How To Set Up Your Chart of Accounts
This week we are going to move from the topic of organizing your small business and registering it with your state agencies to creating a chart of accounts for tracking your income and expenses. As we step into the accounting arena, do not stress. Your profit and loss accounts will correlate more closely to your actual expenses and income than you think. It’s not necessary to develop a chart of accounts with complex account numbers if you are using Quick Books or Excel. If you are a hobbyist who has recently made the jump to entrepreneur, I suggest that you open a business checking account, or at least a second checking account that you use only for paying business expenses and depositing your earnings. Each bank has its own rules for opening accounts. Banks may allow you to open a second personal account if you are operating your business as a sole proprietor, but I advise you to open a business account to prevent any issues from popping up in the future.
When you open that checking account you will create your first account. It will be a business checking account. With your opening deposit – in accounting terms – you will debit your new account with the amount of your deposit and credit your opening equity account. Several beginning software programs makes this easy for you. Quick Books is an extremely popular program that will guide you through choosing a sample chart of accounts that correlates to your busines type. Quicken is a similar system that simplifies entry of purchases, payment of expenses, or recording income. Fresh Books has become a popular competitor of Quick Books – all these programs will guide you through opening your chart of accounts. These programs also allow you to edit the names of most accounts so that they correlate to your business. A lesson that I learned my first year in bookkeeping is that your CPA is going to ask questions regarding the balance is some of your expenses or income accounts. You may need to research transactions for your CPA prior to filing taxes, depending on their level of involvement, because accuracy is essential in bookkeeping.
Let’s take a moment and review a description of the most basic chart of accounts. Accounts included will be separated into assets, liabilities, income, cost of goods sold, expenses, and equity. Here are examples of each type of account. Your checking account is an asset, as is your inventory, but a credit card or bank loan that you open for your business is a liability, your income will be your earnings for items that you sell or services you perform, cost of goods includes the cost that went into making that item that you sold, and an expense will be the shipping charges to send the item to the buyer. Whether you want to handle your own bookkeeping or not, you will need to become familiar with the use of accounts. Your net profit will be your earnings less cost of goods sold and expenses. Your equity, in simplest terms, is your net worth.
As a further description, following is a basic chart of accounts for a carpenter building and selling toy boxes. He’s working out of his garage and has not purchased any equipment specifically for building toy boxes.
- Checking Account
- Petty Cash
- Credit Card
- Bank Loan
- Sale of Toy Boxes
Cost of Goods Sold
- Shipping Boxes
- Investment in Business
As I stated earlier, this is a very basic account listing. Many industries have unique accounts and GAAP regulations. When setting up your company books, the IRS has guidelines that state the following:
Except in a few cases, the law does not require any specific kind of records. You can choose any recordkeeping system suited to your business that clearly shows your income and expenses.
You should set up your recordkeeping system using an accounting method that clearly shows your income for your tax year. If you are in more than one business, you should keep a complete a separate set of records for each business. A corporation’s recordkeeping system should include board of directors meeting minutes.
Your recordkeeping system should include a summary of your business transactions, which shows your gross income, as well as any expenses, deductions, and credits you are reporting. In addition, you must keep supporting documents, such as invoices and receipts, for purchases, sales, payroll, and other business transactions.
It is important to keep these documents because they support the entries in your journals and ledgers and on your tax return. Keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense.