Defining your Chart of Accounnts correctly can save you from accounting headaches later!

A Chart of Accounts is a list of the account names and accounts codes that you have which are categorized according to your five major accounts which are the following:

1. Assets
2. Liabilities
3. Equity
4. Revenue
5. Expenses

Under Assets, you may have sub-accounts like:

Cash
Receivable
Inventory
Equipment

Your "Cash Account" can be further subdivided into another level of sub-accounts like:

Cash in Bank
Cash on Hand

Just like Cash, your other Asset accounts, liabilities, equity, revenue and expense accounts can have sub-accounts and sub-accounts can have accounts under them.

When you make a journal or accounting entry, you deepest level of sub-account. Take the example below:


What is a Chart of Accounts?

As you can see Cash has two (2) sub-accounts which are Cash in Bank and; Cash on Hand.

Further, the Cash in Bank account has another level of sub-accounts which are Cash in Bank, Savings and; Cash in Bank, Checking.

Thus, when you make an accounting entry for Cash in Bank, you must either use Savings or Checking, you cannot just use Cash in Bank, since the balance for Savings or Checking must be automatically be part of Cash in Bank and the Cash in Bank balance must be automatically part of the Cash balance. You can do this manually, but if you purchase off the shelf accounting software like Peachtree or Quickbooks, this things are done automatically.

Different types of businesses have different sets of accounts in their Chart of Accounts.

Now that you have an idea of what is a Chart of Accounts, be sure to define your chart of accounts properly before using them. Make sure you have sub-accounts where they are needed.

Failure to correctly define the proper accounts for your business could result to problems later on if you want to change them. Accounts with balances can be difficult to change or transfer to other accounts that you will add later. Such change would result to numerous adjusting entries. In addition, if your accounts does not represent the accounts you need for Financial analysis, your financial information would have limited information for Financial decision making.

If necessary consult an Accountant in creating your Chart of Accounts.

In my next post, I will discuss Account Codes for your accounts and suggested accounts for various businesses.

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Accounting in ordinary man's language- part 2 (Account normal balances)

Learn the normal balance of each type of account and you will better understand Accounting.

This is very important step in your journey of learning the ins and outs of accounting. Actually a lot of CPA wannabes fail in the CPA Board because they have not taken to heart this concept of normal account balances. The other reason why Accountancy students have a hard time is because they did not do their Practice Set in either Accounting 1 or 2 in their lower years, where they would learn the Accountancy cycle by heart.

Well anyway, you are not here to take the CPA exam but to learn accounting for your business.

What the heck therefore is the concept of "normal account balances".

Normal account balance is the side (debit or credit) where the account would increase. Therefore an assets normal balance is debit because it is increases in the debit side. While a liability is credit because liabilities increases in the credit side.

Are you following me on this?

If not, well that's your problem :), just kidding.

If not, don't worry, I will explain it in further slowly.

Enter the term "Double Entry".

What does double entry mean?

You remember that debit and the credit concept. Picture a two column in MS Excel. Lets say you have a column A and a column B, and we write in the first row of column the word "debit" and in the first row of column B the word "credit".

We now have two columns debit and credit. In double entry, for every amount of transaction you entered in debit column, an equivalent amount should be entered for your credit column and vice-versa.

Did you follow me on that? Maybe I should show you a picture example for you to understand it better. Some of us are more of a visual type of individual .... isn't it? Life would be better if all teachers realize that ........ we would not have been so bored with all the concepts plugged in to our heads during our college days :)

Take a look at the Excel file 4-column example below:

As you can see in our picture above, in the first entry you have a credit sales transaction as shown in the particulars column. For purposes of illustration, lets say you have a sale given on credit in the amount of 100 in your currency. In this case, you have a collectible in the amount of 100 from your customer and an income of 100. So we entered 100 both under your debit and credit column, which in effect made your debit and credit obtain a balanced total. Since we entered the same amount totals in your debit and credit, then we have complied with the term "double entry".

The second transaction is just the same as the first, the only difference is the amount and the sales made was in cash.

However, the third transaction shown above in an Excel file example was a combination of both credit and sales. So as you can see, your debit column showed two entries, first recognizing the cash sales for 100 and in the second entry recognizing the credit sales for 200, thus the total sales is 300. In order two maintain the balance between debit and credit, we recognized the sales income under the credit column for 300.

In my next post, I will explain how create your "Chart of Accounts" which will explain the "Account Name" and "Account Code" columns in the above example.

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Accounting in ordinary man's language- part 1

Accounting is really very simple if we dissect its basic principle and explain it plainly. First you should understand the equation that is the foundation of everything about accounting. Look at the accounting equation below.

The Accounting Equation

Assets (Pag-aari o Ari-arian) = Liabilities (Pagkakautang) + Equity or Capital (Kapital o Puhunan)

Everything that is studied about Accounting revolves around this simple equation.

What are Assets?

Assets provide future benefits. Examples are cash or money (you can use cash to buy office furniture or stocks which are also assets in themselves, cash may also be used to pay liabilities), receivables (since it can be converted to money) and inventories.

In the accounting equation, assets are on the left side. For you to be able to better understand this, think of the left side of the accounting equation as the Debit side. I will explain this concept in more detail later. For now, just remember that the left side is the debit.

What are Liabilities?

Liabilities are obligations to pay other entities or individuals with your assets. Example is when your business owes a bank a sum of money. That is a liability and it will result to future decline in some of your assets that will be used to pay that liability.

What are Equity or Capital?

Equity or Capital is nothing but the investment or funds that you put into the business be it in the form of cash or in-kind. This means that investing something like equipment in a business is a form of equity or capital which is valued accordingly. You can also invest cash into a business, this would result into a person who did the investing having an equity or capital in the business.

Both Liabilities and Equity or Capital is on the right side of the accounting equation which you should remember as the Credit side.

In addition to the account types in the Accounting equation which are assets, liabilities and equity accounts which are called real accounts (because their balances are forwarded to the next accounting period), there are still two types of accounts, which are called nominal accounts (their balances are not forwarded to the next accounting period because they are closed every end of the period) namely:

1. Expense accounts - records your various expenses.
2. Revenue accounts - records your income or revenue.

In my next post we will discuss this accounting equation further by using a few examples for you to understand it better.

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