The basic definition of a Chart of Accounts in common accounting terms is a listing of all accounts of a business that have had or currently have active transactions. However, you shouldn’t confuse it with the General Ledger. It is important to know the difference between the Chart of Accounts and General Ledger due to the need for accuracy in posting business transactions.
What Is a Chart of Accounts?
The chart of accounts in bookkeeping and accounting software applications corresponds with specific classifications such as assets, liabilities, capital expenses, revenue and expenses.
Each of these major classifications also has sub-classifications. For example, the “assets” classification can include cash, fixed assets and current assets. Sub-classifications for liabilities may include current liabilities and long-term liabilities. There are two other classifications that also appear: Balance Sheet Accounts and Income Statement Accounts.
How to Create a Chart of Accounts?
With today’s accounting software applications, each of these classifications is numbered for ease of use and to reduce errors. Thus, a business Chart of Accounts may appear thusly:
Balance Sheet Accounts
1.2 Accounts Receivable
1.5 Prepaid Rent
1.8 Equipment required in the performance of the business
1.9 Accumulated Depreciation
2.1 Accounts Payable
2.2 Salaries Payable
3.1 John Doe, Capital
3.2 John Doe, Drawing
3.3 Income Summary
4. Income Statement Accounts
5.1 Supplies expense
5.2 Payroll expense
5.3 Rent Expense
5.4 Depreciation Expense
5.5 Miscellaneous Expense
Note that each main classification and each sub-classification are noted by numbers. This varies with the type of business transactions that take place on a daily basis and/or as a result of the type of business, i.e., service or product.
Explaining the Chart of Accounts
The most active sub-classifications in a Chart of Accounts are usually General Ledger, Accounts Payable, Accounts Receivable, Order Entry, Sales, Purchasing, Bank Deposits, Payroll, and if applicable, Inventory Control.
The simplest way to understand the Chart is to view it as a full listing of clients, vendors and suppliers, sales, invoicing to your clients or posting of invoices billed to your business by your vendors.
Fortunately, today’s bookkeepers, accountants and business owners can purchase user friendly accounting software that makes the job of daily posting of business transactions timely and effective. However, all accounting software begins with creating the Chart of Accounts first. For existing businesses, this is a simple matter of transferring prior accounts to the new chart. New businesses generally need to create a full draft of the types of accounts and business transactions that will be a major part of their business operations.
The Flow of Accounting Data
Once the chart is set up, a business can make timely use of the flow of accounting data from the moment a sale is finalized to the bank deposit of revenue from sales. It is important that this data gets an update as business transactions change or clients and vendors/suppliers data changes.
In certain businesses, clients may transact variable types of business, such as purchasing products and services. Make sure you do these carefully in order to avoid posting to the wrong client account. The method for defining multiple accounts for the same client differs in each accounting software application.
Business Transactions – The Lifeblood of Every Business
Once the structure of the chart is clear, the work of posting to other applicable modules will be automatic.
In this example, your sales staff finalizes a sale. If this data is sent from their mobile devices to your business accounting system, sales orders are automatically sent to the Order Entry module.
If formal sales order forms are applicable, data must be manually input to the Order Entry Module. Depending on the software in use, this information may create a new listing in the Chart for a new client or it may immediately transfer to as invoicing to Accounts Receivable. Each time your business transactions are recorded, the data is automatically changed in the General Ledger and in other modules, depending on how the Chart was set up originally.
How a Good Chart of Accounts Can Help Your Business
All of today’s bookkeeping and accounting software provides instant access to various types of reports that help business owners know the status of their profit and loss, as well as increases in the number of new clients and changes to the status of existing clients.
By activating a report from the Chart, a business owner can determine the number of new clients over a specific time period. The Chart also allows you to view the types of business transactions that have taken place within that time period.
Viewing the type of business transactions helps your business by showing which products and services are most in demand, the amount of incoming revenue linked to these products and services and also the cost to your business in terms of supplies, travel and other related expenses.
Keep Your Business on Track
Business owners know mistakes are costly. If your Chart is set up with implicit accuracy, your business is less likely to experience costly errors. Much depends on the size of the business and also the volume of business transactions.
In large companies, the job of managing the Chart may be relegated to the “Cost Accounting” department, due to unusually high volume business transactions. In this case, the Cost Accounting department monitors Chart reports and offers determinations on business direction.
Cost accountants are also of utmost importance to make sure all tax exempt and non exempt transactions are in compliance with regard to sales, purchases and payroll expenses. They ensure that tax impounds are accurately assessed and submitted to tax reporting agencies.
For small to medium business owners the Chart provides information in detail on tax exempt and non exempt business transactions. For example, some businesses purchase equipment for their customers. In this case, the Chart will show the specific amount the customer will pay and also cumulative taxation data.
Summing Things Up – Help Your Business Grow
A comprehensive listing of customers, vendors, suppliers, expenses, taxes and business transactions ensures your business operations remain organized and your profits and losses are readily available for viewing in the Chart of Accounts.
Images taken from depositphotos.com.