What is a Chart of Accounts? (And Setting One Up Successfully)

A chart of accounts is just accounting jargon and it’s pretty much the accounting world’s version of a book’s table of contents. Its definition or meaning is quite simple – in essence, it’s a list of accounts. Easy right? This post will help you understand how it is structured, why the length and names of your accounts is important and how the list changes with your business.

If you don’t want to read on, here’s a quick video that you can watch that helps explain what a chart of accounts is:

The Structure of a Chart of Accounts

A chart of accounts structure can be compared to a book.

Think of your words being in a book. Then think of your book being organised into chapters. And then think of your table of contents.

The words are the data being organised into chapters, like accounts.

The book is your general ledger that contains the accounts and their data and finally…

The table of contents is your chart of accounts.

When you split it up – chart being a list, and of accounts, being a list of the available accounts.

A chart of accounts is a list of the names of the accounts that a business has to categorise or organise their financial data like sales and bills.

Let’s say your business has started to now expand and instead of just selling coffee, you’re doing catering.

Well…you can create an account called “Catering Sales” and make it available for recording invoices or receipts that relate to your new catering services.

The general ledger is the system that records the ins and outs in your accounting system while the chart of accounts is a list of the accounts so that you can see what accounts are in your system and available to use.

If you Have a Business, you Need a Chart of Accounts

Let’s say you run a small business and you sell baby clothes from home.

The accounts you may have are postage – to record postage, inventory – when you buy the clothes to sell, sales and stationary.

Then you grow your business and then you need an account to record all your rental payments in.

So you create this account:

  • Rent

This will now appear in your chart of accounts (table of contents).

Then you decide to buy a car to use in the business, you’ll need a new account to record payments related to the purchase of the car and also to record maintenance costs on the car.

So you add the following accounts to your chart of accounts:

  • Car
  • Car maintenance

A Chart of Accounts helps your business keep track of important spending areas, earning areas (e.g. new income stream), purchases, loans and more.

** Length of Your Chart of Accounts – How Long Should Your Chart of Accounts List Be?**

One of the biggest issues I see with chart of accounts is their length.

It’s important to make sure that your list of accounts is not too long but also not too short for your business. It should be the perfect size for your business.

Let’s say you run soap making business from home and you buy stationary. You wouldn’t create multiple accounts for different types of stationary e.g.

  • Scissors
  • Erasers
  • Pens

This would make your list of accounts very long and wouldn’t give you a snapshot of what you want to know. Instead, having an account named:

  • Stationary

Would be suffice and would cut down on the length of your list. This makes it easy to categorise your bills into the right area. Additionally, you don’t need to know how much you spend on “Pens” (unless this is a very important part).

A long chart of accounts makes it more complex and time consuming to manage.

The other issue with length is when it is too short to give the business owner enough information.

Let’s say you have an account called “Sales”. But your business has multiple streams of sales. It sells electronics and furniture.

A chart of accounts that would be too short would be:

  • Sales.

However, you could create two accounts called:

  • Electronic sales
  • Furniture sales

This would give the business owner more information about what area (electronics or furniture) sells the most so they can make decisions in their business (e.g. they might only decide to sell in one area).

Naming is (So) Important in a Chart of Accounts

Naming is another important part in setting up a Chart of Accounts.

Naming is actually very hard to do right.

Let’s say you create an account called:

  • Subscriptions.

Is that going to contain all your digital subscription (e.g. mail campaigns, hosting, spam filtering service etc…) and magazine subscriptions together?

This wouldn’t be a good name because while the items are technically ‘subscriptions’, their purpose is for different reasons. The name of the account should tell you what to expect and how to understand the amounts in that account.

For digital subscriptions that are about hosting your online ecommerce site, I’d create an account called:

  • Online Site Expenses

And any other subscriptions I’d put in:

  • General Subscriptions

This way I know that subscriptions in “Online Site Expenses” are related to running the business website while “General Subscriptions” are as they say... general.

Likewise, when you select a name for your account, you don’t want it to be too specific like “Travel in New York” but you don’t want it to be too broad like “Travel” (because travel could be international and domestic and you don’t want to lump it all together).

Something like:

  • Travel – Intrastate
  • Travel – Interstate
  • Travel – International

Would be good naming convention to give you enough information without being too specific or too broad.

In Summary

Your chart of accounts is a list where you can add new accounts or archive accounts to suit your business circumstances (as businesses change).

Next: Expense Accounting Definition (Easy Explanation by a CPA)

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