Chart of Accounts: What It Is and Why Your Business Should Have One

Chart of Accounts Definition

A business chart of accounts is a visualization of all of the accounts in a business’s general ledger that are currently in use. The chart of accounts is divided between accounts reflected in a business’s balance sheet and accounts reflected in its income statement.

No matter what type of business you operate, you need a chart of accounts. A chart of accounts is the basis of a good business accounting system, and functions essentially as a map of your business’s finances.

In this article we are going to do a deep dive on chart of accounts: what they are, why you need one, and how to go about managing yours. Armed with a chart of accounts, you’ll have a better understanding of your business’s financial outlook, have an easier time following financial reporting standards, and be able to make smarter business decisions.

What Is a Chart of Accounts?

To understand what a chart of accounts is, it first helps to understand what a general ledger is. Your business general ledger is a master document of all the accounts your company has. In other words, it’s the complete record of financial transactions over the life of your business.

Your chart of accounts, on the other hand, is the listing of the accounts that are currently made available for recording transactions in your general ledger, along with the account type, account balance, and a brief description. So essentially your general ledger shows all of your accounts across the entire history of your business, while your chart of accounts only shows the accounts that are currently open.

Your chart of accounts should function as a reflection of your business. Bigger and more complex companies can have hundreds, even thousands of accounts. Small businesses typically have fewer accounts. The types of accounts you have also reveal the nature of your business. If you operate a restaurant you will probably have more references to food products in your chart of accounts.

Every time you record a business transaction—be it taking out a loan, purchasing supplies, or processing an invoice—you must record it in your chart of accounts. But which account do you record it in? Well, let’s take a look at the different types of accounts included in a chart of accounts.

Types of Accounts in a Chart of Accounts

A chart of accounts shows each account a company owns in the order it appears on the company’s financial statements. That means balance sheet accounts are listed first, followed by income statement accounts. Typically, each chart in the list is assigned a multi-digit number for identification purposes. Note that in QuickBooks Online, you can’t order your chart of accounts in any way other than alphabetical.

Let’s take a look at the types of accounts that fall under balance sheets and income statements.

Balance Sheet Accounts

Balance sheet accounts get their name from the fact that they are required for the creation of a business balance sheet. There are three different types of balance sheet accounts:

Asset Accounts

Asset accounts record any resource your company owns that provides value. Examples of asset accounts include things like inventory, real estate, equipment, and accounts receivable.

Liability Accounts

Liability accounts are a reflection of all the debt your company owes. They include things like accounts payable, taxes payable, and wages payable.

Equity Accounts

Equity accounts are a measurement of how valuable a company is to its shareholders. It’s essentially what’s left when you subtract a companies liabilities from its assets. Examples include common stock, preferred stock, and retained earnings.

Income Statement Accounts

Income statement accounts reflect what you’d find on a business’s income statement. Here are the major kinds:

Revenue Accounts

These accounts are a reflection of the revenue your business brings in from the sale of goods, services, or rent.

Expense Accounts

These accounts reflect all the money and resources your business expends in an effort to generate revenue.

If revenue increases, this will increase your business’s asset and equity accounts. On the flip side, if expenses increase, this will decrease your business’s asset and equity accounts. Within your income and expense accounts, many businesses create sub-accounts based on business function of company division. For example, some businesses may organize expense accounts by department: One for sales, one for accounting, etc. Within each department, there will be expense accounts for wages, utilities, and more.

For every business transaction, at least two accounts are involved: One is debited and one is credited. If you use QuickBooks Online and you go to input a transaction, the software will know to debit one account and credit another. For example, if you are paying rent by writing a check, QuickBooks will debit your cash asset account and credit the expense account for rent.

Chart of Accounts: Best Practices

To help you best manage your chart of accounts, here are some things to keep in mind:

• Wait to Delete Old Accounts: In the interest of not messing up your books, it’s best to wait until the end of the year to delete old accounts. Merging or renaming accounts can also create headaches come tax season. However, you can add new accounts at any time.
• Don’t go Overboard with Your Accounts: Create a chart of accounts that will give you important information, but that doesn’t mean every single detail about every single transaction. You don’t need a separate account for every product you sell, and you don’t need a separate account for each utility. Certain items can be lumped together.
• Aim for Consistency: You should strive to create a chart of accounts that doesn’t change much year over year. This way you can compare the performance of different accounts over time, providing you valuable insight into how you are managing your business’s finances.
• Prune Your Accounts: At the end of the year, review all of your accounts and see if there is an opportunity for consolidation. This will make handling your accounts more manageable

Making the Most of Your Chart of Accounts

It can seem overwhelming to manage your chart of accounts, but accounting software can carry most of the burden. The QuickBooks Online default chart of accounts is usually sufficient for most small businesses.

If the setup they provide doesn’t work for you, take the time to find a ProAdvisor to help you create a chart of accounts that will give you the information you need to make decisions about your business and your future. Staying on top of your chart of accounts gives you an accurate snapshot of your business’s financial outlook, and provides you with peace of mind whenever it comes time to make an important business decision.

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from Fundera Ledger https://www.fundera.com/blog/your-guide-to-a-chart-of-accounts/