locate accounts quickly and easily. If you choose to assign numbers to the chart of accounts, proceed to step three, otherwise move to step four. Assign a series of 1000 for each account type. For example, assets could be 1000 through 1999, liabilities could be 2000 through 2999, and equity could be 3000 through 3999. The first number in the chart of accounts represents the account type and each digit after can represent any pattern you choose. Create your purchase order and invoice templates. Accounting software users will find templates within the software program. Spreadsheet users can download a variety of templates from the software manufacturer. Invoices should include the date, business information, customer information, amount due, payment terms or due date and a description of the services or goods provided. Begin using purchase orders for your purchases and invoices to record customer sales. Choose an accounting method--typically either cash or accrual. Cash method accounting requires users to record income received and expenses when paid. Accrual method accounting records income when earned and expenses when incurred. Due to the simplicity of record keeping and data entry, most small businesses report using cash basis accounting; however, an enrolled agent can help you determine which method best suits your accounting and tax needs. Record your transactions in the accounting system using bank statements and invoices. Expenses and purchases should decrease the bank balance. Income and loans should increase the bank balances. References Resources Tips Every transaction has a left (debit) and right (credit) side to balance. Using accounting specific software reduces time and eliminates a lot of the guesswork involved in determining which part of the transaction is a debit and which part is a credit. Updating your accounting books every few days helps you enter the transactions before you lose any details from your memory. Start with the bare minimum number of accounts to make your accounting system function; add accounts as you determine the need for them. Warnings Incorrectly entering debit and credit balances for a transaction will result in misstated financial statements. Writer Bio Jeremy Slaughter began writing business and hobby articles in 2009 after completing his master's degree in accounting at the Keller Graduate School of Management. As a tax, accounting and small business expert, Slaughter co-founded an accounting and tax firm where writing plays a daily role. How Do I Create a General Ledger? How to Set Up Accounting Software How to Set Up an Account in QuickBooks How to Change Account Type in Quicken How to Set Up a Line of Credit Account in Quicken How to Reconcile Accounts Receivable How to Prepare an Income Statement & a Balance Sheet in Financial Accounting How to Import Simply Accounting Into QuickBooks Do Accrued Expenses Reverse Year End Closing? How to Change the Asset Account in QuickBooks How to Close a Temporary Account in QuickBooks What Is the Sequence for Preparing Financial Statements?If you set up your chart of accounts correctly, you can save yourself a lot of time later. While adding and removing accounts is a relatively easy process if you use accounting software, it can be a time-consuming task to adjust your books manually. Your chart of accounts is a list of all of the accounts in your system. As a limited liability corporation providing a service to customers, some of the accounts to include are asset, expense and income accounts. LLCs should include an owner equity account for each member of the corporation. Set up a code system for your accounts. Coding your accounts makes it easier to identify them at a glance. A simple method is to assign a three-digit code to each account. Assign asset accounts numbers in the 100s, liability accounts starting with 200, income accounts beginning with 300 and expense accounts the 400s. Number all of your asset accounts and enter each one into your chart of accounts. Examples of asset accounts include cash, prepaid insurance and rent, accounts receivable and equipment. Specify each account as a debit or a credit account. Specify an owner's equity account for each owner. These accounts can include a capital and a draw account for each. The capital accounts are for owner investments, and the drawing account is for funds the owners withdraw for personal use. Include your income accounts. If your LLC provides different types of services and you want to be able to tell at a glance which services are the most profitable, add an income account for each service. List your expense accounts. Expenses include salaries, supplies, utilities and advertising. If you have equipment that depreciates, include a depreciation expense account. Including an LLC expense account provides you with an account to debit business fees and licenses you must purchase from your state or local government. Divide your liabilities into accounts based on the type of liability it is. For example, set up a "Notes Payable" account for any loans or business credit accounts. Set up real estate loans into their own "Mortgage Loan Payable" account. Include any other account types your service business has. Write the beginning balance of the account and make sure you specify each account as a debit or credit account. References Resources Tips You can set up primary accounts for each type and break the primary account down with subaccounts if you choose. Accounting software typically provides a basic list of accounts you can use as a guideline when making your own chart of accounts. Warnings If you set up too many accounts or subaccounts, you may find it time-consuming when entering credits and debits. Writer Bio Specializing in business and finance, Lee Nichols began writing in 2002. Nichols holds a Bachelor of Arts in Web and Graphic Design and a Bachelor of Science in Business Administration from the University of Mississippi. How Do I Create a General Ledger? How to Change the Asset Account in QuickBooks Bookkeeping: Classification of Accounts Quickbooks Setup Checklist How to Delete an Account in Outlook 13 How to Change Account Type in Quicken How to Determine Net Income or Net Loss After Adjusting Entries How to Find Your Google Accounts What Columns Are Generally Found on an Accounting Work Sheet? How to Do a Journal Entry for Purchases on a Notes Payable How to Prepare an Income Statement & a Balance Sheet in Financial Accounting How to Download Previous Transactions on Quicken
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