The accounting behind Xero

This page outlines some of the accounting used in Xero. It summarises the way Xero deals with typical accounts and transactions.

Xero records and stores all your accounting transactions

Xero automatically creates all the behind-the-scenes journals for each of your accounting transactions. Xero uses the rules of double-entry bookkeeping. This means that for every transaction, Xero posts a debit and credit journal-entry to the general ledger.

Xero uses the accrual method of accounting

The accrual method records income and expenses at the time transactions occur, rather than when payment is made or received. Most reports in Xero are accrual-based. Xero also provides cash-basis reporting.

Check the Help page for the report you're using to see whether it uses the accrual method, cash method, or both. For some reports, Xero uses the cash method if your organisation uses the Cash basis for sales tax.

Set up your organisation's financial details

Xero uses the basic accounting equation approach

Xero records transactions based on the accounting equation:

Assets = Liabilities + Equity

This equation always balances. It is the foundation of double-entry bookkeeping. In essence, it means that a business uses either its liabilities or shareholders' equity to fund its assets.

You can change the chart of accounts to suit your business

The chart of accounts is a list of accounts used to define all your accounting transactions. It organises your transactions into specific accounts so you can gain a better understanding of your business. Xero's entire default chart of accounts fits into the following main account types:

Assets

  • Bank
  • Current Asset
  • Fixed Asset
  • Non-current Asset
  • Prepayment

Liabilities

  • Current Liability
  • Liability
  • Non-current Liability

Expenses

  • Depreciation
  • Direct Costs
  • Expense
  • Overhead

Equity

  • Equity

Revenue

  • Other Income
  • Revenue
  • Sales

If your business has separate departments or cost centres, then Xero enables you to report on these separately. You can do this by adding tracking categories.

Xero offers a wide range of financial reports

In Xero, you can generate financial reports in real time. Xero's reports range from basic accounting reports to advanced management reports. Xero's reports include:

  • Performance reports (such as Profit and Loss, Budget Variance)
  • Position reports (such as Balance Sheet, Aged Payables, Aged Receivables)
  • Cash reports (such as Bank Summary)
  • Accounting reports (such as Trial Balance and General Ledger)

Bank statement lines feed automatically into Xero

Bank reconciliation is a process that matches your bank statement lines, as supplied by the bank, to your accounting transactions in the general ledger. Xero makes bank reconciliation easy by frequently importing bank statement lines from your bank directly into your Xero account. This means you can have a daily view of your cashflow without having to log into your online banking or wait for your paper bank statements.

Set up a bank feed to automatically import online banking transactions into Xero

Xero speeds up bank reconciliation by matching most of your imported bank statement lines to your accounting transactions. Xero also remembers how you've treated other bank statement lines and provides suggested general ledger transactions.

Bank reconciliation

Xero uses a single account for recording all sales tax

Xero uses only one sales tax account. This one account categorises your sales tax into sales tax on income, sales tax on expenses and sales tax payments. This account shows your overall sales tax position.

Xero might call sales tax something different depending on your organisation's country. For example, South African organisations show VAT on their reports and screens in Xero.

Xero attaches sales tax rates to each account in your chart of accounts. This means that whenever you post a transaction in Xero, the sales tax rate and amount automatically attaches to the transaction. Xero provides a default set of sales tax rates, though you can change any of the sales tax default settings if they don't suit your business.

Sales tax in Xero

Tax rates

Xero helps you calculate the sales tax you owe your tax authority

Xero totals all your accounting transactions for your sales tax period and uses these totals to calculate your sales tax obligation. You can then check your sales tax by running Xero's Sales Tax Audit.

Sales Tax Audit report

VAT Audit report

Xero automatically calculates retained earnings

Retained earnings is the portion of income retained by your business. Xero automatically calculates your retained earnings in real time so no year-end journal or rollover is required.

Xero allows you to post manual journals

Use manual journals to record transactions which aren't part of your day-to-day transactions.

Xero calculates your foreign currency gains and losses

If your organisation has multi-currency, then Xero's multi-currency reports will calculate and show your business's foreign currency exposure. Xero bases these calculations on exchange rates from XE.com which are updated every hour. Xero tracks all your foreign currency gains and losses through Xero's 3 foreign currency-specific accounts. Choose a pricing plan with multi-currency if you want this feature.

Xero allows you to allocate credit notes, prepayments and overpayments directly against your invoices

Xero makes entering credit notes, prepayments and overpayments easy by automatically prompting you to allocate them against existing customer and supplier invoices.

Credit notes in Xero

Prepayments in Xero

Overpayments