The Chart of Accounts is the foundation of your bookkeeping system. You can think of it like it's a file cabinet full of files, and each file will store a different kind of bookkeeping information.
So, if you have bookkeeping information for telephone payments made for your business phone line, you will set up a file (an account) for Telephone Expense.
There are many different kinds of accounts that should be included in your Chart of Accounts (as shown below).
Assets are the things that your company owns. Typically they are divided into two groups: 1) current assets and 2) fixed assets
1) Current assets are the things that you can turn easily into cash.
2) Fixed assets are the things that you would have to sell to generate cash. (A good rule of thumb, that we used at the CPA office where I worked, is anything purchased for an amount over $500.00)
Fixed Assets that are typically included in the Chart of Accounts are automobiles, furniture, equipment, and land. An example would be if your company bought a new desk for $630. If the cost of the new furniture is more than $500, the cost will be entered into an asset account (rather than to an expense account).
A liability is the money your company owes.
An example would be if your company were to borrow money from the bank. When you received the money and deposited it into the checking or savings account, the deposit would be entered as a liability account, (not an income account).
Another example would be Accounts Payable. Any bills that come in that your company owes would be treated as a liability.
Your capital account will be set-up differently in your Chart of Accounts depending upon the way that your company is organized. There are three different business structures in which your business can be organized:
1) Sole proprietorship, 2) partnership, or 3) corporation.
1) A sole proprietorship is a single owned business that will be reported on your personal income tax return (Federal Form 1040) on the Schedule C.
A Sole proprietorship will need to set-up two main types of bookkeeping accounts.
The two types of bookkeeping accounts are:
1A) Capital account and 2A) Owner's Drawing account.
1A) The Capital account will be used to keep track of all of the money that you invest in your business from the start date of the business. And it will also include your net profits or losses each year, accumulated from when you started the business.
2A) The Owner's Drawing account will be used for any money that you withdrawal from the business that is used for personal reasons. Examples of these would be amounts you paid for groceries, personal credit cards, mortgage payments, ATM withdrawals that you are using as your wages, and any money that gets deposited into your personal accounts for any reason.
An important thing to keep in mind is that the owner of a sole proprietorship does not get a regular paycheck with money deducted for payroll taxes like an employee.
Instead you will pay quarterly estimated taxes to go towards your end of year tax return. These will be to pay your own Medicare and Social Security taxes that would normally be deducted from a paycheck.
* Please note that any quarterly estimated tax payments made from your business checking account should always be allocated to the Owner's Drawing account.
2) A partnership or LLP (Limited Liability Partnership) will need to set up Capital and Drawing accounts for each partner.
This is similar to how you would set-up the Capital and Draw accounts in your Chart of Accounts if you were a sole proprietorship. You would just add all of the same accounts for each of the partner(s) as well.
3) An "S or C corporation" or an "LLC corporation" will be set-up with a Common Stock account (and occasionaly a Preferred Stock account).
Common stock and preferred stock will show the total sum of stock the company has issued.
The Cost of Goods Sold, (also known as COGS or Job Costs)are all of the amounts that are applicable to running your line of business.
An example of this would be if you sell some kind of product. Your COGS would then include your cost of inventory (the amount paid for your products), any materials (used to make your product), freight charges (paid for when purchasing products), and all labor that is applicable to building the finished product. Each of these would be set-up as a separate account under COGS in the Chart of Accounts.
You would also include any kind of job costs that are reimbursable expenses purchased on behalf of the customer. Such as auto parts bought by a mechanic.
Expenses (or Overhead costs) are all of the fixed amounts you will have even if you run out of work. Examples of these are telephone, rent, utilities, and liability insurance.
Other Income would be the amounts you bring in other than the normal way you do business.
Examples of these would be any interest income you get from your checking or savings accounts, any kind of gains from selling assets, money you get from insurance settlements (such as from a fire), or perhaps rental income that you bring in from renting commercial buildings that you own.
Last but not least! Other Expenses are the amounts that you pay for things outside of your normal business.
Examples of these would be a loss from selling an asset or perhaps stockbroker fees from setting up or buying stock for the business.
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