The accounts in a chart of accounts are organized
in a particular way so that financial statements can be prepared efficiently.
The five major types of accounts are as follows:
The assets, liabilities and equity accounts are
included in the balance sheet of the financial statements. The income and
expense are included on the income statement. At the end of the reporting
period, the net income or loss at the bottom of the income statement is added to
(net income) or subtracted from (net loss) the retained earnings on the balance
sheet. After this amount is added to the equity section of the balance sheet,
the assets should equal the sum of the liabilities and the equity. Many software
packages will “close” this income or loss into the equity accounts when you
process an end of period closing.
Another way that accounts are typically
organized is to list short term assets and liabilities before long term assets
and liabilities. For example, cash is listed before inventory and inventory is
listed before vehicles and equipment. Within liabilities, accounts payable would
be listed before a line of credit with the bank and a line of credit with the
bank would be listed before a mortgage on a building. By listing assets and
liabilities in this organized fashion, it makes it easier for individuals
looking at the financial statements to evaluate the state of the
business.
If you are using packaged software such as Peachtree or
Quicken, the accounts will organize themselves in this way. If you are not using
packaged software, having your accounts set up this way will make your financial
statements more understandable and professional looking to your banker, a
potential partner or investor, and to your tax return preparer or the IRS.