A chart of accounts is an excellent way for you to see your company’s finances. It provides small business owners with a strategy to see their transactions arranged in several categories.
You should know a few things before creating a chart of accounts, especially if you’ll ever plan on adjusting it. Here is what you should know about a chart of accounts.
What is a Chart of Accounts?
A chart of accounts will allow you to see multiple financial transactions accompanied by a description, an identification number, and a name.
You can use a chart of accounts to sort through the categories within a general ledger. Some categories you’ll find within a chart of accounts are:
- Shareholder’s equity
Why is a Chart of Accounts Important?
A chart of accounts is essential because you can see all of your company’s financial transactions based on your small business’s general ledger. This will allow you to search through the transactions easily if needed.
A second benefit to the organization of a chart of accounts is that you can use this information for investment opportunities. A prospective investor or shareholder can view your chart of accounts to determine whether your company has the financial viability.
A chart of accounts will include the following categories:
- Owner’s equity
An explanation of what you should include in each category, including further subcategories, follows.
Assets are what your company owns. Within your chart of accounts, the assets section will begin with the number 1000. This is the same number used for accounting software.
There are two asset types you’ll track in this section: current assets and noncurrent assets. Current assets will include assets that your small business will use in the next year, such as:
- Accounts receivable
- Prepaid expenses
Noncurrent assets or long-term assets are assets that your small business will use for longer than one year. Noncurrent assets include:
- Accumulated depreciation
- Furniture and fixtures
- Plant and equipment
Liabilities are what your company owes. Within your chart of accounts, the liabilities section will begin with the number 2000. This is the same number used for accounting software.
There are two liability types you’ll track in this section: current liabilities and noncurrent liabilities. Current liabilities, or short-term liabilities, will include liabilities that your small business will use next year. Current liabilities include:
- Loans and mortgages payable
- Payroll taxes payable
- Sales taxes payable
Noncurrent liabilities or long-term liabilities are liabilities that your small business will use for longer than one year. Noncurrent liabilities include:
- Loans payable
- Mortgages payable
For a chart of accounts, equity refers to shareholder equity. Some of the equity most commonly found in a chart of accounts are:
- Common stock
- Preferred stock
- Retained earnings
Within your chart of accounts, the equity section will begin with the number 3000. This is the same number used for accounting software.
Operating income is the income that your business primarily makes. Non-operating revenue is revenue that your company makes indirectly. This form of revenue can come from:
- Asset write-downs
- Dividend income
- Foreign exchange gains or losses
- Interest income
- Profits or losses from investments
- Rental income from property
Within your chart of accounts, the revenue section will begin with the number 4000. This is the same number used for accounting software.
Expenses are the last part of a chart of accounts. There are two expense types: operating expenses and non-operating expenses.
Operating expenses are expenses that occur to cover operational costs. You may have expenses from the following:
- Inventory costs
- Step costs
Non-operating expenses are expenses unrelated to business operations. These include:
- Interest charges
Within your chart of accounts, the expenses section will begin with the number 5000. This is the same number used for accounting software.
How to Set up a Chart of Accounts
If you want to set up a chart of accounts for your use, here’s what you’ll need to know. There are three columns used within a chart of accounts: an account name, type of account, and description.
The first column in a chart of accounts is the account name. You’ll list your account names in this column.
Type of Account
The second column in a chart of accounts, to the right of the account name, is type. This will list the account that you’re adding. You can select from an asset, cost of goods sold, equity, expense, income, or liability.
The third column in a chart of account, to the account type’s right, is a description. You’ll describe the transaction that occurred.
If you have to make adjustments to your chart of accounts, there are some things to be aware of.
First, if you want to add an account to your chart of accounts, you should do so before it becomes a problem.
While you can add transactions to your chart of accounts at any point in the year, you don’t want to delay adding transactions and their accompanying information. If you wait, then you may need to adjust other entries in related categories or subcategories.
Second, if you add an account to your chart of accounts, it is helpful to designate a name for it.
The name most commonly used for newly added accounts is Miscellaneous Expenses. This is the name you should use whether you have one uncategorized transaction out of the year or multiple uncategorized transactions.
Third, if you add a Miscellaneous Expense to your account, make sure you provide a more detailed explanation than usual. Even though you’ve already added a description to your chart of accounts, you want to explain how and why this expense is different. As you add accounts to this category, make sure you adjust your chart of accounts as needed.
Finally, and most importantly, you shouldn’t delete any accounts from your chart of accounts until the end of the year. If you delete the accounts earlier, that can create problems that require adjustment.
Work with the Pros
Creating a chart of accounts is very important for your small business. Work with the pros to make sure you don’t encounter problems with your bookkeeping needs.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.