Differentiating Debits and Credits
Because bookkeeping’s debits and credits are different from the ones you’re used to encountering, you’re probably wondering how you’re supposed to know whether a debit or credit will increase or decrease an account. Believe it or not, identifying the difference will become second nature as you start making regular bookkeeping entries. But to make things easier, Table 1-1 is a chart that’s commonly used by all bookkeepers and accountants.
Table 1-1 How Credits and Debits Impact Your Accounts
Chapter 2
Charting the Accounts
In This Chapter
▶ Introducing the Chart of Accounts
▶ Reviewing the types of accounts that make up the chart
▶ Creating your own Chart of Accounts
Can you imagine the mess your checkbook would be if you didn’t record each check you wrote? You’ve probably forgotten to record a check or two on occasion, but you certainly learn your lesson when you realize that an important payment bounces as a result. Yikes!
Keeping the books of a business can be a lot more difficult than maintaining a personal checkbook. Each business transaction must be carefully recorded to make sure it goes into the right account. This careful bookkeeping gives you an effective tool for figuring out how well the business is doing financially.
As a bookkeeper, you need a road map to help you determine where to record all those transactions. This road map is called the Chart of Accounts. This chapter tells you how to set up the Chart of Accounts, which includes many different accounts. It also reviews the types of transactions you enter into each type of account in order to track the key parts of any business: assets, liabilities, equity, revenue, and expenses.
Getting to Know the Chart of Accounts
The Chart of Accounts is the road map that a business creates to organize its financial transactions. After all, you can’t record a transaction until you know where to put it! Essentially, this chart is a list of all the accounts a business has, organized in a specific order; each account has a description that includes the type of account and the types of transactions that should be entered into that account. Every business creates its own Chart of Accounts based on how the business is operated, so you’re unlikely to find two businesses with the exact same Charts of Accounts.
However, some basic organizational and structural characteristics are common to all Charts of Accounts. The organization and structure are designed around two key financial reports: the balance sheet, which shows what your business owns and what it owes, and the income statement, which shows how much money your business took in from sales and how much money it spent to generate those sales. (You can find out more about balance sheets in Book II Chapter 4 and income statements in Book II Chapter 5.)
The Chart of Accounts starts with the balance sheet accounts, which include the following:
✔ Current Assets: Includes all accounts that track things the company owns and expects to use in the next 12 months, such as cash, accounts receivable (money collected from customers), and inventory
✔ Long-term Assets: Includes all accounts that track things the company owns that have a lifespan of more than 12 months, such as buildings, furniture, and equipment
✔ Current Liabilities: Includes all accounts that track debts the company must pay over the next 12 months, such as accounts payable (bills from vendors, contractors, and consultants), interest payable, and credit cards payable
✔ Long-term Liabilities: Includes all accounts that track debts the company must pay over a period of time longer than the next 12 months, such as mortgages payable and bonds payable
✔ Equity: Includes all accounts that track the owners of the company and their claims against the company’s assets, which include any money invested in the company, any money taken out of the company, and any earnings that have been reinvested in the company
The rest of the chart is filled with income statement accounts, which include
✔ Revenue: Includes all accounts that track sales of goods and services as well as revenue generated for the company by other means
✔ Cost of Goods Sold: Includes all accounts that track the direct costs involved in selling the company’s goods or services
✔ Expenses: Includes all accounts that track expenses related to running the business that aren’t directly tied to the sale of individual products or services
When developing the Chart of Accounts, you start by listing all the Asset accounts, the Liability accounts, the Equity accounts, the Revenue accounts, and finally, the Expense accounts. All these accounts come from two places: the balance sheet and the income statement.
Starting with the Balance Sheet Accounts
The first part of the Chart of Accounts is made up of balance sheet accounts, which break down into the following three categories:
✔ Asset: These accounts are used to track what the business owns. Assets include cash on hand, furniture, buildings, vehicles, and so on.
✔ Liability: These accounts track what the business owes, or, more specifically, claims that lenders have against the business’s assets. For example, mortgages on buildings and lines of credit are two common types of liabilities.
✔ Equity: These accounts track what the owners put into the business and the claims owners have against assets. For example, stockholders are company owners that have claims against the business’s assets.
The balance sheet accounts, and the financial report they make up, are so-called because they have to balance out. The value of the assets must be equal to the claims made against those assets. (Remember, these claims are liabilities made by lenders and equity made by owners.)
Book II Chapter 4 discusses the balance sheet in greater detail, including how it’s prepared and used. This section, however, examines the basic