Introduction
Introduction
The Neglected Red-Headed Step-Child !!!!!
Why Would I Say This ?
In my opinion, this topic like the red-headed step-child, is not given the attention and respect it deserves. Many of the textbooks and courses that I've looked at "gloss" over the chart of accounts by giving a definition and throwing in a simple example. This tutorial is my attempt to give this topic the respect that it is due. Of course we're going to define and use examples. Unlike the others though, like learning about a clock, we're not only going to learn to tell time, but also what makes the clock tick.
I, myself was almost guilty of neglecting this topic. I caught myself and decided I needed to treat this topic with the respect that it deserves and made this tutorial.
What Is The Chart Of Accounts ?
The Chart Of Accounts is a listing of all the individual accounts in the general ledger that contains the account's name, a brief description of the account, and optional other identifiers (codes) or a coded account number assigned to aid in recording, classifying, summarizing, and reporting transactions.
Your accounting system is built around this skeleton list of account names called the chart of accounts and is organized by the types of major accounts. The accounts you set up are tailored for your particular type of business.
What's an Account ?
An Account is a separate record for each type of asset, liability, equity, revenue, and expense used to show the beginning balance and to record the increases and decreases using debits and credits for a period of time and the resulting ending balance at the end of the period. All the Individual Accounts make up or become a part of the Chart Of Accounts.
What are the Major Type of Accounts, how are they normally organized, and what are some examples ?
If you don't already know, the major types of accounts are:
- Assets
Formal Definition: The properties used in the operation or investment activities of a business.
Informal Definition: All the good stuff a business has (anything with value). The goodies.
Includes: Cash, Receivables, Investments, Buildings, Land, Equipment, Vehicles, etc.
- Liabilities
Formal Definition: Claims by creditors to the property (assets) of a business until they are paid.
Informal Definition: Other's claims to the business's stuff. Amounts the business owes to others.
Includes: Payables, Notes, Loans, Mortgages, etc.
- Equity
Formal Definition: The owner's rights or claims to the property (assets) of the business.
Informal Definition: What the business owes the owner(s). The good stuff left for the owner(s) assuming all liabilities (amounts owed) have been paid.
Includes: Owner's Capital Invested and the Accumulated Profits or Losses for the business since it began.
- Revenue
Formal Definition: The gross increase in owner's equity resulting from the operations and other activities of the business.
Informal Definition: Amounts a business earns by selling services and products and investing. Amounts billed to customers for services and/or products.
Includes:
Sales of Goods and Services - revenue directly related to daily operations.
Other Income - revenue not directly related to daily operations such as Interest and Dividends.
- Expenses
Formal Definition: Decrease in owner's equity resulting from the cost of goods, fixed assets, and services and supplies consumed in the operations of a business.
Informal Definition: The costs of doing business. The stuff we used and had to pay for or charge to run our business.
Includes:
Cost of Goods Sold - the cost of the products being sold by the business.
Operating Expenses - the expenses related to daily operations such as rent, advertising, insurance, etc.
Other Expenses - the expenses not directly related to daily operations such as Interest and Financing.
The chart of accounts is typically organized and listed in a special order. Balance Sheet Accounts are listed first followed by the Income Statement Accounts.
Note: This USA Order may vary depending on your country.
Balance Sheet Accounts
- Assets
- Liabilities
- Owner's (Stockholders') Equity
Normally, the order of the listing of the asset and liability accounts is based on liquidity. The most liquid accounts are listed first. Thus, when listing assets, cash is listed before accounts receivable which comes before inventory. Likewise for liabilities, accounts payable comes before notes payable because accounts payable are normally paid before notes payable.
Income Statement Accounts
Revenue and Expenses
- Revenue
- Operating Revenues
- Non-operating Revenues and Gains
- Expenses
- Cost Of Sales
- Operating Expenses
- Non-operating Expenses and Losses
Revenue and expense accounts tend to follow the standard of first listing the items most closely or directly related to the operations of the business. The revenues (sales) resulting from normal operations are listed before revenue or income resulting from non-operating sources. Likewise, the operating costs and expenses that are most closely related to the operations of the business are listed before the non-operating expenses. Cost of Sales is listed first followed by operating expenses and then the non-operating expenses. The operating expenses are often grouped into additional categories such as Selling Expenses and General and Administrative Expenses. There are no rigid rules as to the order that the operating expenses are listed within a category.
What Are Sub-Accounts ?
Sub-accounts are used to divide or break a main account into further "mini" accounts to identify, report on, and manage specific divisions of an account. The main account is also referred to as the parent or summary account and the subdivided accounts are called the children. The balance of the main account (parent / summary) is derived from the sum of the balances of all the sub-accounts (children). For example, if you wanted to manage the various components of Motor Vehicle expenses, you could create Sub-Accounts for the Motor Vehicle expenses. An example would be as follows:
Sub-accounts are used to divide or break a main account into further "mini" accounts to identify, report on, and manage specific divisions of an account. The main account is also referred to as the parent or summary account and the subdivided accounts are called the children. The balance of the main account (parent / summary) is derived from the sum of the balances of all the sub-accounts (children). For example, if you wanted to manage the various components of Motor Vehicle expenses, you could create Sub-Accounts for the Motor Vehicle expenses. An example would be as follows:
Motor Vehicle Expenses (Main - Parent - Summary Account) 210-000
Sub-Accounts (Children Accounts) of Motor Vehicle Expense:
Fuel and Oil 210-010
Repairs 210-020License Fees 210-030
What's the General Ledger ?
The General Ledger is just a book (manual system) or computer file (computer system) containing all the account balances and activity (increases and decreases) for all of a business's assets, liabilities, equity, revenue, and expense accounts that are included in the business's chart of accounts. The General Ledger has an account for each account that is listed in the chart of accounts.
Sample General Ledger Account
| Account Name: | Account Number: | ||||
| Date | Description | Post Ref. | Debit | Credit | Balance |
What's the purpose of a Chart Of Accounts ?
It's purpose is to establish a framework for classifying, recording, and reporting on your business transactions and to use as an aid (reference) for looking up accounts and their associated account numbers when recording transactions. In a nutshell, the Chart Of Accounts is simply an organized and coded listing of all the individual accounts used to record your business transactions and that also makeup the General Ledger.
It's purpose is to establish a framework for classifying, recording, and reporting on your business transactions and to use as an aid (reference) for looking up accounts and their associated account numbers when recording transactions. In a nutshell, the Chart Of Accounts is simply an organized and coded listing of all the individual accounts used to record your business transactions and that also makeup the General Ledger.
What do we mean by Coded ?
First let's define what a code is. A code is numbers, letters, or a combination of letters and numbers (alphanumeric) that is used to represent, identify, and organize something. Often, you will see the something referred to as an object. A simple example is an abbreviation for the states that comprise the good ole USA. My state's code is TN which stands for Tennessee. Other examples of common codes that you encounter are area codes used with our telephone system and zip codes used with our postal system or similar codes for your country. The code itself, the numbers, letters, or combination of letters and numbers is usually meaningless. The code gets its meaning when it is assigned or related to something (object) such as a document (invoice number), employee, product, account, etc.
First let's define what a code is. A code is numbers, letters, or a combination of letters and numbers (alphanumeric) that is used to represent, identify, and organize something. Often, you will see the something referred to as an object. A simple example is an abbreviation for the states that comprise the good ole USA. My state's code is TN which stands for Tennessee. Other examples of common codes that you encounter are area codes used with our telephone system and zip codes used with our postal system or similar codes for your country. The code itself, the numbers, letters, or combination of letters and numbers is usually meaningless. The code gets its meaning when it is assigned or related to something (object) such as a document (invoice number), employee, product, account, etc.
In accounting, one of the main uses of codes is to identify accounts. Account Codes can be numeric (numbers), alpha (letters of the alphabet) , or alphanumeric (combination of numbers and letters). Setting up and assigning your codes to the accounts, whether for a manual or computerized system, is the most critical and often the most time consuming and confusing step in establishing and setting up your chart of accounts.
Good codes display the following characteristics:
- Uniformity
Uniformity means always using the code in the same way every time you use it. Dates are often represented differently by different countries. If dates were to be used as a code in the USA, they should always be formatted the same way such as xx/xx/xxxx ( month, day, and year) or the commonly used format for your country. - Uniqueness
Each code and/or code segment should uniquely identify only one thing. If you were going to use an employee's initials as a code to identify your employees you would probably eventually have a problem if you had any employees with the same initials. On the other hand, if you used their social security number you wouldn't encounter any problems because everyone has a unique social security number. - Expandable or Adaptable To Change
Things change and your coding system should be designed to be able to easily expand and change to handle adding new codes (accounts, departments, products, employees, etc.) and reporting requirements as your business grows without having to completely revise your coding system. Applying this characteristic to a chart of accounts would require your account coding system to have flexible user defined accounts that allows unlimited addition of new accounts.
What's Next ?