Can you imagine the mess your checkbook would be if you didn’t record each check you wrote? You’ve probably forgotten to record a check or two on occasion, but you certainly learned your lesson when you realized that an important payment bounced as a result. Yikes!
Keeping the books of a business can be a lot more difficult than maintaining a personal checkbook. Each business transaction must be carefully recorded to make sure it goes into the right account. This careful bookkeeping gives you an effective tool for figuring out how well the business is doing financially.
As a bookkeeper, you need a road map to help you determine where to record all those transactions. This road map is called the Chart of Accounts. This article tells you how to set up the Chart of Accounts, which includes many accounts. It also reviews the types of transactions you enter into each type of account to track the key parts of any business: assets, liabilities, equity, revenue, and expenses.
What is the Chart of Accounts?
The Chart of Accounts is the road map that a business creates to organize its financial transactions. After all, you can’t record a transaction until you know where to put it! Essentially, this chart is a list of all the accounts a business has, organized in a specific order; each account has a description that includes the type of account and the types of transactions that should be entered into that account. Every business creates its own Chart of Accounts based on how the business is operated, so you’re unlikely to find two businesses with exactly the same Chart of Accounts.
Some basic organizational and structural characteristics are common to all Charts of Accounts, however. The organization and structure are designed around two key financial reports: the balance sheet, which shows what your business owns and what it owes, and the income statement, which shows how much money your business took in from sales and how much money it spent to generate those sales.
The Chart of Accounts starts with the balance-sheet accounts, which include the following:
- Current Assets: Includes all accounts that track things the company owns and expects to use in the next 12 months, such as cash, accounts receivable (money collected from customers), and inventory
- Long-Term Assets: Includes all accounts that track things the company owns that have a life span of more than 12 months, such as buildings, furniture, and equipment
- Current Liabilities: Includes all accounts that track debts the company must pay over the next 12 months, such as accounts payable (bills from vendors, contractors, and consultants), interest payable, and credit cards payable
- Long-Term Liabilities: Includes all accounts that track debts the company must pay over a period of time longer than the next 12 months, such as mortgages payable and bonds payable
- Equity: Includes all accounts that track the owners of the company and their claims against the company’s assets, including any money invested in the company, any money taken out of the company, and any earnings that have been reinvested in the company
The rest of the chart is filled with income-statement accounts, which include
- Revenue: Includes all accounts that track sales of goods and services, as well as revenue generated for the company by other means
- Cost of Goods Sold: Includes all accounts that track the direct costs involved in selling the company’s goods or services
- Expenses: Includes all accounts that track expenses related to running the business that aren’t directly tied to the sale of individual products or services
When developing the Chart of Accounts, you start by listing all the Asset accounts, the Liability accounts, the Equity accounts, the Revenue accounts, and the Expense accounts. All these accounts come from two places: the balance sheet and the income statement.
This article reviews the key account types used in most businesses, but this list isn’t cast in stone. You should develop an account list that makes the most sense for how you operate your business and the financial information you want to track. As you explore the accounts that make up the Chart of Accounts, you’ll see how the structure may differ among businesses.
Remember The Chart of Accounts is a money management tool that helps you track your business transactions, so set it up in a way that provides you the financial information you need to make smart business decisions. You’ll probably tweak the accounts in your chart annually, and if necessary, you may add accounts during the year if you find something for which you want more detailed tracking. You can add accounts during the year, but it’s best not to delete accounts until the end of a 12-month reporting period.
The first part of the Chart of Accounts is made up of balance-sheet accounts, which break down into the following three categories:
- Asset: These accounts are used to track what the business owns. Assets include cash on hand, furniture, buildings, and vehicles.
- Liability: These accounts track what the business owes or, more specifically, claims that lenders have against the business’s assets. Mortgages on buildings and lines of credit are two common types of liabilities.
- Equity: These accounts track what the owners put into the business and the claims owners have against assets. Stockholders, for example, are company owners who have claims against the business’s assets.
The balance-sheet accounts, and the financial report they make up, are so called because they have to balance. The value of the assets must be equal to the claims made against those assets. (These claims are liabilities made by lenders and equity made by owners.)
First on the chart come the accounts that track what the company owns: its current and long-term assets.
Current assets are the key assets that your business uses during a 12-month period and will likely not be there next year. The accounts that reflect current assets on the Chart of Accounts are as follows:
- Cash in Checking: Any company’s primary account is the checking account used for operating activities. This account is used to deposit revenue and pay expenses. Some companies have more than one operating account in this category. A company with many divisions may have an operating account for each division.
- Cash in Savings: This account is used for surplus cash. Any cash for which there is no immediate plan is deposited in an interest-earning savings account so that it can earn interest while the company decides what to do with it.
- Cash on Hand: This account is used to track any cash kept at retail stores or in the office. In retail stores, cash must be kept in registers to provide change to customers. In the office, petty cash is often kept around for immediate cash needs that pop up from time to time. This account helps you keep track of the cash held outside a financial institution.
- Accounts Receivable: If you offer your products or services to customers on store credit (meaning your store credit system), you need this account to track the customers who buy on your dime.
Remember Accounts Receivable isn’t used to track purchases made on other types of credit cards, because your business gets paid directly by banks, not customers, when other credit cards are used.
- Inventory: This account tracks the products on hand to sell to your customers. The value of the assets in this account varies depending on how you decide to track the flow of inventory in and out of the business.
- Prepaid Insurance: This account tracks insurance you pay in advance that’s credited as it’s used each month. If you own a building and prepay one year in advance, each month you reduce the amount that you prepaid by math as the prepayment is used.
Depending on the type of business you’re setting up, you may have other current-asset accounts that you decide to track. If you’re starting a service business in consulting, you’re likely to have a Consulting account for tracking cash collected for those services. If you run a business in which you barter assets (such as trading your services for paper goods), you may add a Barter account for business-to-business barter.
Long-term assets are assets that you anticipate your business will use for more than 12 months. This section lists some of the most common long-term assets, starting with the key accounts related to buildings and factories owned by the company:
- Land: This account tracks the land owned by the company. The value of the land is based on the cost of purchasing it. Land value is tracked separately from the value of any buildings standing on that land because land isn’t depreciated in value, but buildings must be depreciated. Depreciation is an accounting method that shows that an asset is being used.
- Buildings: This account tracks the value of any buildings a business owns. As with land, the value of the building is based on the cost of purchasing it. The key difference between buildings and land is that the building’s value is depreciated, as discussed in the preceding item.
- Accumulated Depreciation – Buildings: This account tracks the cumulative amount by which a building is depreciated over its useful life span.
- Leasehold Improvements: This account tracks the value of improvements to buildings or other facilities that a business leases rather than purchases. Frequently, when a business leases a property, it must pay for any improvements that must be made so that it can use that property as intended. If a business leases a store in a strip mall, for example, it’s likely that the space leased is an empty shell or a space filled with shelving and other items that may not match the particular needs of the business. As with buildings, leasehold improvements are depreciated as the value of the asset ages.
- Accumulated Depreciation – Leasehold Improvements: This account tracks the cumulative amount depreciated for leasehold improvements.
Following are types of accounts for smaller long-term assets, such as vehicles and furniture:
- Vehicles: This account tracks any cars, trucks, or other vehicles owned by the business. The initial value of any vehicle is listed in this account, based on the total cost paid to put the vehicle in service. Sometimes, this value is more than the purchase price if additions were needed to make the vehicle usable for the particular type of business. If a business provides transportation for handicapped people and must add equipment to a vehicle to serve the needs of its customers, that equipment is added to the value of the vehicle. Vehicles also depreciate through their useful life span.
- Accumulated Depreciation – Vehicles: This account tracks the depreciation of all vehicles owned by the company.
- Furniture and Fixtures: This account tracks any furniture or fixtures purchased for use in the business. The account includes the value of all chairs, desks, store fixtures, and shelving needed to operate the business. The value of the furniture and fixtures in this account is based on the cost of purchasing these items. These items are depreciated during their useful life span.
- Accumulated Depreciation – Furniture and Fixtures: This account tracks the accumulated depreciation of all furniture and fixtures.
- Equipment: This account tracks equipment that was purchased for use for more than one year, such as computers, copiers, tools, and cash registers. The value of the equipment is based on the cost of purchasing these items. Equipment is also depreciated to show that over time it’s used and must be replaced.
- Accumulated Depreciation – Equipment: This account tracks the accumulated depreciation of all the equipment.
The following accounts track the long-term assets that you can’t touch but that still represent things of value owned by the company, such as organization costs, patents, and copyrights. These assets are called intangible assets. The accounts that track them include
- Organization Costs: This account tracks initial start-up expenses to get the business off the ground. Many such expenses can’t be written off in the first year. Special licenses and legal fees, for example, must be written off over several years via a method similar to depreciation called amortization, which is also tracked.
- Amortization – Organization Costs: This account tracks the accumulated amortization of organization costs during the period in which they’re being written off.
- Patents: This account tracks the costs associated with patents — grants made by governments that guarantee to the inventor of a product or service the exclusive right to make, use, and sell that product or service over a set period. Like organization costs, patent costs are amortized. The value of this asset is based on the expenses the company incurs to get the right to patent the product.
- Amortization – Patents: This account tracks the accumulated amortization of a business’s patents.
- Copyrights: This account tracks the costs incurred to establish copyrights — the legal rights given to an author, playwright, publisher, or other distributor of a publication or production for a unique work of literature, music, drama, or art. This legal right expires after a set number of years, so its value is amortized as the copyright gets used up.
- Goodwill: This account is needed only if a company buys another company for more than the actual value of its tangible assets. Goodwill reflects the intangible value of this purchase for things such as company reputation, store locations, customer base, and other items that increase the value of the business bought.
If you hold a lot of assets that aren’t of great value, you can set up an Other Assets account to track them. Any asset that you track in the Other Assets account and later want to track individually can be shifted to its own account.
After you cover assets, the next stop on the bookkeeping highway is the accounts that track what your business owes to others. These “others” can include vendors from which you buy products or supplies, financial institutions from which you borrow money, and anyone else who lends money to your business. Like assets, liabilities are lumped into two types: current and long-term.
Current liabilities are debts due in the next 12 months. Some of the most common types of current-liabilities accounts that appear on the Chart of Accounts are
- Accounts Payable: This account tracks money the company owes to vendors, contractors, suppliers, and consultants that must be paid in less than a year. Most of these liabilities must be paid 30 to 90 days from billing.
- Sales Tax Collected: You may not think of sales tax as a liability, but because the business collects the tax from the customer and doesn’t pay it immediately to the government entity, the taxes collected become a liability tracked in this account. A business usually collects sales tax throughout the month and then pays it to the local, state, or federal government on a monthly basis.
- Accrued Payroll Taxes: This account tracks payroll taxes collected from employees to pay state, local, or federal income taxes as well as Social Security and Medicare taxes. Companies don’t have to pay these taxes to the government entities immediately, so depending on the size of the payroll, companies may pay payroll taxes on a monthly or quarterly basis.
- Credit Cards Payable: This account tracks all credit-card accounts to which the business is liable. Most companies use credit cards as short-term debt and pay them off completely at the end of each month, but some smaller companies carry credit-card balances over a longer period of time. Because credit cards often have a much higher interest rate than most other lines of credit, most companies transfer any credit-card debt they can’t pay entirely at the end of a month to a line of credit at a bank. When it comes to your Chart of Accounts, you can set up one Credit Cards Payable account, but you may want to set up a separate account for each card your company holds to improve your tracking of credit-card use.
How you set up your current liabilities and how many individual accounts you establish depends on the detail in which you want to track each type of liability. You can set up separate current liability accounts for major vendors if you find that approach provides you a better money management tool. Suppose that a small hardware retail store buys most of the tools it sells from Snap-on.
To keep better control of its spending with Snap-on, the bookkeeper sets up a specific account called Accounts Payable – Snap-on, which is used only for tracking invoices and payments to that vendor. In this example, all other invoices and payments to other vendors and suppliers are tracked in the general Accounts Payable account.
Long-term liabilities are debts due in more than 12 months. The number of long-term liability accounts you maintain in your Chart of Accounts depends on your debt structure. The two most common types are
- Loans Payable: This account tracks any long-term loans, such as a mortgage on your business building. Most businesses have separate Loans Payable accounts for each of their long-term loans. You could have Loans Payable – Mortgage Bank for your building and Loans Payable – Car Bank for your vehicle loan, for example.
- Notes Payable: Some businesses borrow money from other businesses by using notes, a method of borrowing that doesn’t require the company to put up an asset (such as a mortgage on a building or a car loan) as collateral. This account tracks any notes due.
In addition to any separate long-term debt you may want to track in its own account, you may want to set up an account called Other Liabilities that you can use to track types of debt that are so insignificant to the business that you don’t think they need their own accounts.
Every business is owned by somebody. Equity accounts track owners’ contributions to the business as well as their share of ownership. For a corporation, ownership is tracked by sale of individual shares of stock because each stockholder owns a portion of the business. In smaller companies that are owned by one person or a group of people, equity is tracked via Capital and Drawing accounts. Here are the basic Equity accounts that appear in the Chart of Accounts:
- Common Stock: This account reflects the value of outstanding shares of stock sold to investors. A company calculates this value by multiplying the number of shares issued by the value of each share of stock. Only corporations need to establish this account.
- Retained Earnings: This account tracks the profits or losses accumulated since a business was opened. At the end of each year, the profit or loss calculated on the income statement is used to adjust the value of this account. If a company made a $100,000 profit in the past year, the Retained Earnings account would be increased by that amount; if the company lost $100,000, that amount would be subtracted from this account.
- Capital: This account is necessary only for small, unincorporated businesses. The Capital account reflects the amount of initial money the business owner contributed to the company as well as owner contributions made after start-up. The value of this account is based on cash contributions and other assets contributed by the business owner, such as equipment, vehicles, and buildings. If a small company has several partners, each partner gets his or her own Capital account to track his or her contributions.
- Drawing: This account is necessary only for businesses that aren’t incorporated. It tracks any money that a business owner takes out of the business. If the business has several partners, each partner gets his or her own Drawing account to track what he or she takes out of the business.
The income statement is made up of two types of accounts:
- Revenue: These accounts track all money coming into the business, including sales, interest earned on savings, and any other methods used to generate income.
- Expenses: These accounts track all money that a business spends to keep itself afloat.
The bottom line of the income statement shows whether your business made a profit or a loss for a specified period of time. This section examines the various accounts that make up the income-statement portion of the Chart of Accounts.
Record the money you make
First up in the income-statement portion of the Chart of Accounts are accounts that track revenue coming into the business. If you choose to offer discounts or accept returns, that activity also falls within the revenue group. The most common income accounts are
- Sales of Goods or Services: This account, which appears at the top of every income statement, tracks all the money that the company earns by selling its products, services, or both.
- Sales Discounts: Because most businesses offer discounts to encourage sales, this account tracks any reductions to the full price of merchandise.
- Sales Returns: This account tracks transactions related to returns, when a customer returns a product because he or she is unhappy with it for some reason.
When you examine an income statement from a company other than the one you own or are working for, you usually see the following accounts summarized as one line item called Revenue or Net Revenue. Because not all income is generated by sales of products or services, other income accounts that may appear on a Chart of Accounts include
- Other Income: If a company takes in income from a source other than its primary business activity, that income is recorded in this account. A company that encourages recycling and earns income from the items recycled records that income in this account.
- Interest Income: This account tracks any income earned by collecting interest on a company’s savings accounts. If the company loans money to employees or to another company and earns interest on that money, that interest is recorded in this account as well.
- Sale of Fixed Assets: Any time a company sells a fixed asset, such as a car or furniture, any revenue from the sale is recorded in this account. A company should record revenue remaining only after subtracting accumulated depreciation from the original cost of the asset.
Track the cost of sales
Before you can sell a product, you must spend some money to buy or make that product. The type of account used to track the money spent is called a Cost of Goods Sold account. The most common are
- Purchases: This account tracks the purchases of all items you plan to sell.
- Purchase Discount: This account tracks the discounts you may receive from vendors if you pay for your purchase quickly. A company may give you a 2 percent discount on your purchase if you pay the bill in 10 days rather than wait until the end of the 30-day payment allotment, for example.
- Purchase Returns: If you’re unhappy with a product you’ve bought, record the value of any returns in this account.
- Freight Charges: This account tracks charges related to shipping items you purchase for later sale. You may want to keep track of this detail.
- Other Sales Costs: This account is for anything that doesn’t fit into one of the other Cost of Goods Sold accounts.
Acknowledge the money you spend
Expense accounts take the cake for the longest list of individual accounts. Any money you spend on the business that can’t be tied directly to the sale of an individual product falls under the expense account category. Advertising a storewide sale isn’t directly tied to the sale of any one product, for example, so the costs associated with advertising fall into this category.
Remember The Chart of Accounts mirrors your business operations, so it’s up to you to decide how much detail you want to keep in your expense accounts. Most businesses have expenses that are unique to their operations, so your list probably will be longer than the one presented here. You also may find that you don’t need some of these accounts.
On your Chart of Accounts, the expense accounts don’t have to appear in any specific order, so they’re listed here alphabetically. Here are the most common expense accounts:
- Advertising: This account tracks expenses involved in promoting a business or its products. Money spent on newspaper, television, magazine, and radio advertising is recorded here, as well as any money spent to print flyers and mailings to customers. For community events such as cancer walks or crafts fairs, associated costs are tracked in this account as well.
- Bank Service Charges: This account tracks any charges made by a bank to service a company’s bank accounts.
- Dues and Subscriptions: This account tracks expenses related to business club membership or subscriptions to magazines.
- Equipment Rental: This account tracks expenses related to renting equipment for a short-term project. A business that needs to rent a truck to pick up some new fixtures for its store records that truck rental in this account.
- Insurance: This account tracks any money paid to buy insurance. Many businesses break this account into several accounts, such as Insurance – Employees Group (any expenses paid for employee insurance) or Insurance – Officers’ Life (money spent to buy insurance to protect the life of a key owner or officer of the company). Companies often insure their key owners and executives because an unexpected death, especially for a small company, may mean facing many unexpected expenses to keep the company’s doors open. In such a case, you can use insurance proceeds to cover those expenses.
- Legal and Accounting: This account tracks any money that’s paid for legal or accounting advice.
- Miscellaneous Expenses: This account is for expenses that don’t fit into one of a company’s established accounts. If certain miscellaneous expenses occur frequently, a company may choose to add an account to the Chart of Accounts and move related expenses into that new account by subtracting all related transactions from the Miscellaneous Expenses account and adding them to the new account. With this shuffle, it’s important to carefully balance the adjusting transaction to avoid errors or double-counting.
- Office Expense: This account tracks any items purchased to run an office. Office supplies such as paper, pens, and business cards fit in this account. As with Miscellaneous Expenses, a company may choose to track some Office Expense items in their own accounts. If you find that your office is using a lot of copy paper and you want to track that cost separately, you set up a Copy Paper expense account. Just be sure that you really need the detail, because the number of accounts can get unwieldy.
- Payroll Taxes: This account tracks any taxes paid related to employee payroll, such as the employer’s share of Social Security and Medicare, unemployment compensation, and workers’ compensation.
- Postage: This account tracks money spent on stamps and shipping. If a company does a large amount of shipping through vendors such as UPS or Federal Express, it may want to track that spending in separate accounts for each vendor. This option is particularly helpful for small companies that sell over the Internet or through catalogs.
- Rent Expense: This account tracks rental costs for a business’s office or retail space.
- Salaries and Wages: This account tracks any money paid to employees as salary or wages.
- Supplies: This account tracks any business supplies that don’t fit into the category of office supplies. Supplies needed for the operation of retail stores, for example, are tracked in this account.
- Travel and Entertainment: This account tracks money spent for business purposes on travel or entertainment. Some businesses separate these expenses into several accounts, such as Travel and Entertainment – Meals, Travel and Entertainment – Travel, and Travel and Entertainment – Entertainment.
- Telephone: This account tracks all business expenses related to telephones and telephone calls.
- Utilities: This account tracks money paid for utilities (such as electricity, gas, and water).
- Vehicles: This account tracks expenses related to the operation of company vehicles.
Set Up Your Chart of Accounts
You can use the lists of accounts provided in this article to start setting up your business’s own Chart of Accounts. There’s really no secret; just make a list of the accounts that apply to your business.
Remember Don’t panic if you can’t think of every type of account you may need for your business. It’s very easy to add to the Chart of Accounts at any time. Just add the account to the list and distribute the revised list to any employees who use it. (Even employees who aren’t involved in bookkeeping need a copy of your Chart of Accounts if they code invoices or other transactions and need to indicate the accounts in which those transactions should be recorded.)
The Chart of Accounts usually includes at least three columns:
- Account: Account names
- Type: Type of account (Asset, Liability, Equity, Income, Cost of Goods Sold, or Expense)
- Description: Description of the type of transaction that should be recorded in the account
Many companies also assign numbers to the accounts to be used for coding charges. If your company is using a computerized system, the computer automatically assigns the account number. Otherwise, you need to plan your numbering system. The most common number system is as follows:
- Asset accounts: 1,000 to 1,999
- Liability accounts: 2,000 to 2,999
- Equity accounts: 3,000 to 3,999
- Sales and Cost of Goods Sold accounts: 4,000 to 4,999
- Expense accounts: 5,000 to 6,999
This numbering system matches the one used by computerized accounting systems, making it easy at some future time to automate the books by using a computerized accounting system. When you get your computerized system, whichever accounting software you use, all you need to do is review the chart options for the type of business you run, delete any accounts you don’t want, and add any new accounts that fit your business plan.
If you’re setting up your Chart of Accounts manually, be sure to leave a lot of room between accounts to add new accounts. You might number your Cash in Checking account 1,000 and your Accounts Receivable account 1,100, which leaves you plenty of room to add other accounts to track cash.