Chart of Accounts: Understanding Its Purpose and Functionality

If you’re curious about what a chart of accounts is and whether your business needs one, you’ve come to the right place. In this article, we’ll define it, explain how it works, and outline its structure, while also highlighting its importance for businesses of all sizes—including yours.

Before we jump in here is a TLDR:

A chart of accounts (COA) is like a table of contents that organizes transactions through accounts, helping to keep your finances organized and accessible. It typically includes five main categories: assets, liabilities, equity, revenue, and expenses. While there’s no standard structure for a COA, maintaining a consistent layout year-over-year is essential. Although not mandatory, a COA is vital for quick access to your transaction details.

Now that we've covered the basics, let’s dive deeper.

What is a Chart of Accounts?

A chart of accounts (COA) is a crucial accounting tool that serves as an index of every financial account in a company’s general ledger (your record-keeping system). It categorizes all financial transactions throughout an accounting cycle, listing them by category and line item.

Typically, a COA includes account names, associated codes, details, and balances. Depending on your organization and accounting software, you may also see detailed transactions under each account.

How Does a Chart of Accounts Work?

A chart of accounts works by clearly organizing financial transactions, allowing business owners, investors, and other stakeholders to gain a clearer understanding of a business’s financial health.

Think of it as a table of contents that directs you to specific line items, such as accounts payable, sales, costs, and expenses.

How is a Chart of Accounts Structured?

A chart of accounts displays information derived from the financial statements. Generally, balance sheet accounts appear first, followed by accounts related to the income statement. The five primary categories are assets, liabilities, equity, revenue, and expenses.

These primary accounts can be further divided into sub-accounts, enabling easier access to detailed information for assessing your business's financial status. Depending on your business's size and structure, you might also organize your COA by function or department.

What Accounts are Within a COA?

Let’s break down those primary accounts:

- Assets: Resources owned by your business that provide value, such as cash, equipment, vehicles, inventory, and accounts receivable.

- Liabilities: Debts your company owes, including taxes, accounts payable, and loans.

- Equity: The remaining value after subtracting liabilities from assets, which may include stock and retained earnings.

- Revenue: Income generated from goods or services, including sales and interest revenue.

- Expenses:Costs incurred to generate revenue, such as payroll, marketing, and rent. Net income is calculated by subtracting expenses from revenue.

Chart of Accounts Numbering

Each account in your COA should be numbered for easy identification. The first digit of the account number helps categorize it. For instance, assets might range from 100 to 199, while liabilities could be numbered 200 to 299. The specific numbering will depend on your business size.

Chart of Accounts (COA) Example

Chart of accounts can vary widely, but here’s an example based on the structure described:

- 100-199: Assets

- 200-299: Liabilities

- 300-399:Equity

- 400-499:Revenue

- 500-599:Expenses

Why is a Chart of Accounts Important for Small Businesses?

As a small business owner, you juggle numerous tasks, including managing expenses and tracking transactions. A chart of accounts (COA) helps you organize these transactions and generate essential financial documents, such as balance sheets and income statements.

With your transactions sorted and easily accessible, you can gain valuable insights into your business's current performance, enabling you to strategize for future growth.

How to Create a Chart of Accounts

While there’s no one-size-fits-all format for a chart of accounts, you can follow these guidelines:

1. Numbering: Assign each account a unique number that is easy to identify.

2. Categorization: Group accounts by these numbers (for example, assets could be numbered 100-199, while liabilities could range from 200-299).

It’s also important to maintain the same format for each accounting cycle, so when you compare data, you’re making accurate comparisons.

Using accounting software, like Wave’s, can streamline this process. It ensures consistency and takes care of the heavy lifting, eliminating the need for manual spreadsheets and reducing the risk of losing track of your expense items.