Properly recording transactions is an important facet of accurate financial reporting. With a chart of accounts, it’s easier to understand how to categorize transactions and keep your books in good order.
In this guide, we’ll cover what a chart of accounts is, why they’re important for businesses, and how to properly prepare one to streamline transaction recording.
A chart of accounts (COA) is a list of all the financial accounts that are found in a company’s general ledger.
The chart of accounts for accounting does not consist of individual transactions or balances in each account. Rather, it’s a way for businesses to see how their various accounts are structured so they can get an overview of all the ways the business spends and makes money.
As we’ll explore in more detail below, there is a general chart of account format that businesses will follow. However, this can be altered to meet the unique needs and operations of a given company. As you can imagine, a Software-as-a-Service (SaaS) company can have different accounting and reporting needs than an eCommerce brand or healthcare company. Their COA can be customized to reflect this.
While a relatively simple concept, a chart of accounts in accounting is an important organizational tool.
It clearly defines the various accounts and sub-categories that a company uses to categorize its transactions. This helps accountants ensure consistency and accuracy in bookkeeping, accounting, and reporting activities, which is the baseline for proper financial management and business decision-making.
Again, businesses have some leeway when it comes to organizing their COA. In fact, they can even add as many accounts and sub-accounts to the COA as needed to properly categorize transactions. This can range anywhere from just a handful of accounts to dozens or even hundreds – depending on the company’s size and industry.
That being said, there are a few that will be included in all COAs, which are listed below. If you use outsourced bookkeeping services, you can get expert support understanding how to categorize transactions and set up your COA.
Assets are any resources that a business owns or uses for economic benefit. This includes both short-term (current) and long-term (fixed) assets, as well as intangible assets. Some common examples include:
Assets are recorded on the balance sheet. However, the specific asset sub-accounts a business uses will be specific to its operations. For instance, an eCommerce store may not own land or vehicles, though a physical retailer may.
Liabilities are essentially the opposite of assets. These accounts include any financial obligation the business owes another business, individual, or entity. As with assets, liabilities are reported on the balance sheet. Some of the sub-categories that typically fall into the liabilities category include:
Compared to the asset category, there might be less variation in the liabilities sub-accounts across different business sizes and industries.
Shareholder’s equity is another balance sheet account, which consists of any retained earnings, common stock, or preferred stock the company has issued.
Revenue or income accounts are used to track sales activity and any money the business generates from routine operations. They are considered income statement accounts.
Companies may only use one general revenue account to track all sales. Or, they may break it down into each revenue source, using different accounts to track revenue for specific product lines.
Expenses are the other income statement accounts, representing the cash outflows businesses make to support operations. This often includes:
Most COAs follow the same general structure to help leaders, investors, and other stakeholders understand what they’re looking at.
A COA typically looks like a table or list with a few columns for the account identifier, a description or name, and the type of account it is. Businesses may include an additional column to list out the specific financial statement that the sub-account corresponds to — be it the balance sheet or income statement.
COAs often have a numbered system, assigning numbers one through five to the main categories. Thus, any sub-accounts corresponding to them will start with the same number, making for easy organization.
When preparing a chart of accounts, the following steps can help you set it up properly.
The first step is to assess your operations and understand the specific accounts you’ll need to support accurate financial reporting.
Consider the various sources of income, the types of expenses you have, and any other unique transactions or industry-specific requirements you deal with.
Use the five main categories of accounts (assets, liabilities, equity, revenue, expenses) to categorize the sub-accounts appropriately.
Give each sub-account a logical name or description to help your team understand what types of transactions should correspond to each one.
One of the key steps in creating a COA is implementing a numerical system to keep the accounts and sub-categories organized.
Companies can decide internally how they’d like to number accounts and what the protocols will be. Whatever numbering system they decide on, it’s important to set clear guidelines for how they will be used, ensuring consistency in their records.
Let’s say you’ve designated “1” for assets, “2” for liabilities, and so on. Each sub-account will begin with 1, followed by a unique identifier afterward to distinguish the individual account. In this case, the cash account might be 101, accounts receivable are 102, equipment is 103, etc.
Your COA doesn’t have to be set in stone. Once you set it up, give yourself some time to test it out and see how well it works in practice. Your team can make tweaks as needed based on the actual transactions that come in.
For instance, maybe you start off only with one revenue account to cover all sales activity. However, over time, you may find that it would be helpful to break revenues down by merchandise sales and gift card sales, offering deeper insights to help your team make more strategic decisions.
Of course, you should try to avoid making constant modifications to your COA, as it can impact your financial reporting. Try to keep it consistent once you find a structure that works for you. Working with an experienced bookkeeping team, like Bob’s Bookkeepers, can help you create a chart of accounts that makes the most sense for your business’s needs.
Now that we’ve reviewed how to create a chart of accounts, here’s an example of what one might look like for an apparel store.
As we’ve discussed throughout, there are no chart of accounting standards, and businesses can alter the format and structure to their internal needs. COAs are not required, even though many businesses find them helpful in properly categorizing transactions and organizing accounting records.
Companies should find a format that suits their operations and business needs, helping to streamline transaction reporting. Over time, they can review the COA to ensure it’s still appropriate, eliminating any underutilized or unnecessary accounts and adding new ones to accommodate emerging needs.
Managing bookkeeping and accounting workflows may not be your team’s core competency. If you’d like more time to spend on growing your business and have the peace of mind that your finances are kept in order, outsource bookkeeping matters to an expert team like Bob’s Bookkeepers.
Contact us today for more information about our custom outsourced bookkeeping services.
