Learn It
Imagine a business as a big jar of coins. If you just toss every coin in, you know how much money you have — but you do not know where it came from or where it went. An account is a labeled container for one kind of money event. Cash goes in the Cash account. Money owed by customers goes in Accounts Receivable. Rent paid goes in Rent Expense.
The chart of accounts is the full list of accounts a business uses. Think of it as the table of contents for the books. Every transaction gets sorted into one or more accounts from this list.
Accounts are grouped into five main types. Each type tells you something different about the business.
The Five Account Types
Assets
Things the business owns that have value. Cash, equipment, inventory, and money customers owe you are all assets. If the business could use it or sell it, it is an asset.
Liabilities
Money the business owes to someone else. Unpaid bills, bank loans, and credit card balances are liabilities. A liability is a promise to pay later.
Equity
What belongs to the owner after all debts are paid. It starts with the owner's investment and grows when the business earns revenue. It shrinks when the owner takes money out.
Income
Money the business earns from doing its work. Service revenue, sales revenue, and interest earned are all income accounts. Income increases equity.
Expenses
Costs of running the business. Rent, utilities, supplies, and wages are expenses. Expenses decrease equity because they use up the business's resources.
See It
Here is a simple chart of accounts for a small landscaping business. Notice how each account fits one of the five types, and how the account numbers are grouped by type.
| # | Account Name | Type |
|---|---|---|
| 1000 | Checking Account | Asset |
| 1200 | Accounts Receivable | Asset |
| 1500 | Equipment | Asset |
| 2000 | Accounts Payable | Liability |
| 2100 | Loan Payable | Liability |
| 3000 | Owner's Capital | Equity |
| 4000 | Service Revenue | Income |
| 5000 | Rent Expense | Expense |
| 5100 | Supplies Expense | Expense |
| 5200 | Utilities Expense | Expense |
The numbers are not random. Accounts starting with 1 are assets, 2 are liabilities, 3 is equity, 4 is income, and 5 is expenses. This numbering helps a bookkeeper find the right account quickly.
Do It
Now try it yourself. Read each account name and decide which type it belongs to. This is the skill a bookkeeper uses every day when recording transactions.
Do It — Classify the Accounts
For each account, choose the type it belongs to. Think about whether the account represents something the business owns, owes, belongs to the owner, is earned, or is spent.
Checking Account
Cash the business owns in the bank
Accounts Receivable
Money customers owe the business
Accounts Payable
Money the business owes suppliers
Loan Payable
Money the business owes a lender
Owner's Capital
What the owner invested
Service Revenue
Money earned from doing work
Rent Expense
Cost of renting space
Office Supplies
Cost of supplies used up
Prove It
Answer each question, then read the explanation. There's no score — this is just to help the ideas stick.
Question 1
A customer pays you for a service. Why does the bookkeeper record this event?
Question 2
Which of these is the best description of a source document?
Question 3
What is the main difference between bookkeeping and accounting?
Key Takeaways
- An account is a labeled container for one kind of money event.
- The chart of accounts is the full list of accounts a business uses.
- Accounts are grouped into five types: Assets, Liabilities, Equity, Income, and Expenses.
- Assets are what you own. Liabilities are what you owe. Equity belongs to the owner.
- Income is earned. Expenses are spent. Both affect equity.
- A consistent chart of accounts keeps the books organized and comparable over time.