Accounts and the Chart of Accounts | Free Bookkeeping & Accounting Course

What you'll learn

What an account is and how its balance moves.
The accounts almost every U.S. small business uses.
How to build a numbered chart of accounts that maps to your tax return.
The difference between balance sheet (permanent) and income statement (temporary) accounts.
How to calculate straight-line depreciation on equipment.

To record hundreds or thousands of transactions in an orderly way, accounting groups them into accounts. An account is like a labeled folder: "Cash," "Accounts Payable," "Sales Revenue," "Rent Expense." In this lesson you'll see the accounts small businesses use most, how they're organized into a chart of accounts, and one special account that trips up beginners: accumulated depreciation.

What an account is

An account collects every increase and decrease of one item. The Cash account, for example, captures every deposit, card settlement, transfer and payment, and its balance tells you how much is in the business checking account at any moment. If you use accounting software, every bank transaction you categorize lands in one of these accounts.

Accounts fall into five families. The first three appear on the balance sheet; the last two on the income statement:

1000s · Assets

Cash, accounts receivable, inventory, prepaid expenses, equipment.

Balance sheet

2000s · Liabilities

Accounts payable, credit cards, sales tax payable, payroll liabilities, loans.

Balance sheet

3000s · Equity

Owner's capital and draws, or common stock and retained earnings for a corporation.

Balance sheet

4000s · Revenue

Sales, service revenue, catering income, interest income.

Income statement

5000s–7000s · Expenses

Cost of goods sold, wages, rent, utilities, advertising, depreciation, interest.

Income statement

The accounts you'll use most

Family	Account	What it records
Assets	Cash (checking, savings, petty cash)	Money in the bank and in the register.
	Accounts receivable	Invoices customers haven't paid yet.
	Inventory	Goods held for sale or ingredients to make products.
	Prepaid expenses	Costs paid in advance, such as a year of insurance.
	Equipment, furniture, vehicles	Long-lived assets used in the business (often called fixed assets or PP&E).
	Accumulated depreciation	Wear and tear recorded so far on fixed assets. It reduces their value.
Liabilities	Accounts payable	Supplier bills not yet paid.
	Credit card payable	Balance owed on the business credit card.
	Sales tax payable	Sales tax collected from customers that belongs to the state.
	Payroll liabilities	Net wages owed and payroll taxes withheld or owed by the employer.
	Notes or loans payable	Bank loans, SBA loans, equipment financing.
Equity	Owner's capital (or common stock)	What the owners invested.
	Owner's draws (or dividends/distributions)	What the owners took out. It reduces equity.
	Retained earnings	Past profits kept in the business (used mainly by corporations).
Revenue	Sales or service revenue	Income from the main activity.
Revenue	Other income	Interest earned, a one-time gain on selling equipment.
Expenses	Cost of goods sold (COGS)	What the products you sold cost you.
	Operating expenses	Wages, rent, utilities, software, advertising, insurance, depreciation.
	Interest expense	Interest on loans and credit cards.
	Income tax expense	Used by C corporations, which pay income tax at the business level.

1. Which account records what customers owe you for sales you've invoiced but not collected?

Accounts payable
Owner's capital
Accounts receivable

Accounts receivable is an asset: money coming to you. Accounts payable is the opposite, money you owe suppliers.

The chart of accounts

Every business keeps an ordered, numbered list of its accounts: the chart of accounts. The number tells you (and your software) which family an account belongs to, so financial statements can be built automatically. In the U.S. there's no official chart that businesses must use, unlike some countries. The most common convention is four-digit numbers by family. Here's Brightside Coffee's starter chart:

1000  ASSETS
1010  Cash – business checking
1100  Accounts receivable
1200  Inventory – coffee and supplies
1300  Prepaid expenses
1500  Equipment
1510  Accumulated depreciation – equipment
2000  LIABILITIES
2010  Accounts payable
2100  Sales tax payable
2200  Payroll liabilities
2500  Notes payable – bank loan
3000  EQUITY
3010  Owner's capital – Maya Torres
3020  Owner's draws
4000  REVENUE
4010  Sales – coffee and food
4020  Catering revenue
5000  COST OF GOODS SOLD
5010  Cost of goods sold
6000  OPERATING EXPENSES
6010  Wages
6020  Payroll taxes
6100  Rent
6200  Utilities
6300  Advertising and marketing
6400  Software and subscriptions
6500  Depreciation
7000  OTHER EXPENSES
7010  Interest expense

Leaving gaps between numbers (1010, 1100, 1200…) makes room for new accounts later without renumbering everything.

You rarely have to start from a blank page. QuickBooks, Xero and Wave all create a default chart when you set up a company, often tailored to your industry. The smart move is to trim it: hide the accounts you'll never use, rename the vague ones ("Miscellaneous" is where bookkeeping goes to die) and add the two or three that matter for your business, such as separate revenue accounts for in-store sales and catering so you can see which one is growing.

Make your expense accounts match your tax return

Small businesses report their income and expenses to the IRS on a specific form: Schedule C for a sole proprietor or single-member LLC like Brightside, Form 1065 for a partnership or multi-member LLC, Form 1120-S for an S corporation and Form 1120 for a C corporation. Naming your expense accounts after the lines on your form (advertising, insurance, rent, utilities, wages and so on) means your year-end totals drop straight into the return. Your CPA will thank you, and you'll pay for fewer hours of cleanup.

Keep it lean

A small business rarely needs more than 30 to 50 accounts. A chart with 300 accounts that nobody understands is worse than a short one used consistently. What matters is separating expenses by type (rent, wages, advertising, software) so you can see where the money goes. Use your software's classes, tags or locations for extra detail instead of creating new accounts for everything.

Permanent vs. temporary accounts

The five families behave differently at the end of each year:

Balance sheet accountsPermanent (real) accounts

Families: Assets, liabilities, equity
At year-end: Balances carry forward. The cash in the bank on December 31 is still there on January 1.
Example: Cash, Equipment, Notes Payable

Carry over

Income statement accountsTemporary (nominal) accounts

Families: Revenue, expenses (and owner's draws)
At year-end: Closed out: their balances move into equity as profit or loss, and they start the new year at zero.
Example: Sales Revenue, Rent Expense

Reset to zero

You'll do the closing entries yourself in lesson 7. For now, remember: on January 1, "Sales" starts again at $0, but "Cash" doesn't.

2. Which of these accounts is temporary and starts each new year at zero?

Cash
Advertising expense
Notes payable

Revenue and expense accounts are temporary. At year-end their balances are closed into equity, and they restart at zero.

A special account: depreciation

Brightside's espresso machine cost $12,000 and should last about 5 years. It wouldn't make sense to charge all $12,000 as an expense in the first month; the machine will help earn revenue for 60 months. So its cost is spread over its useful life through depreciation. The simplest and most common method is straight-line:

Annual depreciation (straight-line) = (Cost − Salvage value) ÷ Useful life in years
Brightside: ($12,000 − $0) ÷ 5 years = $2,400 per year
Monthly:    $2,400 ÷ 12 = $200 per month

Each month Brightside records $200 of Depreciation Expense and adds $200 to Accumulated Depreciation. Accumulated depreciation is a contra-asset account: it sits right under Equipment on the balance sheet and is subtracted from it. The result, cost minus accumulated depreciation, is the machine's book value:

Book value of the $12,000 espresso machine

Purchase$12,000

End of year 1$9,600

End of year 2$7,200

End of year 3$4,800

End of year 4$2,400

End of year 5$0

Two things to notice. First, depreciation is an expense that uses no cash: the money left when the machine was bought. That gap between profit and cash comes back in the cash flow statement. Second, book value isn't market value: a five-year-old espresso machine might still sell for a few thousand dollars, but the books don't chase resale prices.

4. Brightside's balance sheet shows Equipment of $12,000 and Accumulated Depreciation of $2,600. What is the equipment's book value?

$9,400
$14,600
$2,600

Book value = cost − accumulated depreciation = $12,000 − $2,600 = $9,400. That's 13 months of $200 depreciation already recorded.

Book depreciation vs. tax depreciation

Your books use straight-line to show the machine's real cost per year. Your tax return follows IRS rules (MACRS), and the tax code may also let you deduct much or all of an asset's cost in the year you buy it through Section 179 expensing or bonus depreciation. That's why the depreciation on your tax return often differs from your books. Both are legitimate; they serve different purposes. Lesson 13 shows how to reconcile them.

3. A bakery buys a $24,000 oven with a 6-year useful life and an expected salvage value of $3,000. What's the annual straight-line depreciation?

$4,000
$3,500
$3,000

($24,000 − $3,000) ÷ 6 = $3,500 per year. Salvage value is subtracted first because that part of the cost will come back when the oven is sold.

Practice exercise

Classify each account as an asset, liability, equity, revenue or expense, and say whether it's current or long-term where that applies:

Facebook and Google ads
Delivery van
Sales tax payable
Interest earned on a business savings account
Three-year equipment loan
Coffee beans on the storeroom shelf
Owner's draws

See solution

Expense (advertising and marketing).
Long-term asset (vehicle), depreciated over its useful life.
Current liability: the money belongs to the state and is usually remitted monthly or quarterly.
Revenue (other income, because it isn't the main activity).
Liability: the principal due in the next 12 months is current; the rest is long-term.
Current asset (inventory).
Equity, as a reduction. It's not an expense.

Summary

An account collects all the increases and decreases of one item and has a balance.
A chart of accounts numbers them by family: 1000s assets, 2000s liabilities, 3000s equity, 4000s revenue, 5000s and up for costs and expenses.
Name expense accounts after the lines on your tax form so year-end reporting is painless.
Balance sheet accounts carry forward; revenue and expense accounts reset to zero each year.
Depreciation spreads a fixed asset's cost over its useful life; accumulated depreciation reduces its book value.

Next lesson: Debits and Credits: Double-Entry Bookkeeping with Examples. You'll learn the debit and credit rules and record Brightside's first month as journal entries, including sales tax.