The financial world is filled with terms that can seem intimidating to someone without a strong finance background. One such finance term is Chart of Accounts. The chart of accounts is full of details and can contain a huge amount of data entries and rows in Excel.
In reality, it’s not too confusing. I promise!
Let’s break down what it is and how it works.
Defining Chart of Accounts (COA)
A Chart of Accounts (COA) is an index of all of the financial accounts in a company’s general ledger and acts as the backbone of a company’s financial system. The chart of accounts is carefully organized by categories and line items, making it one of the most important and detailed resources for tracking financial activities and for financial reporting.
The Importance of a Chart of Accounts
A chart of accounts is a vital financial tool that organizes numerous financial transactions in a manner that is easy to access. Because transactions are displayed as line items, they can be quickly found and assessed. Furthermore, big companies can have thousands of line items so a chart of accounts allows them to easily be broken down into different hierarchies and categories. This is crucial for categorizing, sorting, and reporting data.
Why Chart of Accounts Matters
The chart of accounts is important in offering a clear and transparent view of a company’s financial health to interested parties, such as investors and shareholders. This comprehensive listing of accounts in the general ledger allows for easy organization of finances.
To facilitate quick location of specific accounts, each COA typically features an identification code, name, and a brief description. Businesses can adjust their COAs to reflect their size and nature, ensuring that the tool remains relevant and useful over time.
For the sake of accuracy in period-to-period comparisons, it’s crucial to maintain the same chart of account format over time.
Anatomy of a COA
A chart of accounts operates in a manner similar to personal finance tools. For instance, if you have different types of accounts at a bank, such as checking, savings, and a certificate of deposit, you would typically see an overview of your balances when you log into your online account. Similarly, using a personal finance app that aggregates all your financial accounts, like Mint or Personal Capital, provides a similar view that a COA offers a business – a complete overview of assets and liabilities.
The structure of a COA can vary depending on the company’s size and the nature of its business. However, most COAs follow a specific structure, which is designed to mirror the order of information as it appears in financial statements.
Structure of Chart of Accounts
The COA is generally structured to display information in the same sequence it appears on financial statements. This means that balance sheet accounts are listed first, followed by income statement accounts.
Primary accounts such as assets, liabilities, shareholders’ equity, revenue, and expenses can be further divided into sub-accounts. These sub-accounts include operating revenues, operating expenses, non-operating revenues, and non-operating losses. The sub-accounts may also be organized by business functions or company divisions.
For instance, a small company’s COA might categorize sub-accounts under the primary assets, primary liabilities, and primary shareholders’ equity accounts as follows:
- Savings account
- Petty cash balance
- Accounts receivable
- Undeposited funds
- Inventory assets
- Prepaid insurance
- Company credit card
- Accrued liabilities
- Accounts payable
- Payroll liabilities
- Notes payable
Account Identifiers in Chart of Accounts
A chart of accounts usually contains identification codes, names, and brief descriptions for each account to help users easily locate specific accounts. This coding system is crucial because a COA can display a multitude of line items for each transaction in every primary account.
For instance, a company may decide to code:
- Assets from 100 to 199
- Liabilities from 200 to 299
- Equity from 300 to 399
- And so forth
These codes can then be broken down further into categories like:
- Current assets (110-119)
- Current liabilities (210-219)
The number of figures used depends on the size and complexity of a company and its transactions.
A simplified version of the identification code system might look something like this:
|Number||Account Description||Account Type||Statement|
|110||Savings||Assets (Current)||Balance Sheet|
|115||Inventory||Assets (Current)||Balance Sheet|
|140||Property Plant and Equipment (PP&E)||Assets (Noncurrent)||Balance Sheet|
|212||Payroll due||Liabilities (Current)||Balance Sheet|
|218||Utilities||Liabilities (Current)||Balance Sheet|
|250||Long term loans||Liabilities (Noncurrent)||Balance Sheet|
|330||Preferred Stock||Equity||Balance Sheet|
|560||Marketing Expenses||Expenses||Income Statement|
Note how the coding system helps break down each listing into hierarchies and categories. For example all of the listings from 100-199 are assets while all of the listings from 200-299 are liabilities.
Furthermore, anything from 100-119 are current assets, while anything from 120-199 are noncurrent assets. The same applies to 200-219 (current liabilities) and 220-299 (noncurrent liabilities).
This coding system can be broken down into further categories and details depending on the amount of listings and how detailed the company wants the chart of accounts to be.
Many organizations structure their COAs so that expense information is separately compiled by department. Thus, the sales department, engineering department, and accounting department all have the same set of expense accounts. Examples of expense accounts include the cost of goods sold (COGS), depreciation expense, utility expense, and wages expense.
Visualizing a Chart of Accounts
To understand the structure and format of a complete COA, it’s helpful to view an example. Below is a representation of a chart of accounts in Excel:
Adhering to Financial Standards
While COAs can be customized to reflect a company’s operations, public companies must adhere to the guidelines set out by the Financial Accounting Standards Board (FASB) and generally accepted accounting principles (GAAP).
Maintaining consistency in your COA from year to year is the most important thing when dealing with charts of accounts. This consistency ensures that accurate comparisons of the company’s finances can be made over time.
There isn’t a single, universally accepted COA format, but one word is key here: Consistency!. Each company is free to use, create, or modify any format that suits its needs. However, the most common format organizes information by individual account and assigns each account a code and description. Consistency in the format over time is vital for ensuring reliable period-to-period and year-to-year comparisons.
Is a Chart of Accounts Required?
While not legally required, a chart of accounts is considered necessary by businesses of all types and sizes. It helps categorize all transactions so that they can be referenced quickly and easily.
A chart of accounts is an essential document that numbers all the financial transactions conducted by a company in an accounting period. The information is usually arranged in categories that match those on the balance sheet and income statement.
The COA serves as an invaluable tool for accessing detailed financial information, benefiting individuals within companies as well as external people, including investors and shareholders. The chart of accounts is not just a regular financial document but rather it is an integral part of strategic financial management and informed decision-making.