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:
- Keep it Simple
- 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.
- 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.
- 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.
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