A business’s chart of accounts is a simple list of its financial accounts that becomes a kind of blueprint or roadmap reflecting the business’s financial architecture. If that architecture is really well-thought-out — in alignment with the finances of the business — a chart of accounts will be a key reference tool that helps make financial analyses easier to achieve.
Whether or not its leaders are familiar with financial principles, any small business ready to grow to the next level will find a chart of accounts a necessary tool.
What Is a Chart of Accounts (COA)?
At the highest level, a chart of accounts is a list of all the financial accounts on a company’s general ledger, which is the central record of all the business’s transactions within an accounting period.
A chart of accounts assigns an alphanumeric code to each account, and that code is what enables subsequent reporting and analysis. In this way, the chart of accounts can be a tool to help business managers run their companies effectively by helping to produce accurate and timely financial reports for owners and investors.
- A chart of accounts is a business’s list of financial accounts, reflecting the structure of the company’s balance sheet and income statement.
- Detailed chart of accounts categories are individual to the business and set by management.
- Once established, it’s best never to change a chart of accounts. But since businesses operate in the real world, it’s important to think through changes carefully when needed.
Chart of Accounts Explained
Every business should have three principal financial statements: a balance sheet, an income statement — the formal name for what many people call “the P&L”, or profit and loss statement — and a cash flow statement. Only the balance sheet and income statement accounts are reflected on the chart of accounts.
Note that in this case, “accounts” are the finance equivalents of folders in computer storage, used for tracking purposes — not literal bank accounts.
Because balance sheets and income statements are based on accounts that are all listed on it, the chart of accounts is a catalog that reflects the entirety of a business’s finances. It separates revenue, expenses, assets, liabilities and equity into different accounts. This separate tracking gives managers a better understanding of where money is coming into and going out of the business on a day-to-day basis.
How Charts of Accounts (COA) Work
There are two high-level categories on a chart of accounts: balance sheet accounts, which record the company’s assets, debts and net worth, and income statement accounts, which record income from all sources as well as expenditures. Balance sheet accounts feed into the company’s balance sheet, and income accounts feed into the company’s income statement.
Balance sheet accounts are subdivided into three groups: asset accounts, which record all valuable resources the company owns; liability accounts, which record all the company’s debts; and equity accounts, which represent the value left in the business after liabilities have been subtracted from assets.
Income accounts are subdivided into two groups: revenue accounts, which record the company’s income from all sources, and expense accounts, which record all the company’s expenditures.
Within each of these groups are lines representing individual account types. Each line includes a brief description of the account’s transaction type, such as asset or liability; the account type it belongs to; and a unique code. And, each line on a chart of accounts represents an account in the company’s general ledger.
What Is Included in a Chart of Accounts?
A chart of accounts includes line items for every account in a business’s general ledger, which records transaction activity related to nearly everything the company owns, everything it owes and the equity belonging to its owners or shareholders. It is thus a complete reference to where of the company’s finances are recorded.
However, exactly what lines a company has in its chart of accounts is a management decision and depends on the nature of its business and how it is financed. For example, asset accounts might include unsold inventory for a shop, intellectual property for a design company or, for a large conglomerate, accounting goodwill from its acquisitions.
The lines in a chart of accounts can be related to each other. For example, a company that is financed principally with debt will have liability accounts for its debts and expense accounts for the interest payments arising from those debts.
Categories on the Chart of Account
Most charts of accounts have five top-level categories. The first three flow into the balance sheet, and the other two flow into the income statement. The five are:
Some, however, break out gains and losses as top-level categories instead of including gains within revenue and losses within expenses, making seven in all.
It’s often easiest to structure the subcategories in a chart of accounts broadly along the same lines as the financial reports into which they feed. So balance sheet accounts follow the structure of the balance sheet, and income accounts follow the structure of the income statement.
Here’s how that works.
Balance sheet accounts
The balance sheet divides assets and liabilities into current and noncurrent, so it can be helpful to do this on the chart of accounts, too.
Asset accounts record everything the company owns.
Current assets are assets that are either cash or can be quickly and easily realized in cash terms and include:
- Cash and cash equivalents, such as bank deposit accounts;
- Marketable securities, such as bonds and shares in publicly traded companies;
- Inventory; and
- Accounts receivable.
Non-current assets are assets that can’t easily be sold to obtain cash. Some of them can, however, be used as collateral for borrowing. They can include:
- Real estate, or premises;
- Plant and equipment;
- Intellectual property, such as patents;
- Goodwill, which is the difference between the amount a company pays to acquire a company and the fair value of that company’s assets; and
- Investments, such as stakes in private companies or joint ventures.
Liability accounts record everything the company owes.
Current liabilities are debts that must be paid back or otherwise settled within one year. They include:
- Bank overdrafts and other debts falling due in one year or less;
- Accounts payable, such as supplier invoices that have not yet been settled;
- Accrued expenses, such as electricity usage that has not yet been billed by the utility company; and
Non-current liabilities are long-term debts and other liabilities, such as leases, that don’t need to be settled within one year.
Equity accounts record the company’s net worth, which is the difference between the value of its assets and the value of its liabilities. Equity accounts can include the following:
- Common stock (issued shares);
- Treasury stock (shares that have been repurchased by the company);
- Retained earnings (last year’s profits);
- General reserve (money set aside to cover unexpected eventualities); and
- Owners’ equity (the owner’s money used to fund the business).
Income statement accounts
Income statements are divided into categories for revenue and gains and expenses and losses. Those are the next-level categories on the chart of accounts. Here’s how that works.
Revenue accounts record the company’s income from all sources, both earned, such as from sales and fees, and unearned, such as investment gains. Negative income, such as sales returns, goes into income accounts, not expense accounts. Income accounts typically include the following:
- Sales revenue;
- Sales returns; and
- Investment gains.
Expense accounts record all the company’s expenditures, plus non-cash expenses such as depreciation and amortization. Typical expense accounts include:
- Cost of goods or services sold (COGS);
- Marketing, advertising and promotions;
- Travel expenses;
- General and administrative expenses such as rent, utility bills, insurance and legal fees;
- Depreciation and amortization;
- Interest paid; and
- Taxes paid.
Setting Up the Chart of Accounts
When setting up a chart of accounts for the first time, it’s important to think about how the business works, not just about how it needs to report for legal and tax purposes. How many business lines are there? What kinds of expenses does the business typically incur? What types of assets does it have, including intangibles?
Managers can list as many accounts in a chart of accounts as they need to give them a detailed view of all the financial activity going on in the company. It’s important to consider such potential financial analyses when establishing the chart of accounts because, ideally, once it is set up it shouldn’t be changed.
But during setup, a business can adjust the basic structure shown in the previous section to better meet management needs. For example, you could further divide your expenses into direct costs — expenses that directly feed into your cost of production — and indirect costs. This would make it easier to calculate gross margins. It can also be helpful to relate the chart of accounts to budget categories, so managers can see at a glance how the business is performing against expectations when they review the listed accounts.
When you’ve decided roughly how many lines will be on your chart of accounts and how they will be categorized, the next step is to code them. Typically, the coding system on a chart of accounts is structured so that various categories of accounts can be easily identified. So, for example, asset accounts might all have codes beginning with A, while liability accounts might have codes beginning with L.
Here’s an example of a simple structured coding system:
Chart of Accounts Examples
Here’s what a basic chart of accounts might look like for a small manufacturing company.
Note the structured coding system that enables management to pull out the various components of the financial statements quickly and easily:
Assets all begin “1” and, within that, current assets are grouped together beginning with “10”.
Liabilities begin “2” and, within that, current liabilities are grouped together beginning with “20”.
Equity accounts begin with “3”, and there is plenty of room to add more equity types if the owners decide to sell part of their stakes.
In this example, revenue, beginning with “4”, is not broken down, but again, there is plenty of room to add more revenue types.
Expenses all begin “5” and, within that, general and administrative expenses all begin with “51”.
It’s easy to construct a simple balance sheet and income statement from this chart of accounts. But there’s not much detail to work with, so it might be helpful to break this format down further so managers can see more clearly where money is coming from and where it is going. Let’s restructure this chart of accounts to present it more clearly and provide more detail for management.
This two-level chart of accounts has much more detail than the first example, yet it’s easier to read. The granularity in the income and expense accounts could give management a clearer picture of where money is coming from and where it’s going. And, this chart can still be used to produce the all-important balance sheet and income statement.
Why Is the Chart of Accounts Important?
The chart of accounts is important because it’s the primary reference tool for a company’s financial structure. It’s the central hub for the company’s financial accounts, which are the source of its principal financial statements. A well-constructed chart of accounts enables management to obtain a birds-eye view of the company’s financial performance from its general ledger. In the same way, it also helps the company to simplify and streamline end-of-period reporting.
Chart of Accounts Best Practices
Over the years, accounting managers have developed a handful of practices that serve most companies well in developing their first charts of accounts.
Use a basic structure that is aligned to the business’s financial reporting needs
Keep your balance sheet and income accounts separate, but make sure they relate to each other where necessary. For example, if the company has debts, make sure the chart of accounts has both debt liability accounts and interest expense accounts.
Organize the chart of accounts to support management decision-making
Define the business’s account types based on how the business works. Make sure the chart of accounts gives a clear picture of where money is coming from and where it’s going. Align the chart with budget categories so the business’s performance against expectations can be seen at a glance.
Use structured codes and subheadings to help pull out key information quickly and easily
A five-digit structured code can give enough granularity for two or three levels in a chart of accounts. Leave enough room in the coding scheme to add lines when needed.
Make use of modern accounting software
Note that cloud-based accounting software can add dimensionality to transaction details that can stand in for additional levels on a chart of accounts, easing the burden of a complex coding scheme.
Don’t overdo the details
You want to be able to see what’s going on, not get so bogged down in details that you can’t see the woods for the trees. If your chart of accounts has more than three levels, consider setting up subledgers.
Change your chart of accounts only at period-ends
You want to avoid changes as much as possible, but in no event should you remove lines from a chart of accounts or reorganize it in the middle of an accounting period.
How to Adjust a Chart of Accounts
While businesses are best off never changing their charts of accounts, they also must operate in the real world. When necessary, you can add lines to a chart of accounts, provided you have enough room in your coding scheme, but you will most likely have to make manual adjustments to journal entries to move the balance from existing lines to the new ones. Here’s how to do that.
Suppose that in the more detailed chart of accounts example above, the small manufacturing company is selling far more service contracts this year than it has historically. In fact, it’s selling a service contract along with almost all of its goods. But the service contracts have different prices depending on the product sold. So, management wants to break down line 40030, Service Contracts (income) into two lines: Service Contract Line A and Service Contract Line B.
We need to create two new lines and then apportion the existing balance from 40030 between them:
Create new lines in the chart of accounts:
Because the change is happening halfway through the accounting period, the existing line 40030 can’t be deleted. Numbering the new lines like this keeps the old and new lines together as a group:
40031 Service Contract Line A
40032 Service Contract Line B
Apportion the balance:
Let’s suppose that at the time of the change, the balance on line 40030 is $300,000. Invoice receipts show $200,000 of that came from service contracts for Line A and the remainder from contracts for Line B. So we need to make the following journal entries:
Automate and Manage Your Chart of Accounts With Accounting Software
Once a business decides how to organize its chart of accounts, it can be set up on accounting software that populates the resulting accounts automatically from invoices and receipts so managers won’t have to manually reconcile a paper trail back to the appropriate account. Modern accounting software lets you make journal entries as and when you need them, so you can manage your chart of accounts to meet the business’s changing needs. And accounting software can produce powerful and timely reports for management and statutory purposes.
If you aren’t confident about setting up a chart of accounts from scratch, some accounting software provides templates that can be adapted to meet your business’s needs. If the business has an existing paper-based chart of accounts, migrating it to cloud-based accounting software (at a period end, of course) can save time, reduce errors and improve business control. Further, NetSuite’s cloud-based financial management software can add dimensions to transaction data at any time, simplifying a chart of accounts’ coding scheme.
The chart of accounts is the accounting hub around which a business’s finances revolves. A well-organized chart of accounts is a blueprint for a powerful accounting system that can help a business manage more effectively on a day-to-day basis, as well as produce management and statutory reports — especially when used in combination with a comprehensive accounting software package.
Chart of Accounts FAQ
What is the standard chart of accounts?
The standard chart of accounts lists the accounts that record everything a company owns, owes, earns and spends. It also lists the accounts that record the company’s net worth, which is the difference between what it owns and what it owes. A standard chart of accounts is divided into two sections: the balance sheet section and the income statement section. These feed, respectively, into the balance sheet and the income statement, which are the company’s two most important financial statements.
Is a chart of accounts similar to a balance sheet?
The chart of accounts isn’t a balance sheet, but it includes all the elements that business managers need to create a company’s balance sheet.
What are the five types of accounts?
The five types of accounts in a chart of accounts are:
- Assets: Everything the company owns;
- Liabilities: Everything the company owes;
- Equity: The company’s net worth;
- Income: Everything the company receives; and
- Expenses: Everything the company pays.