Everything you need to know about the Chart of Accounts [explained by a Certitfied Accountant]
Chart of accounts (COA) is the foundation of a company’s accounting system because it provides a centralized birds-eye view of all general ledger accounts and a logical structure that facilitates efficient categorization of journal entries and management of financial records.
For example, a well-designed chart of accounts makes it easy for bookkeepers and accountants to figure out which financial transactions should be recorded into which general ledger account.
The accounting software then aggregates the information into an entity’s financial statements.
To facilitate intuitive navigation, the chart of accounts typically contains:
In other words, chart of accounts is like a ….
Keep reading for examples of what a real-life chart of accounts looks like, exactly how do you create one–and use it to your best advantage >>>
|Chart of Accounts List|
|Financial Statement Accounts||Chart of Accounts Category|
|Balance Sheet||Current Assets|
|Income Statement||Operating Revenue|
|Non-operating Revenues & Gains|
|Non-operating Expenses & Losses|
Typically, a standard chart of accounts is arranged in the order of how accounts are listed in the financial statements, where:
Essentially, if you placed the statements of financial position and performance on top of each other, you would come up with the chart of accounts.
Nevertheless, the exact structure of the chart of accounts is the reflection on the individual needs of each entity.
Each account in the chart of accounts is usually assigned a unique code by which it can be easily identified. This identifier can be numeric, alphabetic, or alphanumeric, with each digit/letter typically representing the type of account, company division, region, department and other classifiers.
For example, in a four-digit numerical system:
|Chart of Accounts: Numbering Example|
|Assets: 1000-1999||1 > Asset account|
|11 >> Current asset account|
|110 >>> Cash account|
|Liabilities: 2000-2999||2 > Liability account|
|21 >> Current liability account|
|210 >>> Accounts payable account|
While a reference system with 3-4 digits may suffice for a local small business, the chart of accounts can get very complex very fast for a large corporation with multiple divisions in multiple countries, which could be managing thousands of accounts with much longer identifiers.
Even for a small business, however, more digits allow the flexibility to add new accounts as the business grows in the future, while maintaining the logical order of the coding system.
The structure of the chart of accounts makes it easier to locate specific accounts, facilitates consistent posting of journal entries, and enables efficient management of financial information over time.
Since different types of entities use different types of accounts, there is no one single chart of accounts template that would be applicable to all businesses.
Instead, each entity has the flexibility to customize its accounts chart to fit the specific individual needs of the business.
Hence, the type and number of accounts used in a chart of accounts depends on a number of internal and external factors, including:
While in most jurisdictions and industries it is entirely up to each entity to design the chart of accounts according to its specific requirements, others provide general guidelines or are even regulated by law.
For example, companies in the United States must have certain accounts in place to comply with the tax reporting requirements of the IRS (Internal Revenue Service). One of the IRS stipulations is that expenses like travel and entertainment should be tracked in individual accounts.
Therefore, when crafting a chart of accounts, always consider the tax legislation, financial reporting standards, government regulations and other compliance requirements relevant in your circumstances.
The chart of accounts is as large and complex as the entity itself.
For instance, a small local business (e.g., think local bakery) will need much more compact list of accounts than a large multinational corporation (e.g., think Apple or Google) that can easily accumulate thousands of accounts.
Similarly, the accounts listed within the chart of accounts will largely depend on the nature of the business.
In addition to the universal general accounts that are prevalent in most entities, each entity will include certain accounts that are particular to its industry sector.
Consider how vastly different must be the charts of accounts of companies in the business of:
For example, many accounts that are essential in manufacturing are not commonly used by retail businesses, including the composition of cost of goods sold (COGS). Although both businesses will report COGS on their financial statements, the manufacturer’s COGS will encompass various manufacturing inputs, while the retailer’s COGS will mostly consist of the stock merchandise purchased.
And even within the manufacturing line of business, a manufacturer in the aerospace sector will have a much different looking chart of accounts than one that produces computer hardware or even clothing apparel.
For standardization purposes, many industry associations publish recommended charts of accounts for their respective sectors.
Also, accounting software packages tend to come with a set of predefined charts of accounts for different types of businesses in variety of industry sectors.
Moreover, the chart’s structure is influenced by the information a company’s internal management needs for decision making as well as the demands of external stakeholders who use its financial statements for various different purposes.
The most important component when working with a chart of accounts is consistency, which enables the comparison of financials across multiple accounting periods and business units.
However, there is a trade-off between the ability to make historical comparisons and the ease of use:
On one hand, keeping the number of accounts to a minimum will make the accounting system more straightforward to use.
On the other hand, organizing the chart with a higher level of detail from the beginning allows for more flexibility in categorizing financial transactions and more consistent historical comparisons over time.
If you start off with only a handful of accounts and then keep expanding the list as your business grows, it may become increasingly challenging to compare financial results against the previous years.
Therefore, it is advisable to initially create a list of accounts that is unlikely to significantly change for as long as possible and keep it congruent among all areas of business.
Individual subsidiaries, divisions, departments and any other reporting units of a larger entity should keep their charts of accounts aligned to facilitate the consolidation of their financial results as part of the overall entity.
If the business units keep changing their account lists and deviate from the standard company chart, in may become difficult and time consuming to consolidate the many variants into one version of truth for the entire business.
In order to keep the number of accounts down to a manageable level, you may periodically review the list and close any accounts that are not fully utilized.
Just remember that while you can add an account to the chart at any time throughout the financial year, you should not delete any accounts until the end of an accounting period.
If you delete an account in the middle of the financial year, it may cause confusion in your accounting records.
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