Bookkeeping – Chart of Accounts (Lesson 11)

The chart of account is a list of all accounts used by that respective business and is in order by the six group types. Assets are first, then liabilities, equity, revenue, cost of sales and finally expenses.

Now comes the more interesting aspects of being a bookkeeper. To properly create a set of ledgers there must be a list of accounts. This list is referred to as the ‘Chart of Accounts’ or for shorthand – COA .

 

Six Types of Accounts

The COA is merely a list of accounts grouped by the type of accounts as explained in Lesson 1. There are basically six types of accounts. Quick review:

Balance Sheet Types
1) Assets
2) Liabilities
3) Equity

Income Statement Types
4) Revenue
5)Cost of Sales
6) Expenses

Remember 1-3 are your balance sheet accounts and 4-6 are your income statement (P&L) accounts.

A really basic chart of accounts will look like this:

Assets
Liabilities
Equity
Revenue
Cost of Sales
Expenses

Now nobody sets up their chart of accounts to look like this. However, if you ran a really simple business like a lemonade stand, that chart will work! Seriously, the only asset you would have is cash, customers pay for the cups of lemonade which is revenue; there are costs for the ingredients and maybe one or two expenses. The profit or losses flow to equity as explained in Lesson 9.

Simple Set of Accounts

But businesses are not this simply. How then is a chart of accounts taken to a more informative level?

Well the main types of accounts are expanded to provide a little more clarity as follows:

Assets
  Current Assets
  Fixed Assets
  Other Assets

Liabilities
Current Liabilities
  Long-Term Notes

Equity – See Lesson 10 for more information about Equity
  Initial Investment
  Historical Earnings
  Current Earnings
  Payments to Owners

Revenue
  Sales
  Adjustments
  Other Sources

Cost of Sales
Materials
  Labor
  Other

Expenses
  Management
  Facilities
  Sales & Marketing
  Office
  Insurance
  Other

Now look at this COA closely. It follows very closely to the lesson about debits and credits in various types of accounts lessons (Lessons 3 – 10). This chart of accounts will work with just about any really small business operation. However, it still could get clearer by expanding it one more level. 

Traditional Chart of Accounts

Take a look at this:

Balance Sheet Accounts
Assets
  Current Assets
     Cash
     Accounts Receivable
     Other
Fixed Assets
      Transportation
      Equipment
      Real Estate
Other Assets
      Long – Term Notes Receivable
      Intangibles

Liabilities
Current Liabilities
      Accounts Payable
      Credit Cards
      Accrued Payroll
      Short – Term Notes
  Long-Term Notes
      Transportation Loans
      Real Estate Mortgage 

Equity – See Lesson 10 for more information about Equity
  Initial Investment
       Stock
       Capital Paid in Excess
   Historical Earnings
       Year 1
       Year 2
       Year 3
   Current Earnings
   Payments to Owners
      Investor A
      Investor B
      Investor C

Income Statement Accounts
Revenue
  Sales
      Department Retail
      Department Service
      Department Financing
Adjustments
 Other Sources
      Penalties/Fines/Customer Charges
      Interest
Cost of Sales
Materials
      Prefabricated
      Customized
       General
   Labor
      Manufacturing
      Retail
      Service
   Other
Expenses
Management
      Upper Level
      Administration
  Facilities
       Rent
       Maintenance
       Taxes/CAM
   Sales & Marketing

Office
      Supplies
      Technology
      Postage
    Insurance
       General Liability
       Property
       Worker’s Comp
       Auto
    Other

Do you notice how it is getting a little more complicated? It is important for you to understand that no matter how detailed we get with this COA, each account still falls within a TYPE of ACCOUNT for accounting purposes. In addition, that type has a preferred form of status as to a DEBIT or a CREDIT ending balance as discussed in the prior 10 lessons.

NO MATTER HOW DETAILED THE CHART OF ACCOUNTS GET; ALL ACCOUNTS MUST FALL WITHIN ONE OF THE SIX TYPES OF ACCOUNTS.

 

Detailed Chart of Accounts

You can still get really detailed with your COA as illustrated here with the Cash Section of the Asset group.

ASSETS
Current Assets
    Cash on Hand
    Regular Checking
    Payroll Checking
    Savings

This is the level that most small business reach in the form of detail with their respective charts of accounts. It is rare, very rare for it to go further. However, as time goes on and the business has several stores or operating centers, it can get much more detailed. And it is appropriate to reach that level provided the business is generating enough income to cover the associated costs of having such detail.

 Look at this continuation of the CASH section:

ASSETS
 Current Assets
       *Cash on Hand
                  Main Store
                  Southside Store
                  Wilderness Service Site
                  Traveling Sales Reps
         *Regular Checking
                  Wells Fargo # 4222
                   Bank of America # 9987
                   Hometown Bank # 6645
          *Payroll Checking
          *Savings

The secret to this is to generate a COA that not only makes sense but fits the purpose of the company and how the business operates. The biggest mistake I’ve seen in creating a chart of accounts is TOO MUCH DETAIL. I’m not kidding, I’ve seen a 4 person business with over 300 accounts in their chart of accounts. Where they got carried away was in the cost of goods sold section. They had a different account for every type of material purchased. It was a contractor and it looked like this:

   Cost of Sales
Materials
         Lumber
              Framing
                  2X4
                  2X6
                  2X8
                  2X10
                  2X12
              Flooring
                  3/16’s
                  ½
                  1/16’s

It went on like that for trim, decking, and shed. It was ugly. I simply asked if they gained anything from having that much detail? Seriously there would only be 2 to 3 entries in the roof plywood section. 

Here are some guidelines for you as a bookkeeper:

1. Keep it Simple
2. If there is a total dollar value of less than $100 on an annual basis recorded to this account, consider consolidating the account with another.
3. If two or more accounts are the same function, consider consolidating. A good example is fuel for Car # 1, Car # 2, and Car # 3. If you really want to know who is consuming the most gas, look at the odometers.  Consolidate the three accounts into one.
4. Try to have less than 100 accounts in all.

This lesson is really just an introduction to the chart of accounts. There is more material related to the Chart of Accounts and if you wish to read more go to businessecon.org and search:

• Chart of Accounts
• Trial Balance – Purpose and Interpretation
• Financial Statements for Small Business

I also have very detailed articles related to the respective areas of both the balance sheet and income statement. Look in the How to Read the Financial Reports section of the website for more help. 

Notice I did not cover the number system used with the COA? I did this on purpose as future lessons for bookkeeping and accounting will include this concept. For now, I wanted to help you understand the simple layout for a chart of accounts. The key is that all the accounts fall into one of the six types of accounts. ACT ON KNOWLEDGE.