What’s a chart of accounts?
A chart of accounts, aka the COA, is the foundation of your financial record-keeping system. It allows you to sort all your financial transactions between different categories. For example, your business may purchase inventory or pay the rent for your office. You wouldn’t want to mix inventory with rent within the same category or account as they are different item types. Each category or account holds financial transactions that relate to similar item types. For example, you may have an account called ‘Utilities’ that includes transactions related to electricity, fuel, phone charges and so on.
Each account on your COA belongs to one of two big families of accounts with further sub-families as follows:
1. The balance sheet accounts:
Asset accounts: The resources that a company owns and that will provide a future benefit or help to generate profit (e.g. property, inventory, cash).
Liability accounts: The obligation to pay another entity.
Equity accounts: The remaining amount available to shareholders once all liabilities have been deducted from assets.
2. The profit and loss accounts:
Revenue accounts: E.g. sales, service revenue, interest income etc.
Expense accounts: E.g. cost of goods sold, salaries, utilities, rent, depreciation etc.
Why do you need a chart of accounts?
With a chart of accounts in place, you are able to run financial reports that allow you to compare the various categories of accounts across different time periods. This helps you make informed decisions about your business.
A chart of accounts provides you with an organised view of your finances and a clear insight into the overall financial health of your company.
A chart of accounts also helps you to produce financial statements that comply with financial reporting standards.
What should your chart of accounts look like?
The accounts’ names should be clear and concise so that it is easy to navigate the chart of accounts and resulting financial reports and statements. For example, you wouldn’t want to name an account ‘Supplies for the office’ but instead you would use ‘Office Supplies’.
Your accounts should roll up to the correct families of accounts as described earlier (assets / liabilities / equity / revenue / expense accounts). If you also use sub-categories of accounts, these should roll up to the correct parent account. For example, you wouldn’t want to have the ‘Electricity’ account rolling up to a parent account such as ‘Salaries’. It should instead roll up to the ‘Utilities’ parent account.
You should review your chart of accounts from time to time to ensure that it is still relevant to your company’s way of operating. You can create new accounts at any time. You can also make old accounts inactive or delete them, however it is best to wait until the end of the year to do so to avoid disrupting your books.
