What is a Chart of Accounts?
Whenever you record a business transaction—whether it’s taking out a new bank loan, receiving an invoice from a client, or buying a new laptop for the office—you need to log it into the correct account. But how do you know which account to use? That’s where the chart of accounts comes in.
Let’s break down what the chart of accounts is, what it looks like, and why it’s so crucial for your business.
What is the Chart of Accounts?
A chart of accounts (COA) is a complete list of all your company’s accounts, organised in one place as part of your general ledger. It gives you an overview of every part of your business that either spends or earns money. The main types of accounts include Revenue, Expenses, Assets, Liabilities, and Equity.
Think of it in terms of personal finance. When you log into your bank, you see a dashboard listing your different accounts—like checking, savings, and credit cards—with their balances. It’s a snapshot of where your money is.
The same idea applies to a business’s chart of accounts, though it’s usually more complex since businesses typically have more account types than an individuals. Despite the complexity, the purpose remains the same: to provide a clear picture of your business’s financial activities by listing all the accounts involved in its daily operations.
Similar reading: A beginner's guide to record-keeping for small businesses.
Why is the chart of accounts important?
The chart of accounts is super important for a few reasons. First, it keeps your financial records organized. Think of it as a big filing system for all your business transactions. When everything is neatly categorised, it’s easier to track your income and expenses, see where your money is going, and make informed decisions.
Second, a well-organised chart of accounts helps you stay on top of compliance and reporting. Whether you’re preparing for tax season or creating financial reports for stakeholders, having all your accounts clearly laid out makes the process much smoother and less stressful.
Lastly, it provides a clear financial snapshot of your business. At any given time, you can look at your chart of accounts and get a good idea of your financial health. Are you spending too much in one area? Do you need to cut back somewhere? Or maybe you’re doing great and have some extra cash to invest in growth. The chart of accounts helps you see all that at a glance.
In short, it’s like having a well-organised toolbox—everything you need is in its place, making it easier to manage your business and plan for the future.
What are balance sheet accounts?
Balance sheet accounts are essential for creating a balance sheet, one of the most common financial statements. There are 3 types of balance sheet accounts:
- Asset accounts: These track resources your company owns that add value, like land, equipment, cash, and even intangible things like patents, trademarks, and software.
- Liability accounts: These record all the debts your company owes. They often include terms like "payable" (e.g., accounts payable, wages payable). Another example is "unearned revenues," which are payments received before services are delivered.
- Equity accounts: These are a bit more abstract. They represent what's left after subtracting liabilities from assets, essentially showing the company's value to its owner or shareholders.
What are income statement accounts?
Income statement accounts are used to generate the income statement, another crucial financial statement.
- Revenue accounts: These keep track of income from selling goods, services, or rent.
- Expense accounts: These record all the money and resources spent to generate revenue, such as utilities, wages, and rent.
How do the balance sheet & income statement accounts interact?
The interaction between these accounts is complex, but a key rule is that revenues increase your organisation's equity and asset accounts while expenses decrease your assets and equity.
How do you adjust your chart of accounts?
Adjusting your chart of accounts involves a few key steps to ensure your financial records stay accurate and organized:
- Review current accounts: Start by looking over your existing accounts. Identify any that are no longer relevant or that need updating to reflect changes in your business.
- Add new accounts: If you’ve started new activities or need better tracking for certain transactions, add new accounts. Make sure they fit logically within your existing structure.
- Remove or merge accounts: If you find redundant or outdated accounts, you can either delete them or merge them with other similar accounts. Just make sure not to lose any important historical data.
- Reclassify transactions: If you've added or changed accounts, you might need to reclassify past transactions to ensure they’re recorded in the right place.
- Update account numbers: Ensure that your account numbering system remains logical and organized. Adjust numbers if needed to keep everything in order.
- Communicate changes: Ensure that anyone who uses the chart of accounts, like your accounting team, is aware of the changes. This will help avoid confusion & ensure consistency.
- Regular reviews: Periodically review and adjust your chart of accounts to keep it aligned with your business needs. Regular maintenance can prevent more issues down the line.
How is a Chart of Accounts (COA) grouped for reporting purposes?
A COA is grouped into four main reporting categories: cash, liabilities and shareholder equity, revenue, and expenses.
What does a typical COA include?
A typical COA includes assets, liabilities, equity, revenue, and expenses. Each category is broken down into sub-categories to provide more detailed information.
What are the primary financial statements?
The core financial statements are the balance sheet, income statement, and statement of cash flow.
How do you differentiate & categorise asset and liability accounts?
Assets / liabilities are categorised based on their nature. Assets include things like bank accounts, real estate, prepaid expenses, and accounts receivable. Liabilities include accounts payable, loans, credit card debt, and other expenses that need to be paid. Liability accounts often have “payable” in their name.
How can a COA help drive business decisions?
Tracking account data with a COA provides a clear basis for comparing financial information over time. This ensures you have accurate data for making informed business decisions that promote growth.
What is the difference between a COA and a General Ledger (GL)?
A COA is a list of all accounts, along with descriptions of their uses. The GL includes the COA and also contains detailed financial records, including debit and credit balances for each account.
What is the best software for setting up and using a COA?
There are many accounting software options available for small and medium businesses. These tools offer various features to help you manage your assets and liabilities more effectively.
Check out Inkle Books for the best solutions.
How do you set up a Chart of Accounts (COA)?
Creating a Chart of Accounts (COA) is a key step in keeping your business’s finances organised.
Here’s how you can do it:
- Understand your business needs: Think about what your business specifically needs in terms of financial tracking. Consider the types of transactions you’ll be dealing with and how detailed your financial reports need to be.
- Create major account categories: Start with the main categories: Assets, Liabilities, Equity, Revenue, and Expenses. These are the foundation of your COA.
- Define sub-categories: Within each main category, create sub-categories for more detail. For example, under Assets, you might have Cash, Accounts Receivable, Inventory, and Equipment.
- Assign account numbers: Use a logical numbering system for your accounts. For instance, assets could start with 1, liabilities with 2, equity with 3, revenue with 4, and expenses with 5. This makes everything easier to find and organise.
- Describe each account: Write clear descriptions for each account so anyone can understand what it’s for. This helps keep things consistent when recording transactions.
- Set up in accounting software: Enter your COA into your accounting software. Most software lets you customise and tweak your COA as needed, making it easier to manage and update.
- Review and adjust: Regularly check your COA to make sure it still fits your business needs. Make changes as your business grows or evolves to keep your financial records accurate.
- Train your team: Ensure everyone who will use the COA knows how it’s organised and how to use it properly. This avoids mistakes and keeps your records consistent.
Example of a Chart of Accounts
Imagine a small company called COA. Their chart of accounts (COA) would list out several sub-accounts under main categories like assets, liabilities, and shareholders' equity.
For assets, they might include:
- Cash
- Savings account
- Petty cash balance
- Accounts receivable
- Undeposited funds
- Inventory assets
- Prepaid insurance
- Vehicles
- Buildings
Under liabilities, you’d find:
- Company credit card
- Accrued liabilities
- Accounts payable
- Payroll liabilities
- Notes payable
And for shareholders' equity, they’d have:
- Common stock
- Preferred stock
- Retained earnings
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