Chart of accounts in business accounting

6. Setting up a chart of accounts

A chart of accounts is central to accounting and financial reporting. Charts of accounts are tailored to meet reporting and accounting needs of a particular business. For instance, merchandising and construction businesses will have different charts of accounts because selling goods and building houses entail different operations. For new businesses, it might take some time before the final chart of accounts is set up as new accounts will be added and old (e.g., redundant) accounts will be removed or deactivated. As a business progresses, the chart of accounts can be modified (updated) to better reflect the company’s operations. Accounting software usually allows inserting new accounts at a later date without disturbing the original sequence.

As we noted earlier balance sheet accounts are fairly standard for many businesses: for example, cash, accounts receivable, inventory, prepaid expenses, fixed assets, accounts payable, wages payable, notes payable, retained earnings, capital, drawing, etc. Income statement accounts are usually tailored to the type of business operations. Income statement accounts are set up to match business needs. Revenue accounts should reflect the major types of goods sold or services offered. Cost of goods sold will match the revenue type. Expenses should reflect the major types of selling and administrative expenses of the business.

A chart of accounts should be as simple as possible because lengthy and complex charts of accounts can create various problems. For example, it might be more difficult to train new bookkeeping staff to use a complex chart of accounts. Such a chart of accounts can be also more expensive to audit. At the same time a chart of accounts should be able to capture enough detail to allow preparing required internal and external financial reports.

As mentioned earlier, a chart of accounts may be updated to better match business operations. When a business grows, new accounts may need to be added while some accounts might need to be “deleted.” Examples of changes that could require a chart of accounts update are listed below:

  • New regulatory requirements: new accounting standards could require a separate recording of certain transactions.
  • Business acquisition: new accounts or a new pattern of numbering accounts might be needed to reflect new operations.
  • Organizational changes: changes in an organizational structure of a company may require respective adjustments in the chart of accounts.
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