We recently had a few inquiries submitted to the Bean Counter (Have a question? Submit it here) about chart of accounts, what they are, and why they matter.
A chart of accounts is a way of sorting the information gathered from all the activities of your business. It is a list of categories used to collect information.
These categories could be something like:
- A Bank Account for all your checks and deposits
- A Sales account to accumulate all your information for invoices to you customers
- A Cost of Goods account to accumulate all the costs for the materials or goods that you sell
- Office Expenses for all the paper, ink, pens and pencils, etc that you purchase
A Chart of Accounts organizes these categories in a certain order so that you will know the status of your business and if you are making a profit.
In Round 1, we learned the very basics of debits and credits, but this time around, we're going to step it up a notch. If you need a quick refresher, take a second to look over what we discussed last time.
To start this round we'll talk about the T-Account, which consists of three parts- the title, the left side (aka debit), and the right side (aka credit). It's called a T-Account because in its most basic form, it looks like a "T"
Any time you enter an amount on the left side, you debit the account, and any time you enter an amount on the right side, you credit the account (remember from last week that increases in assets or decreases in liabilities are debits and vice-versa for credits).
Remember the law of conservation? It says that matter cannot be created or destroyed, and the same holds true when you're talking about money. We can't just pull money out of thin air (unfortunately) and place it into an account. You have to take it from one account to put into another, which is why each transaction you make affects multiple accounts. It also means that debits must equal credits after every transaction.
In order to keep track of the debits and credits, the double-entry system (and chart of accounts) was created. With the double-entry system, any amount entered into the accounting records shows up in two different places.
Let's use this as an example: Your business company makes and sells boxing gloves and you make a sale. When a customer pays cash for the gloves, an account would show the cash received in the Cash account (as a debit) and in the Sales account (as a credit).
Using the double entry system has its benefits because it helps to spot any errors that might pop up when making entries.
If you can remember all of this, you're ready for Round 3- The recording process.
