A chart of accounts is actually what you track your finances through. The accounts that appear on the face of the balance sheet, profit & loss, and general ledger are actually someone who has set the category of the account for it and then has allocated transactions to the particular category.
A chart of accounts is an index of all the financial accounts in the general ledger of a company.
A chart of accounts is an organizational tool to break down the transaction into understandable categories and subcategories based on the five main types of classification.
A chart of accounts enables you to see transactions with descriptions, Numbers, and names. As explained earlier in the definition section the chart of accounts makes it understandable and you can sort transactions or accounts (similar transaction category) in the general ledger. The main 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 necessary because you can track the financial figures and records of transactions through a general ledger, which is possible through the chart of accounts.
A chart of accounts is tailored according to company operational requirements. The investors can go through charts of accounts and account balances for the investment option. Also, investors use financial statements whether to invest in a business or not that line appearing on the balance sheet is also the chart of accounts.
A chart of accounts will include the following categories:
- Owner’s equity
Assets are the items that the company owns from past activities and have future economic benefits in terms of cash inflows. You can set the number along with the name and description for assets its starts with 1000. You can apply this for setting up your charts of accounts in accounting software such as QBO.
There are two main categories of assets dependent on time that are current and non-current assets.
Current assets are the assets that the company will benefit from for 12 months. current assets include:
- Accounts receivable
- Prepaid expenses
Non-current assets are assets that are useful for more than 12 months. Non-current assets include:
- Property plant and equipment
- Furniture and fixtures
- Lease right of use
Liabilities are what your company owes. While setting the chart of accounts the liabilities number starts from 2000.
The chart of accounts will include the following items for current liability but is not limited to:
- Unearned income
- Accrued expenses
- Payroll taxes payable
- Sales taxes payable
- Loans and mortgages payable
Non-current liabilities accounts include:
- Mortgages payable
For a chart of accounts, the equity no starts with 3000 and refers to shareholder equity. Some of the equity most commonly found in a chart of accounts are:
- Share capital
- Common stock
- Preferred stock
- Retained earnings
- Owner draws
Revenue is the sales of the business. Operating income is the income your business earns from primary business activity.
Non-operating revenue is revenue that your company makes from other than the principal activity. This form of revenue can come from:
- Sales revenue
- Interest income
- Dividend income
- Foreign exchange gains or losses
- Profits or losses from investments
- Rental income from property
The revenue section starts with the 4000 number along with the name and description.
Expenses may be related to operating activities called operating expenses and other non-operating expenses.
Operating expenses are expenses that occur to run a business or operational activity. You may have expenses from the following:
- Salaries and wages
- Legal and professional
Non-operating expenses are expenses not related to business operations. These include:
- Interest charges
How to Set up a Chart of Accounts
If you want to set a chart of accounts here are the three things you can look at while setting a chart of accounts.
The first and most important is the name of the account which will be a specific and valid name such as salary and wages, marketing, Inventory, and so on.
Type of Account
The second thing to add is the type of account. This is the broad category in which various accounts fall. That may be the cost of goods sold, assets, liabilities, equity, assets, and expense.
The description is short text added to understand what is the account type about what transaction it will.