Accounting Equation & Numbering

Accounting Equation

When working with a new client, a lot of times the discussion starts around software and flows, and eventually follows a meandering path back through the annals of my memory to ACC 101.

While accounting software looks fancy and intimidating, there are a few things that we go over that helps. I recently put this up on our company whiteboard, and had several people comment on how helpful it was, so I thought I would try to replicate it here.

The main accounting equation you need to know is:

Assets = Liabilities + Equity (Look familiar? It’s the backbone of your Balance Sheet)

The Profit and Loss is a temporary statement that “closes” periodically. The Balance Sheet does NOT and is referred to as a PERPETUAL statement - as in, it is the statement that never goes away, and will carry a balance forward into infinity and beyond (bad Toy Story reference). They are both related. How? When your Profit and Loss CLOSES, it doesn’t go poof. As you may remember from math class, everything goes somewhere.

Your Net Income (or Loss) rolls up into your Balance Sheet under Retained Earnings (the super complicated account which actually isn’t too bad - it is the sum of Earnings that are Retained over time). THEN your P&L can go POOF, since it is temporary, and start over for the next period.

SO, once you understand this premise, the rest starts falling into place. Once you realize your accounting software is one big algebraic equation, that either makes it way easier, or in some cases, causes a panic attack if you didn’t do well in Algebra. I hope it is the former. :-)

Account Numbering

The next question we tackle is around account numbering. Believe it or not, those numbers have a purpose, and used to have a big purpose. I used to be very thankful for those numbers. They also follow a system.

Back in the early aughts when I first entered the accounting workforce we hand keyed invoices into an ERP. I worked for a construction management company, and a large one. I used to enter 100-200 transactions a day. When you knew the account number, you could key that in without looking at the chart of accounts and entering in the name every time. Hence, volume transactions were entered in a fraction of the time. Work smarter, not harder.

Beyond efficiency, the numbers clue you into what type of account it is. There are slight different variations of this, but what I use is below. Some larger firms will also have department and division codes, but I don’t see them used as much as the account codes.

A simple schematic for numbering is below. If you need help, reach out to us. Pro tip: Leave room between codes in case you have to set up new ones later. Don’t leave yourself having to edit a whole list because you didn’t think about future accounts. :-)

1 - Assets

2 - Liabilities

3 - Equity

4 - Revenue

5 - COGS

6 - Operational Expenses

7 - Other Income (non-primary income not related to operations)

8 - I usually use this for Other Expenses. Some companies use 7’s for this as well.

9 - This is my “do not use account”. If there is something that needs to be active for some odd reason, but doesn’t have a strong purpose, I will usually make this a 9. EX: Ask My Accountant. This way it falls to the bottom if needed.