Understanding account types is an important part of setting up a chart of accounts and keeping your company’s finances organized. Each account serves a specific purpose, helping classify financial transactions and ensuring they appear in the correct financial reports.
The following sections explain the different types of accounts in accounting, what they represent, and how businesses use them.
The chart of accounts is the backbone of your accounting system. It’s important to set it up correctly, and understanding account types is a key part of that process.
When setting up your chart of accounts, choosing the right account type is crucial because your business’s accounting relies on these classifications. The account type determines where financial information appears in reports, such as the balance sheet and income statement. Choosing the right account type helps ensure accurate financial reporting and gives you a clearer picture of your company’s financial health.
Accounts with balances that carry forward from one accounting period to the next generally appear on the balance sheet. These include accounts receivable and payable, asset accounts, liability accounts, equity accounts, and bank and credit card accounts.
The income statement, also called the profit and loss statement, reports income and expense accounts. These include cost of goods sold, other income such as interest earned, and other expenses such as depreciation.
Account types generally fall into categories based on the financial statements they affect. The following is a list of accounts commonly found in a business chart of accounts.
Your company’s chart of accounts is a complete list of all account names used in the general ledger. Each account usually has a numerical account ID that helps locate it when recording transactions. These accounts classify financial information so you can summarize it and present it in financial reports.
A chart of accounts can vary depending on the type of business. For example, a contracting company might have accounts for labor income, parts and materials, technician wages, rent, insurance, and office wages. The goal is to organize accounts so you can track business activity and understand where money comes from and where it goes.
A chart of accounts list comes into play whenever you record a financial transaction, including customer sales, inventory purchases, vendor bills, and other business expenses. These accounts also appear on your company’s income statement, balance sheet, and other financial reports.
For a contracting company, accounts might include Labor Income, Parts and Materials, Technician Wages, Rent, Insurance, Office Wages, and more.
The Financial Accounting Standards Board’s conceptual framework explains the basic elements of financial statements and how they relate to a company’s financial position and performance.
The following sections explain the different account types commonly used in a chart of accounts. These classifications are largely universal, although specific account names and available detail types can vary between accounting systems.
A/R is a form of current asset. It represents money clients owe for products or services your company sells or materials it furnishes when customers do not pay at the time of sale. Typically, accounts receivable balances come from sales invoices that include payment terms.
Accounts receivable is used in accrual-based accounting. Your company records the revenue when it earns it, even if the customer has not yet paid.
For example, if your company completes a $2,500 service job and gives the customer 30 days to pay, you record the $2,500 in accounts receivable until the customer pays.
Learn more about accounts receivable management.
A/P is a form of current liability. It represents the money your company owes vendors for goods, supplies, and services purchased on an open account.
Businesses use accounts payable in accrual-based accounting. These balances generally come due in 30 or 60 days and do not include regular interest. Do not confuse accounts payable with Notes Payable.
For example, if your company purchases $1,000 in parts and materials from a supplier on credit, you record the $1,000 in accounts payable until you pay the bill.
A bank account is a current asset. Add one bank account for every account your company has at a bank or other financial institution.
These accounts include checking accounts, savings accounts, and other business bank accounts. Track each one separately so you can monitor cash balances and reconcile transactions against bank statements.
Fixed assets represent property, plant, or equipment that your company acquires for business use rather than resale. Businesses call them fixed assets because they intend to use them for long periods.
Examples include buildings, vehicles, machinery, tools, and office equipment.
Fixed assets generally appear on the balance sheet. Your company typically depreciates them over their useful lives rather than expensing the entire purchase at once.
Current assets include resources your company expects to convert into cash, sell, or use within one year or its normal operating cycle, whichever is longer.
It includes the following account types:
For example, a contracting company might have cash in its checking account, outstanding customer invoices, and parts inventory waiting for use on jobs. All of these qualify as current assets.
Other assets represent assets that do not qualify as current assets or fixed assets. These generally include noncurrent assets that your company does not expect to convert into cash within one year or its normal operating cycle.
Notes receivable with maturity dates at least one year beyond the current balance sheet date qualify as noncurrent assets.
Additional examples may include certain long-term investments and intangible assets, depending on their nature.
Other Current Assets represent resources your company expects to convert into cash, sell, or use within a short period, usually less than a year.
Prepaid expenses, employee advances, and notes receivable with maturity dates of less than one year from the current balance sheet date qualify as current assets.
For example, if your company pays its annual insurance premium in advance, you generally record the unused portion as a prepaid expense until the coverage period passes.
Current liabilities represent obligations due within one year or the normal operating cycle of the business, whichever is longer.
It includes the following account types:
These accounts represent amounts your company owes and must pay using available resources.
Other Current Liabilities represent debts and obligations due within a short period, usually less than a year, that do not qualify as accounts payable.
Your company generally pays these debts using current assets.
Examples include accrued expenses, certain payroll obligations, and short-term loans.
Also known as “Overhead,” expenses represent money your company spends on normal administrative and operating activities. Examples include rent, insurance, office wages, utilities, telephone, and more. Please also see Cost of Goods Sold.
Expenses appear on the income statement and reduce your company’s net income.
It is very important to separate your overhead into fixed and variable types.
Fixed overhead remains essentially unchanged within a certain range of business activity. Examples include salaries, liability insurance, and rent.
I like to refer to variable overhead as “somewhat variable overhead” because it changes slightly with income or business activity. Examples include gasoline, small tools, office supplies, and legal fees.
Understanding the difference between fixed and variable overhead helps you see how operating costs change as business activity increases or decreases.
Note: If income exceeds expenses, your company produces a net income. If expenses exceed income, the business operates at a net loss.
Other Expense represents money your company spends on items outside normal business operations, such as certain corporate taxes or losses from unusual transactions.
Businesses generally separate these expenses from regular operating expenses to make financial reports easier to understand.
Cost of Goods Sold represents the cost of goods and materials your company holds in inventory and then sells. It also represents the known cost of items or services your company provides to clients.
Cost of Goods Sold (also known as Cost of Sales) includes the direct costs associated with providing products or services to customers.
For a contracting company, these costs might include parts and materials installed on a job, direct labor, and subcontractor costs, depending on how the company structures its accounting.
Note: Your company calculates Cost of Goods Sold for inventory items based on its inventory costing method, such as FIFO, LIFO, or Average Cost, subject to applicable accounting requirements.
An Income account records revenue (money coming into your company). These accounts help categorize and separate your income.
They represent the inflow of assets your company receives from selling products and services to clients.
For example, a contracting company might separate its income into Labor Income, Parts and Materials Income, Installation Income, and Service Agreement Income.
If income exceeds expenses, your company earns a net income. If expenses exceed income, the business operates at a net loss.
Other Income represents money your company receives from sources outside normal business operations, such as interest income.
For example, if your company earns interest on a business savings account, you may record that interest as Other Income rather than regular service or sales revenue.
A Credit Card account is a current liability account. Use it to track credit card purchases, bills, and payments.
For example, if your company purchases $500 in supplies using a business credit card, the transaction increases the credit card liability until you pay the balance.
Track credit card accounts separately from bank accounts because they represent money your company owes rather than cash it holds.
Long-Term Liabilities represent debts your company does not have to pay for a relatively long period, usually more than one year.
Examples include building loans, vehicle loans, and other long-term business financing.
However, your company generally classifies portions of long-term loans and notes payable that come due within the next year as current liabilities on the balance sheet. The remaining balance stays classified as a long-term liability.
Owner’s Equity represents the owner’s financial interest in the business after subtracting liabilities from assets.
It includes the owner’s original investment, additional contributions, withdrawals or distributions, and accumulated business profits or losses.
For example, if a business owner contributes $25,000 to start a company, that investment increases the owner’s equity in the business.
Equity, also known as capital, represents the owner’s claims against the company’s assets after subtracting liabilities.
The basic accounting equation is:
Assets = Liabilities + Equity
In other words, equity is what remains after you subtract everything the company owes from everything it owns.
The OpenStax explanation of financial statement elements provides additional examples of how assets, liabilities, equity, revenue, and expenses relate to financial statements.
The Retained Earnings account represents the accumulated profits a company has not distributed to its owners.
At the close of a fiscal year, a corporation closes its revenue and expense account balances. The resulting net income or loss then flows into retained earnings.
The retained earnings balance continues to accumulate throughout the life of the business. Profits increase it, while losses and distributions to shareholders decrease it.
For businesses organized as sole proprietorships or partnerships, accumulated profits and owner distributions generally appear in the appropriate owner’s equity accounts instead.
Understanding account types is a good starting point for organizing your company’s financial records. These related accounting resources can help you learn more:
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