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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 components of the balance sheet, as reflected in the Chart of Accounts.

Tackling assets

First on the chart are always the accounts that track what the company owns – its assets: current assets and long-term assets.

Current assets

Current assets are the key assets that your business uses up during a 12-month period and will likely not be there the next year. The accounts that reflect current assets on the Chart of Accounts are as follows:

✔ Cash in Checking: Any company’s primary account is the checking account used for operating activities. This is the account used to deposit revenues and pay expenses. Some companies have more than one operating account in this category; for example, a company with many divisions may have an operating account for each division.

✔ Cash in Savings: This account is used for surplus cash. Any cash for which there is no immediate plan is deposited in an interest-earning savings account so that it can at least earn interest while the company decides what to do with it.

✔ Cash on Hand: This account is used to track any cash kept at retail stores or in the office. In retail stores, cash must be kept in registers in order to provide change to customers. In the office, petty cash is often kept around for immediate cash needs that pop up from time to time. This account helps you keep track of the cash held outside a financial institution.

✔ Accounts Receivable: If you offer your products or services to customers on store credit (meaning your store credit system), then you need this account to track the customers who buy on your dime.

Accounts Receivable isn’t used to track purchases made on other types of credit cards because your business gets paid directly by banks, not customers, when other credit cards are used. Head to Book III Chapter 2 to read more about this scenario and the corresponding type of account.

✔ Inventory: This account tracks the products on hand to sell to your customers. The value of the assets in this account varies depending on how you decide to track the flow of inventory in and out of the business. Book III Chapter 1 discusses inventory valuation and tracking in greater detail.

✔ Prepaid Insurance: This account tracks insurance you pay in advance that’s credited as it’s used up each month. For example, if you own a building and prepay one year in advance, each month you reduce the amount that you prepaid by 1/12 as the prepayment is used up.

Depending upon the type of business you’re setting up, you may have other current asset accounts that you decide to track. For example, if you’re starting a service business in consulting, you’re likely to have a Consulting account for tracking cash collected for those services. If you run a business in which you barter assets (such as trading your services for paper goods), you may add a Barter account for business-to-business barter.

Long-term assets

Long-term assets are assets that you anticipate your business will use for more than 12 months. This section lists some of the most common long-term assets, starting with the key accounts related to buildings and factories owned by the company:

✔ Land: This account tracks the land owned by the company. The value of the land is based on the cost of purchasing it. Land value is tracked separately from the value of any buildings standing on that land because land isn’t depreciated in value, but buildings must be depreciated. Depreciation is an accounting method that shows an asset is being used up. Book IV Chapter 1 talks more about depreciation.

✔ Buildings: This account tracks the value of any buildings a business owns. As with land, the value of the building is based on the cost of purchasing it. The key difference between buildings and land is that the building’s value is depreciated, as discussed in the previous bullet.

✔ Accumulated Depreciation – Buildings: This account tracks the cumulative amount a building is depreciated over its useful lifespan. Book IV Chapter 1 talks more about how to calculate depreciation.

✔ Leasehold Improvements: This account tracks the value of improvements to buildings or other facilities that a business leases rather than purchases. Frequently when a business leases a property, it must pay for any improvements necessary in order to use that property the way it’s needed. For example, if a business leases a store in a strip mall, it’s likely that the space leased is an empty shell or filled with shelving and other items that may not match the particular needs of the business. As with buildings, leasehold improvements are depreciated as the value of the asset ages.

✔ Accumulated Depreciation – Leasehold Improvements: This account tracks the cumulative amount depreciated for leasehold improvements.

The following are the types of accounts for smaller long-term assets, such as vehicles and furniture:

✔ Vehicles: This account tracks any cars, trucks, or other vehicles owned by the business. The initial value of any vehicle is listed in this account based on the total cost paid to put the vehicle in service. Sometimes this value is more than the purchase price if additions were needed to make the vehicle usable for the particular type of business. For example, if a business provides transportation for the handicapped and must add additional equipment to a vehicle in order to serve the needs of its customers, that additional equipment is added to the value of the vehicle. Vehicles also depreciate through their useful lifespan.

✔ Accumulated Depreciation – Vehicles: This account tracks the depreciation of all vehicles owned by the company.

✔ Furniture and Fixtures: This account tracks any furniture or fixtures purchased for use in the business. The account includes the value of all chairs, desks, store fixtures, and shelving needed to operate the business. The value of the furniture and fixtures in this account is based on the cost of purchasing these items. These items are depreciated during their useful lifespan.

✔ Accumulated Depreciation – Furniture and Fixtures: This account tracks the accumulated depreciation of all furniture and fixtures.

✔ Equipment: This account tracks equipment that was purchased for use for more than one year, such as computers, copiers, tools, and cash registers. The value of the equipment is based on the cost to purchase these items. Equipment is also depreciated to show that over time it gets used up and must be replaced.

✔ Accumulated Depreciation – Equipment: This account tracks the accumulated depreciation of all the equipment.

The following accounts track the long-term assets that you can’t touch but that still represent things of value owned by the company, such as organization costs, patents, and copyrights. These are called intangible assets, and the accounts that track them include

✔ Organization Costs: This account tracks initial start-up expenses to get the business off the ground. Many such expenses can’t be written off in the first year. For example, special licenses and legal fees must be written off over a number of years using a method similar to depreciation, called amortization, which is also tracked. Book IV Chapter 1 discusses amortization in greater detail.

✔ Amortization – Organization Costs: This account tracks the accumulated amortization of organization costs during the period in which they’re being written-off.

✔ Patents: This account tracks the costs associated with patents, grants made by governments that guarantee to the inventor of a product or service the exclusive right to make, use, and sell that product or service over a set period of time. Like organization costs, patent costs are amortized. The value of this asset is based on the expenses the company incurs to get the right to patent the product.

✔ Amortization – Patents: This account tracks the accumulated amortization of a business’s patents.

✔ Copyrights: This account tracks the costs incurred to establish copyrights, the legal rights given to an author, playwright, publisher, or any other distributor of a publication or production for a unique work of literature, music, drama, or art. This legal right expires after a set number of years, so its value is amortized as the copyright gets used up.

✔ Goodwill: This account is only needed if a company buys another company for more than the actual value of its tangible assets. Goodwill reflects the intangible value of this purchase for things like company reputation, store locations, customer base, and other items that increase the value of the business bought.

If you hold a lot of assets that aren’t of great value, you can also set up an “Other Assets” account to track them. Any asset you track in the Other Assets account that you later want to track individually can be shifted to its own account. Book IV Chapter 6 discusses adjusting the Chart of Accounts.

Laying out your liabilities

After you cover assets, the next stop on the bookkeeping highway is the accounts that track what your business owes to others. These “others” can include vendors from which you buy products or supplies, financial institutions from which you borrow money, and anyone else who lends money to your business. Like assets, liabilities are lumped into two types: current liabilities and long-term liabilities.

Current liabilities

Current liabilities are debts due in the next 12 months. Some of the most common types of current liabilities accounts that appear on the Chart of Accounts are

✔ Accounts Payable: Tracks money the company owes to vendors, contractors, suppliers, and consultants that must be paid in less than a year. Most of these liabilities must be paid 30 to 90 days from billing.

✔ Sales Tax Collected: You may not think of sales tax as a liability, but because the business collects the tax from the customer and doesn’t pay it immediately to the government entity, the taxes collected become a liability tracked in this account. A business usually collects sales tax throughout the month and then pays it to the local, state, or federal government on a monthly basis. Book V Chapter 4 discusses paying sales taxes in greater detail.

✔ Accrued Payroll Taxes: This account tracks payroll taxes collected from employees to pay state, local, or federal income taxes as well as Social Security and Medicare taxes. Companies don’t have to pay these taxes to the government entities immediately, so depending on the size of the payroll, companies may pay payroll taxes on a monthly or quarterly basis. Book III Chapter 3 discusses how to handle payroll taxes.

✔ Credit Cards Payable: This account tracks all credit-card accounts to which the business is liable. Most companies use credit cards as short-term debt and pay them off completely at the end of each month, but some smaller companies carry credit-card balances over a longer period of time. Because credit cards often have a much higher interest rate than most lines of credits, most companies transfer any credit-card debt they can’t pay entirely at the end of a month to a line of credit at a bank. When it comes to your Chart of Accounts, you can set up one Credit Card Payable account, but you may want to set up a separate account for each card your company holds to improve tracking credit-card usage.

How you set up your current liabilities and how many individual accounts you establish depends on how detailed you want to track each type of liability. For example, you can set up separate current liability accounts for major vendors if you find that approach provides you with a better money management tool. For example, suppose that a small hardware retail store buys most of the tools it sells from Snap-on. To keep better control of its spending with Snap-on, the bookkeeper sets up a specific account called Accounts Payable – Snap-on, which is used only for tracking invoices and payments to that vendor. In this example, all other invoices and payments to other vendors and suppliers are tracked in the general Accounts Payable account.

Long-term liabilities

Long-term liabilities are debts due in more than 12 months. The number of long-term liability accounts you maintain on your Chart of Accounts depends on your debt structure. The two most common types are

✔ Loans Payable: This account tracks any long-term loans, such as a mortgage on your business building. Most businesses have separate loans payable accounts for each of their long-term loans. For example, you could have Loans Payable – Mortgage Bank for your building and Loans Payable – Car Bank for your vehicle loan.

✔ Notes Payable: Some businesses borrow money from other businesses using notes, a method of borrowing that doesn’t require the company to put up an asset, such as a mortgage on a building or a car loan, as collateral. This account tracks any notes due.

In addition to any separate long-term debt you may want to track in its own account, you may also want to set up an account called Other Liabilities that you can use to track types of debt that are so insignificant to the business that you don’t think they need their own accounts.

Eyeing the equity

Every business is owned by somebody. Equity accounts track owners’ contributions to the business as well as their share of ownership. For a corporation, ownership is tracked by the sale of individual shares of stock because each stockholder owns a portion of the business. In smaller companies that are owned by one person or a group of people, equity is tracked using Capital and Drawing accounts. Here are the basic equity accounts that appear in the Chart of Accounts:

✔ Common Stock: This account reflects the value of outstanding shares of stock sold to investors. A company calculates this value by multiplying the number of shares issued by the value of each share of stock. Only corporations need to establish this account.

✔ Retained Earnings: This account tracks the profits or losses accumulated since a business was opened. At the end of each year, the profit or loss calculated on the income statement is used to adjust the value of this account. For example, if a company made a $100,000 profit in the past year, the Retained Earnings account would be increased by that amount; if the company lost $100,000, then that amount would be subtracted from this account.

✔ Capital: This account is only necessary for small, unincorporated businesses. The Capital account reflects the amount of initial money the business owner contributed to the company as well as owner contributions made after the initial start-up. The value of this account is based on cash contributions and other assets contributed by the business owner, such as equipment, vehicles, or buildings. If a small company has several different partners, then each partner gets his or her own Capital account to track his or her contributions.

✔ Drawing: This account is only necessary for businesses that aren’t incorporated. It tracks any money that a business owner takes out of the business. If the business has several partners, each partner gets his or her own Drawing account to track what he or she takes out of the business.