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 uses the accrual method of accounting
- Xero uses the basic accounting equation approach
- You can change the chart of accounts to suit your business
- Xero offers a wide range of financial reports
- Bank statement lines feed automatically into Xero
- Xero uses a single account for recording all VAT
- Xero helps you calculate the VAT you owe to HMRC
- Xero automatically calculates retained earnings
- Xero allows you to post manual journals
- Xero calculates your foreign currency gains and losses
- Xero allows you to allocate credit notes, prepayments and overpayments directly against your invoices
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 scheme for VAT.
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:
- Current Asset
- Fixed Asset
- Non-current Asset
- Current Liability
- Non-current Liability
- Direct Costs
- Other Income
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.
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.
Xero uses a single account for recording all VAT
Xero uses only one VAT account. This one account categorises your VAT into VAT on income, VAT on expenses and VAT payments. This account shows your overall VAT position.
Xero attaches VAT rates to each account in your chart of accounts. This means that whenever you post a transaction in Xero, the VAT rate and amount automatically attaches to the transaction. Xero provides a default set of VAT rates, though you can change any of the VAT default settings if they don't suit your business.
Xero helps you calculate the VAT you owe to HMRC
Xero totals all your accounting transactions for your VAT period and uses these totals to calculate your VAT obligation. You can then check your VAT by running Xero's VAT 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.