What if you had to retrieve the dollar amount on an invoice that was issued a year ago? You might have to sort through a pile of paperwork for hours, going by the order of the time of filing. There may be even more problems that will occur, such as missing documents. What if you had to report on all notes payable within the 3 months that followed? It would be an even more hectic process. This is where using a chart of accounts shows its usefulness.
What is the Chart of Accounts (COA)?
In simple terms, the chart of accounts is a financial organizational tool that is a complete list of every account being run by a business. An account is a record for each type of asset, liability, equity, revenue, and expense. The COA sorts different specific accounts, consolidating accounts of the same type for easier tracking and logging.
In many businesses, the charter of accounts is a key tool to help organize a business’ financial record-keeping system and is a foundation to set up all accounting systems.
Historically, the methodology was to set up separately labeled drawers for this type of paperwork processing. Luckily, the proliferation of accounting software has made this easier by automatically labelling and categorizing the entries for easier finding.
The complexity of a chart of accounts is directly correlated to the complexity of the business. There may be hundreds of categories and sub-categories of accounts, depending on the size of the business.
Typically, a COA contains the name of the account, account numbers, and a brief description. However, the common practice is to list in order of how it appears on the financial statements. Balance sheet accounts usually appear first, and then the income statement accounts.
BALANCE SHEET ACCOUNTS:
- Petty Cash
- Marketable Securities
- Accounts Receivable
- Allowance on Doubtful Accounts
- Prepaid Expenses
- Fixed Assets
- Accounts Payable
- Accrued Liabilities
- Taxes Payable
- Wages Payable
- Notes Payable
- Common Stock
- Preferred Stock
- Retained Earnings
INCOME STATEMENT ACCOUNTS:
- Cost of Goods Sold
- Bank Fees
- Depreciation Expense
- Payroll Tax Expense
- Supplies Expense
- Utilities Expense
- Wages Expense
The most important pieces to consider are assets, liabilities, revenue, and expense accounts, as having the ability to separate these accounts gives a high-level overview of a business’s financial health.
What does a business own? There are current assets, which are assets that can be easily liquidated, for example, cash in the bank, money market accounts, accounts receivable, and inventory. Fixed assets are more difficult to liquidate including office equipment, vehicles, heavy machinery, and land. Examples of categories under assets would be deposited funds, prepaid insurance, and company vehicles.
What does the business owe? A good example is an outstanding loan. Any account denoted by ‘loan’ or ‘payable’ is a liability. Liabilities are categorized as short, medium, and long-term liabilities. Examples of accounts that would be categorized as liabilities include vehicle loans, the mortgage on an office building, and payroll dues.
Where does the business’ money come from? Sources of revenue include product and service sales, professional fees, royalties, commissions, etc. Revenue that does not come from the day-to-day business is categorized as Other Income. Chart of accounts examples that would be under revenue includes service income (e.g. training), labor income (e.g. construction), and reimbursement income (e.g. mileage).
What payments are the business doing regularly? Some examples include utility expenses (gas, water, internet), and professional services e.g. legal services, insurance, and medical costs. An expense that is one-off is labeled as an Other Expense. Examples of accounts under expenses include wages expense, supplies expense, prepaid expenses, bank charges, and depreciation expenses.
A chart of accounts is useful for any size of the business, either small businesses or larger businesses. It makes finding financial documents and recording financial information on the general ledger much easier and efficient.