What is a Chart of Accounts & Why is It Important

What is a Chart of Accounts & Why is It Important

The chart of accounts is a list of all the financial accounts that your organization uses. It's the backbone of any accounting system, so it's important to get it right.

The COA includes three sections: asset accounts, liability accounts and equity accounts. 

Assets include cash and other things you own; liabilities are debts you owe, such as loans or unpaid invoices; and equity represents ownership in your business by showing shareholders' investment in their company.

The chart of accounts is a complete listing of the general ledger accounts of a business.

The chart of accounts is a complete listing of the general ledger accounts of a business.

It’s the first thing you need to set up when you start a business, and it contains everything from your cash to your inventory to your debtors (and even your creditors).

The chart of accounts is used to create financial statements, which means that if you want to see how much money you have and where it came from, this is where that information will be stored.

What Is a Chart of Accounts (COA)?

A Chart of Accounts (COA) is a list of all the accounts in your organization. It's used to organize your financial statements, which are used to track and report on your business's performance. 

In addition to helping you analyze how your company is doing financially, the COA also helps ensure that transactions are recorded correctly by ensuring the right data is captured.

Each account in the chart of accounts represents an asset, liability, equity, expense or revenue type.

Each account in the chart of accounts represents an asset, liability, equity, expense or revenue type. 

Accounts are organized by type, and each account is assigned a number that is used to identify it on financial statements.

How Charts of Accounts (COA) Works

A Chart of Accounts (COA) lists every account you have in your business. It helps you organize your finances and track how much money you have coming in and going out so that you can make informed decisions about how to manage your money.

It's easy to see why a chart of accounts is so important for any business: it lets you report accurate financial statements for tax purposes, tracks your business's financial performance over time, and provides management with the information they need from their books at any given moment.

The primary benefit of having a chart of accounts is that it provides structure to your organization's financial statements.

The primary benefit of having a chart of accounts is that it provides structure to your organization’s financial statements. 

It helps you organize your finances, maintain consistent bookkeeping and reporting, prepare financial statements, keep track of your finances and manage them more effectively. 

The chart can also be used to make projections and decisions about future operations.

It helps you organize your finances and maintain consistent bookkeeping

A chart of accounts is an accounting system that helps you keep track of your transactions. 

It helps you understand your business's financial position, make better decisions, and manage your business more effectively.

Using a standard chart of accounts ensures that all relevant data is captured and accurately reported

A standard chart of accounts ensures that all relevant data is captured and accurately reported. 

It also makes it easy to compare financial information across organizations. 

Finally, using a standard chart of accounts allows for creating easy business reports to read, understand, and interpret.

How Do I Use a Chart of Accounts?

A chart of accounts is a list of all the accounts in your business. It helps you organize your finances and maintain consistent bookkeeping by ensuring that all relevant data is captured and accurately reported. 

For example, if you're using QuickBooks to manage your accounting, the program automatically creates a chart of accounts for you. 

You can then customize it to match how you want to view transactions in different areas (e.g., employees vs contractors).

A standard chart of accounts ensures that all relevant data is captured and accurately reported across multiple financial statements (balance sheet, income statement, cash flow statement) while also providing consistency over time: 

because companies with similar operations use similar types of transactions (e.g., purchases vs sales), they often have similar charts of accounts which allows users to easily compare performance across peer groups within their industry or sector.

Asset Accounts

  • Accounts for tangible items that are owned by the business. These could be physical assets, such as land and buildings, or intangible assets, such as patents and copyrights.
  • Examples of accounts for tangible assets include Accounts Receivable, Inventory and Property, Plant and Equipment (PP&E).

Liability Accounts

Liabilities are amounts owed by the business to creditors. These can be in the form of accounts payable and accounts receivable. 

Liabilities are usually recorded as an account in your Chart of Accounts and then posted to their respective general ledger accounts monthly.

The most common types of liabilities include:

  • Accounts Payable (AP) - money owed for purchases made on credit within a specific time period
  • Accrued Expenses - expenses that have been incurred but not yet paid for, such as unpaid bills, taxes, insurance premiums or utility bills

Equity Accounts

Equity accounts are used to track the assets owned by your business as well as its liabilities.

They can be considered a tool for determining how much money your business has at any given time. 

They're particularly useful if you manage multiple businesses or want to keep track of each business's finances.

In addition to tracking its own equity, an account generally keeps track of how much money you owe other people or groups (liabilities). 

For example, suppose you borrow money from someone else to start your company. In that case, that loan becomes part of your liabilities—and, therefore, will be reflected in an equity account for every transaction involving it.

Example of a COA

An example of a COA is below: General ledger accounts

  • Cash, receivables & payables are the three main categories of transactions. Subledger accounts can be created as needed to track subcategories within these three primary categories. For example, if you want to track cash in your bank account separately from cash in your petty cash drawer, you can create an account called Bank Cash and another called Petty Cash. Similarly, you may have customers who purchase goods from your company using different payment methods (e.g., credit card or PayPal). To keep track of these customer payments, you could create two sub-ledger accounts: Purchases on Credit Cards and Purchases via PayPal.

Subledger accounts

These are smaller ledgers that detail specific information about other general ledger accounts (or between sub-ledger accounts). 

They're typically used when there isn't enough space on the general ledger page itself—for instance, if there need to be several columns for each entry for it to be legible—but aren't necessary otherwise. For example:

Creating a chart of accounts

  • Create a chart of accounts. To ensure that the data you enter in your accounting software is accurate and consistent, you should use a standard chart of accounts (COA). A COA lists all the asset, liability, equity, expense and revenue categories and their subcategories.
  • List each category's data in each category. For example, Assets: Cash on Hand; Liabilities: Accounts Payable, Revenues: Sales Income; Expenses: Salaries Paid.
  • Use subcategories when necessary to differentiate between types of assets or liabilities etc., or if the item encompasses two different types of accounts, such as "Accounts Receivable", which includes money owed to you from customers but also money owed by suppliers for goods sold on credit terms other than cash/check payments.

Special Considerations

To decide which accounts you need to include in your chart of accounts, it's important to consider what types of transactions will most likely be recorded in each account. 

For example, if a business purchases cars for resale and does not intend to use these vehicles for personal use (i.e., they're not intended as company cars), then the purchase of those vehicles should be recorded in a separate asset account called "Vehicles."

Similarly, if that same business sells used vehicles on its website or at an on-site location, those sales should be recorded in an income account called "Sales."

This is how large businesses create a comprehensive list of all their assets (and liabilities).

Conclusion

A chart of accounts is one of the most important tools in your accounting toolkit. 

They structure your organization's financial statements and help ensure that all relevant data is captured and accurately reported. 

They also help you organize your finances and maintain consistent bookkeeping.

FAQ's related to What is chart of accounts & why is important 

1. How do I set up my chart of accounts?

The first step in setting up a chart of accounts is to review what kind of information you want to capture and how you want that information to be organized. Then, based on these decisions, decide on the number of accounts (e.g., assets, liabilities) that will best suit your needs. Once you've established this framework, it's time for some heavy lifting and account mapping!

2. How do I maintain my chart of accounts?

Once your chart is built out correctly, and in the right format, the next step is maintenance—and two main things can go wrong here: 

  • incorrect posting and 
  • incorrect coding! 

When creating transactions in QuickBooks Online or Desktop Software, make sure they're posted correctly by double-checking everything before saving them as accepted drafts/postings/transactions. Also, check all numbers when entering data into any field related to tracking inventory items (if applicable).

If everything looks good, but something still doesn't seem right after saving as an accepted posting/drafting transaction, then check whether its coding was correct at entry level—or if it might need adjusting later on downstream after accounting functions kick in like reconciliation processes or journal entries created automatically by QuickBooks Online or Desktop Software due dates processing settings being used incorrectly by a user during the creation process.

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