Successful accounting methods require a diverse set of skills, especially financial insight, which is crucial for smaller organizations with limited time and resources. Managing finances meticulously through a well-structured Chart of Accounts and General Ledger provides valuable insights, discipline, and improves operational processes, including regulatory compliance. Therefore, let’s focus on the Chart of Accounts (COA) as a key indicator of an organization’s financial health.
A Chart of Accounts (COA) is a directory in a company‘s general ledger that categorizes all financial accounts. It lists transactions by category and specific details for a given accounting period.
Chart of Accounts and its Functions
Utilizing a COA enables companies to effectively organize their financial information, offering interested parties such as investors and shareholders a transparent view of their financial well-being. This separation of expenditures, revenue, assets, and liabilities not only facilitates this understanding but also ensures that financial statements adhere to reporting standards.
To draw a parallel to personal finances, consider having a checking account, savings account, and a Certificate of Deposit (CD) with the same bank. When you access your accounts online, you typically see an overview displaying the balance in each account. Similarly, using online tools like Mint or Personal Capital to manage all your financial accounts provides a comparable perspective to a company’s COA. It presents all your assets and liabilities in one consolidated view.
It’s important to note that there isn’t a standardized format for a chart of accounts. While they generally adhere to the fundamental structure outlined below, their final structure and appearance depend on the specific business type and size.
COA Importance
Chart of Accounts is like a special tool for money that helps keep track of all the financial stuff in a neat and easy way. It shows all the money actions one by one, so you can easily see and understand them. This is really important for showing investors and others a big picture of a company’s money information.
How it Works
COA is like a money organizer that companies use. It helps them keep track of their money and shows it clearly to people who care about it, like investors and owners. It separates spending, earnings, things they own, and money they owe. This makes sure their money reports follow the rules.
Imagine you have a few different bank accounts, like checking, savings, and a certificate of deposit (CD) at the same bank. When you log in to your bank’s website, you usually see a page that shows how much money is in each account. Think of this as your own personal COA. It’s like seeing all your money stuff on one page.
COAs don’t have just one way to look. They all have the same basic structure, but they can look different depending on the business and how big it is.
Structure of COA
The company’s COA is typically structured to reflect the sequence of information presentation in financial statements. This arrangement begins with the listing of balance sheet accounts followed by those from the income statement.
These main accounts encompass assets, liabilities, shareholders’ equity, revenue, and expenses. They can be further subdivided into sub-accounts, such as operating revenues, operating expenses, non-operating revenues, and non-operating losses.
The accounts for operating revenues and operating expenses may undergo additional categorization based on business functions and/or company divisions.
For instance, in the case of a small company‘s COA, it could comprise the following sub-accounts beneath the primary categories of assets, liabilities, and shareholders’ equity:
1) Assets
Assets are comprised of a list of different components showing the value of monies on hand and owed to you, as well as property owned
- Cash
- Savings account
- Petty cash balance
- Accounts receivable
- Undeposited funds
- Inventory assets
- Prepaid insurance
- Vehicles
- Buildings
2) Liabilities
Liabilities, in essence, represent funds that your organization owes or must pay.
- Company credit card
- Accrued liabilities
- Accounts payable
- Payroll liabilities
- Notes payable
3) Shareholders’ equity
This refers to the remaining interest in the assets of a company after taking its liabilities. It also represents the claim or stake of the company’s shareholders within the company’s assets.
- Common stock
- Preferred stock
- Retained earnings
4) Revenue
Income or revenue signifies the accumulation of gains from various origins.
- Sales
- Interest
- Billing adjustments
5) Expenses (Direct and Indirect)
All the forms of currency and assets that a business utilizes in its endeavors to generate income. To determine net income, you deduct expenses from revenue. Expense categories might encompass the following.
- Administrative costs
- Operational expenses
- Taxes
- Insurance
- Vehicle costs
6) Cost of Goods Sold (COGS)
The Cost of Goods Sold (COGS) represents the supplementary expenditures required for the successful provision of a product or service.
- Labor cost
- Material costs
- Subcontractor Expenses
- Equipment costs
Setting up a Chart of Accounts
You can easily obtain a Sample Chart of Accounts from the internet, or you have the option to create your own by using standard default numbers and customizing sub-designations for various account types.
To facilitate quick and easy reference for readers and to provide instant recognition of specific accounts, each Chart of Accounts typically includes identification codes, account names, and brief descriptions.
This coding system holds significance because the Chart of Accounts can encompass numerous line items for each transaction within every primary account.
In most instances, asset accounts are assigned numbers starting with 1, followed by four additional digits (1-XXXX), while liability accounts commence with the number 2 (2-XXXX), and so forth down the numeric sequence. This structural approach proves practical for businesses engaged in manufacturing or sales, offering enhanced specificity in their Chart of Accounts framework. By employing multiple three- or four-digit sub-account designations, you can achieve more comprehensive transaction tracking and enhance overall fiscal transparency.
Many organizations structure their Chart of Accounts in a manner that segregates expense data by department. Consequently, various departments such as sales, engineering, and accounting utilize the same set of expense accounts. Examples of expense accounts encompass the cost of goods sold (COGS), depreciation expense, utility expenses, and wages expense.
COA Best Practices
- Delay deleting old accounts to avoid complicating your financial records; it’s advisable to do so at the year’s end to prevent potential tax season issues when merging or renaming accounts. Nonetheless, you have the flexibility to introduce new accounts whenever necessary.
- Exercise prudence when creating your Chart of Accounts (COA). Focus on generating a COA that imparts essential information without delving into excessive detail for each transaction. Avoid the need for a distinct account for every product or utility; instead, group similar items together.
- Strive for consistency when structuring your COA. Aim for minimal changes from year to year, facilitating comparisons between various accounts over time. This consistency offers valuable insights into your business’s financial management.
- Perform an annual review of your accounts, particularly at year-end, to identify opportunities for consolidation. This streamlining process enhances the manageability of your accounts.
Conclusion
A chart of accounts is a structured record that assigns numbers and categorizes every financial transaction conducted by a company during an accounting period. Typically, this information is organized into categories that align with those found on the balance sheet and income statement.
This chart of accounts serves as a valuable resource, offering easy access to in-depth financial data for individuals within the company and external parties, such as investors and shareholders.
