The word “account” has a different meaning in the world of accounting than most people are used to.  Some of us are used to the idea of a “bank account”, which is seen as a sort of “mini-vault” in which we keep our money.  Others think of “account” as a another word for “client”.  Both of these uses of account are based on the term “account” from accounting, but in accounting an “account” can be other things as well.

In accounting, an account is simply a label used for recording a dollar balance and a history of changes to that balance.  The dollar balance may be associated with an actual bank account, or it may represent the money owed you by a client.  It might also represent your reported income, expenses, or the value of assets that you own.

Account Types

In order to make it clear what each account is being used for, it is given a “type”.  The type determines where the account appears in the different reports, and also how it can be used when entering income, expenses, transfers, and payments.

Account Numbers

The account number is a short-hand for naming the account; if you’re doing all your data entry using the number pad on the keyboard, it’s pretty easy to punch in a four digit number, much easier than it is to move your hands over to the main part of the keyboard.  Some accountants and bookkeepers are entering a lot of data in a day, and they want to be as fast as possible.

For historical reasons the numbers are organized so that they start with digits that show what part of the balance sheet an account is on, and the less significant numbers determine the order of accounts within that section.

Chart of Accounts

The design of a “chart of accounts” and the numbering of the accounts is a task which has traditionally been a very important part of setting up an accounting system.  The list of accounts and their numbers is called the “Chart of Accounts”.  In our accounting software, you can rename, renumber, add or remove accounts at any time, so you designing a chart of accounts ahead of time may not be necessary, although it could be useful.

Summary

In accounting, an “account” is not just a bank account or a client account.  It could represent the dollar value of other, more abstract things.  Depending on what it represents, it’s given a type.  For efficient data entry, it’s given a number to use as a shorthand.  The list of accounts, their numbers and types, is called the “Chart of Accounts”.

Setting up all of your accounts is the first step to a smooth and efficient experience on Clarity Accounting.

Did you know that an account is more than a bank account, or a client account?  Read more about what we mean by the word “account” in What are Accounts?

One important part of bookkeeping is keeping track of your earnings and spending.  Most countries in the world require business owners to report business expenses in different categories such as “office supplies” or “meals and entertainment”.  Different types of revenue may be taxed differently than others; for example, interest income may be taxed differently than capital gains.  You will also want to categorize your income and expenses to help optimize your business and increase your profit margins.  In the accounting system, each income and expense category will be called an “account” - either an “income account” or an “expense account”.

Another important part of accounting is keeping track of your assets; Cash is the most simple type of asset, but anything your business owns that has a sale value is also considered an asset.  Like income and expenses, assets are tracked using accounts; an “asset account” represents the total value of a particular type of asset.  For actual cash in the bank or your pocket, this will be the actual cash value; for equipment and goods, the balance of the account is total resale value.

The third kind of account it is important to mention is “liability accounts”.  These represent things which are the opposite of an asset - instead of a sale value they actually cost you money to get rid of!  The most common type of liability is credit issued from a vendor or a bank.  Lines of credit, business loans, credit card debt, and accounts payable are all classified as liabilities.

We recommend that you discuss with an accountant how you should best categorize your income, expenses, assets, and liabilities into accounts, so that you can set up the correct accounts right from the beginning.

Account Set Up in Clarity Accounting

To set up and organize your accounts, follow the following instructions:

1. Log in to Clarity Accounting
2. Go to the Dashboard (unless you have yet to verify your email or create a business profile)
3. Go under the “Setup” section and click on “Accounts”
4. Set up your Bank and Cash accounts: enter the name of the bank account and a description of what you use this account for.  For example, if you have a business chequing account at Royal Bank, you would put:

   Name: Royal Bank Business Chequing
   Description: Deposit consulting income checks, pay business related bills.
   
   

5. Click the “Add Account” link beside the “type” or “description” box to add the new account.
6. Repeat the previous two steps for any other bank accounts your business uses
7. Go down the page and apply a similar process for credit card, income, and expense accounts…
8. To edit any accounts that have been included in your list of accounts, you can simply click on the account and change anything you wish to change to suit your needs.

There are many types of “Accounts” and this can get confusing for many people (including myself).  Here is a breakdown of the different types of Account Categories.

Payment Accounts

Cash Accounts

The “Cash” account is used to record cash payments, deposits, and withdrawals.  In Clarity Accounting, this would be applicable when entering income and expenses under the “Terms or Payment Accounts” section.  This just showed that you were payed by cash or you have paid for something with cash.  One example of selecting the payment terms to be paid by cash is when a business owner accidentally paid for an expense from his/her personal credit card.  In this case, many business owners might choose to say that they have payed for this expense with cash since the personal credit card is not tracked for business purposes.

Bank Accounts checking or savings

This refers to the bank accounts that are used for the purpose of running your business.  For example, a small business often has a “checking account” where the money can be deposited and used for bill payments.  A business may also put aside some the taxes they might owe the government at the end of the year in a “Savings Account”.

If you have any further questions about Bank / Cash Accounts, please view related discussions under:
Bank Accounts.

Credit Cards

If you do not know what a credit card is, stop reading right here.  Ignorance is bliss…

For the 99.99% of the businesses around the world, credit cards have become a indispensable tool for running a small business.  In fact, it is quite normal for a small business owner to own multiple credit cards.

Credit cards are great for keeping tracking of expenses because many credit card companies will send you a statement at the end of the month with details of your business expenses.  This provides an excellent opportunity for you to check to see if the expenses you have entered into your online accounting software can match up with the credit card statement.

Undeposited Funds

Many businesses collect cash and cheques into an envelope and deposit them all at the bank in one lump sum.  Since this appears on the bank statement as one transaction, we record these as “undeposited funds” first.  When the money goes to the bank we create a transfer from “undeposited funds” to the appropriate bank account.  When we do a bank statement reconciliation, the transaction date and amount will match a line on the bank or credit card statement.

Please view related discussions

Income Accounts interest income, other income

Income accounts are often used to categorize the source of income so that you can track where your money is coming from.  For example, Habitsoft, Inc. began as a custom software development company that also provided consulting services.  Therefore, when setting up the income accounts for Habitsoft, Inc, there were 3 different income accounts that were set up: (1) Custom Software Development Income, (2) Consulting Income, (3) Interest Income (for any interests paid by the bank on the positive balance of the bank account).  You may also use the “Other Income” category for things you are not sure about that you might want to consult with your accountant later.

It is also important to note that different types of income can be taxed differently depending on the tax rules of your country / region.

Expense Accounts

Bank accounts represent cash - real money.  Bank accounts are used in transactions where cash moves; either between your accounts as part of a transfer, or as part of a payment on an invoice or bill.

“Real” Bank Accounts

Most bank accounts are the kind of account everyone is familiar with - an account you have at a bank.  The balance of your “real” bank account at the bank should, on any given date, match the balance of that account on your business’ balance sheet.  Bank accounts are tracked in your accounting system for two reasons:

1. you can track your bank balances all in one place
2. bank statement reconciliation helps to correct bookkeeping errors

Typically only bank accounts which are owned by the business, or at least mostly used by the business, are recorded separately in the accounting system, because only they can be reconciled with the bank.  Bank reconciliation refers to the process of matching your recorded transactions from invoices and receipts with the bank statement.

Virtual Bank Accounts

However, in your accounting system there will be some accounts listed as bank accounts which are not held at the bank.  These “virtual bank accounts” are categorized as “bank” accounts to avoid having too many different types of accounts, and because they are otherwise used identically to bank accounts in the rules of accounting.  Some “virtual” bank accounts may include: cash accounts and undeposited funds.

Cash, a.k.a. Petty Cash

The “petty cash” account is the one used to record cash payments, deposits, and withdrawals.  To record a cash deposit, create a transfer from cash to a bank account; a withdrawal is a transfer from a bank account into cash.

Keep all cash receipts! Although for accounting purposes this account is treated as a bank account, there is no bank statement allowing you (or an auditor) to double-check your cash transactions.  For this reason, it’s doubly important that you keep receipts for all the cash-based transactions you record in the books, because only the ones for which you have a receipt will be accepted by an auditor, whereas with a real bank account there is at least some record of the transactions.

Cash is also used as a catch-all for expenses which are paid for using a bank or credit card not registered to the business.  As far as the business is concerned, these transactions might as well be cash, because they use bank or credit card accounts which won’t be compared to the business’ books.

For convenience, you may want to create a few separate cash accounts to distinguish the cash used by different people in the business.  This will help you better keep track of your cash.

Undeposited Funds

Many businesses collect cash and cheques into an envelope and deposit them all at the bank in one lump sum.  Since this appears on the bank statement as one transaction, and we’d like to have our bank statement match our own books, we record these as “undeposited funds” first.  Then, when the money goes to the bank we create a transfer from “undeposited funds” to the appropriate bank account.  Now when we do the bank reconciliation, the transaction date and amount will match a line on the bank statement.