Chart of Accounts
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What is the Chart of Accounts? – Definition
The chart of accounts is a list of every account in the general ledger of an accounting
system. Unlike a trial balance that only lists accounts that are active or have balances at
the end of the period, the chart lists all of the accounts in the system. It’s a simple list of
account numbers and names. It doesn’t include any other information about each account
like balances, debits, and credits like a trial balance does.
You can think of this like a rolodex of accounts that the bookkeeper and the accounting
software can use to record transactions, make reports, and prepare financial statements
throughout the year.
Chart of Accounts Format and Number System
Each account is typically assigned a number based on the order it appears on the financial
statements. Balance sheet accounts are usually presented first followed by income
statement accounts. Thus, accounts are assigned numbers and listed in this order: assets,
liabilities, equity, income, expenses, other.
Most companies use a numbering system that groups accounts into financial statement
categories. For example, all asset accounts might have a prefix of 1 while liability
accounts might have a prefix of 2. This numbering system looks like this:
Assets: 1-001
Liabilities: 2-001
Equity: 3-001
Revenues: 4-001
Expenses: 5-001
Other: 6-001
This numbering system helps bookkeepers and accountants keep track of accounts along
with what category they belong two. For instance, if an account’s name or description is
ambiguous, the bookkeeper can simply look at the prefix to know exactly what it is. Take
insurance for example. An account might simply be named “insurance offset.” What does
that mean? Is it a prepaid asset or an expense that was paid out? The bookkeeper would
be able to tell the difference by the account number. An asset would have the prefix of 1
and an expense would have a prefix of 5. This structure can avoid confusion in the
bookkeeper process and ensure the proper account is selected when recording
transactions.
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Although most accounting software packages like Quickbooks come with a standard or
default list of accounts, bookkeepers can set up and customize their account structure to fit
their business and industry.
For example, many companies have different departments that incur similar costs like
supplies. Management might want to evaluate the supplies expenses for each department
to see which one is using its resources the most efficiently. To make this comparison
easier, the bookkeeper could tag the expenses to different departments of simply use
different numbered accounts for each department. Department 1 could use 5-001-1 for its
supplies expense while department 2 could use 5-0001-2 to differentiate it from the other
departments.
Example and Template
How to Use the Chart of Accounts
There are many different ways to structure a chart of accounts, but the important thing to
remember is that simplicity is key. The more accounts are added to the chart and the more
complex the numbering system is, the more difficult it will be to keep track of them and
actually use the accounting system. Simple is always better than complicated.
Here’s a standard example chart of accounts.
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As you can see, each account is listed numerically in financial statement order with the
number in the first column and the name or description in the second column.
How to Create a Chart of Accounts
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There are a few things that you should keep in mind when you are building a chart of
accounts for your business.
Numbering – Don’t use all concurrent numbers for your accounts. You will probably need
to add accounts in the future. If you don’t leave gaps in between each number, you won’t
be able to add new accounts in the right order. For example, assume your cash account is
1-001 and your accounts receivable account is 1-002, now you want to add a petty cash
account. Well, this should be listed between the cash and accounts receivable in the chart,
but there isn’t a number in between them. Look at the number pattern in our example
above.
Size – Set up your chart to have enough accounts to record transactions properly, but don’t
go over board. The more accounts you have, the more difficult it will be consolidate them
into financial statements and reports. Also, it’s important to periodically look through the
chart and consolidate duplicate accounts.
Changes – It’s inevitable that you will need to add accounts to your chart in the future, but
don’t drastically change the numbering structure and total number of accounts in the future.
A big change will make it difficult to compare accounting record between these years.
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