The chart of accounts is really the starting point for your bookkeeping and accounting. It is a listing of all the accounts that will be used to record business transactions and accounting entries. Each transaction that is recorded, and each accounting entry that is made will be posted to an account that has been set up in the chart of accounts, which then forms the outline from which financial statements and reports will be generated.

General Considerations

The following are some considerations to keep in mind when using a particular chart of accounts, adapting one, or building one from scratch:

• What financial information do you need to manage your business?
• What financial reporting will you be doing, and to whom?
• What information will you need to prepare your tax returns?
• Is your business subject to any special regulatory reporting requirements?

Level of Detail

Another consideration is the level of detail that should be contained in the chart of accounts. A very general chart of accounts, with only broad categories of accounts, may facilitate bookkeeping but may not provide you with much in terms of analysis capability. And, on the other hand, a very complex chart of accounts may make bookkeeping cumbersome and difficult. In general, the chart of accounts should be broken down into the level of detail you are capable of, and interested in managing, provided it meets the necessary requirements in terms of financial, tax, and regulatory reporting.

Coding

Generally, in accounting or bookkeeping software, codes are assigned to identify the various accounts. The numbering scheme may be pre-established or you may need to set it up yourself. Number ranges can be used to define major account categories and sub-categories, with individual numbers assigned to each account within a given range. Here it is important to have a logical numbering sequence that is sufficiently broad, and flexible enough to allow you to add accounts as necessary, to meet the ongoing needs of your business as it evolves and grows.

Chart of Accounts and the Trial Balance

The chart of accounts is the basis upon which a trial balance is generated. A trial balance is a listing of all accounts, with their respective opening balances, debits and credits for the period, and ending balances. The trial balance, in turn, is the basis for producing the financial statements – the balance sheet and income statement. The chart of accounts generally follows the sequence of accounts as they would be presented in the balance sheet, followed by the accounts to be presented in the income statement. Therefore, the order of accounts is generally as follows:

• Assets
• Liabilities
• Equity
• Income
• Expenses

Assets

Assets are generally classified in broad categories as:

• Current assets
• Property, plant and equipment
• Other assets

The order in which accounts are generally presented on the balance sheet may vary in different countries. In Europe, for instance, it is more common to start with fixed assets, while in the Americas the balance sheet starts with the most liquid assets.

Current Assets

Current assets can be broken down into cash and cash equivalents, accounts receivable, inventory, prepaid expenses, and deferred charges. The cash section would include accounts such as cash on hand, petty cash, bank accounts, time deposits, certificates of deposit, temporary cash investments, marketable securities, negotiable instruments or other similar accounts. You may want to have separate accounts set up for each bank account, if you have more than one, to facilitate reconciliation and control.

The accounts receivable section will include an account for trade receivables, or accounts receivable from customers and clients. This account is normally supported by a subledger, with a separate account for each customer or client. An account entitled “allowance for doubtful accounts” or “allowance for bad debts” is used to record accounts that may not be collected. This account normally has a credit balance, with the offsetting charge to a corresponding account in the expense section.

Receivables that are formally documented are normally recorded as notes receivable. If your business is one of a group of affiliated companies, is a subsidiary of a parent company, or has ownership interests in other companies, the receivable section could include accounts receivable from related companies, intercompany receivables, due from affiliates, or similar accounts. These could be accounts receivable or notes receivable, or both.

Other accounts that could be set up in the receivables section include expense advances, due from employees, employee loans, due from officers, recoverable taxes, and other or miscellaneous receivables.

The accounts set up in the inventory section depend on the line of business. Some general examples include raw materials, supplies, work-in-process, and finished products or finished goods. An inventory subledger may be maintained to keep track of each individual product.

Prepaid expenses could be recorded in a single account, or separate accounts could be set up for different types of prepaid expenses, such as prepaid insurance, prepaid rent, prepaid interest, prepaid contracts, or contractor advances. There should be an account for estimated advance income tax payments, for U.S. federal income tax, and state and local income tax payments, if applicable.

Deferred charges could also be recorded in one account, or in separate accounts for deferred expenses, deferred taxes, deferred customs duties, and others, as necessary.

Property, Plant and Equipment

If your business has few fixed assets, it may be sufficient to record then in one general ledger account, with a subledger or other support specifically identifying each asset. On the other hand, if your business is capital intensive, you may prefer to set up different general ledger accounts for different classes of assets, such as land, buildings and installations, construction and infrastructure, construction in progress, machinery and equipment, furniture and fixtures, vehicles, leaseholds and leasehold improvements, and other fixed assets.

Accumulated depreciation accounts should generally be set up to mirror the way the corresponding assets are recorded.

Other Assets

The other assets section includes long-term accounts and notes receivables, from employees, owners and officers, related companies, or others. This section could also include security deposits and other guarantees. Other assets also include long-term investments, including investments in related or affiliated companies.

Another category of accounts that fall under other assets would be intangibles, such as organization costs or start-up costs that you choose to defer and amortize over a period of time. Other deferred charges accounts may also be needed for amounts that are paid and will contribute to the generation of income over a period longer than one year. Goodwill is another account in this section, and normally corresponds to acquisitions in which the amount paid exceeds the book value of the assets or investment acquired. Related accounts for amortization of intangible assets also appear in this section.

Liabilities

Liability accounts are separated into short-term liabilities, for obligations due within the current operating period, which is normally considered to be one year, and long-term liabilities, for obligations with due dates beyond one year.

Current Liabilities

Current liability accounts include bank loans. These accounts may have different titles such as short-term bank debt, notes payable to banks –short-term, or amounts due to banks and financial institutions. There may be one or more accounts set up for current installments of obligations under capital leases.

A principal account in the current liabilities section is trade accounts payable, which may also be called commercial accounts payable, vendors payable, or payable to suppliers. Like its counterpart, trade accounts receivable in the current assets section, there is normally a subledger for trade accounts payable, to keep track of individual vendor accounts.

Other short-term liability accounts include notes payable (other than bank notes), dividends payable (in the case of a corporation), income taxes payable, and other accounts payable, or miscellaneous payables.

If there are affiliated companies involved, there could be liability accounts with titles such as accounts payable to related companies, intercompany accounts and notes payable, current payables – affiliates, or current payables – intercompany.

Accruals constitute another class of accounts in the current liabilities section. Accruals are used to record expenses incurred, that apply to the current period, but that have not yet been billed. There could be one account called accruals, or accrued expenses, or separate accounts could be set up for accrued utilities, accrued vacations, accrued taxes, and others.

If you have employees and a payroll, you will need employee withholding accounts to record the amounts withheld from employees’ paychecks and pending payment to the appropriate institution. Withholding accounts may be set up for taxes, including U.S. federal income tax, state income tax, local income tax, Social Security or FICA tax; court-ordered withholdings, for child support, for example; and for benefit plans, including pension plans and health care plans. If your business offers a plan for elective salary deferrals, there should be a withholding account set up for the portion of pay that employees elect to defer.

As an employer, there will also be liability accounts for the employer payroll taxes, including FICA, federal and state unemployment, and for workers’ compensation insurance. If your business has a matching contribution pension plan or another type of employee benefit plan, there should be an account set up to record your liability as the employer to contribute to these plans.

Other taxes payable accounts that may need to be set up include sales tax payable, real estate and property taxes, and income taxes, including federal, state and local. Although not used in the United States, value added tax (VAT) payable is a common account in many countries. These payable accounts are used to record tax liabilities for which the amount has been determined (a return has been prepared, for example) and are pending payment.

Accrued tax accounts are used to record taxes that apply to the period, calculated based on earnings or another basis, but for which a return has not yet been filed, and the definitive amount due has not yet been determined. For example, U.S. income tax may be accrued each month, although the final liability will not be definitively known until the return is filed at year-end.

Another class of liability accounts includes income received in advance, or unearned income, such as advance payments on contracts which have not been completed. Another type of liability account in this section could be deposits that you are holding, and will eventually have to return.

Long-term Liabilities

Long-term liability accounts reflect the corresponding accounts in the current liabilities sections. These include the long-term portion of amounts payable to banks and other creditors. There may be a long-term liability account for obligations under capital leases. Long-term liabilities may also include notes payable, commercial paper, and bonds payable. And, there could be intercompany accounts and notes payable.

Equity

The accounts set up in this section will depend on the legal structure of your business. In a sole proprietorship, there will be an owner’s capital account, to show the amount invested in the business. An owner’s withdrawal account should also be set up to record amounts withdrawn from the business. In a partnership, there are partners’ capital accounts and partners’ withdrawal accounts. If separate accounts for each partner are not set up on the chart of accounts, there should be a supporting record of each partner’s individual account.

In a corporation, there should be a capital stock account, which may be broken down into common stock and preferred stock, if applicable. If the stock has a par or stated value and is sold at more than this amount, the excess would be recorded in an additional paid-in capital, or share premium account. Any stock that the corporation buys back is recorded in a treasury stock account. There may also be accounts set up for legally-required, or other types of reserves.

In addition to capital contributions or paid-in capital, the equity section also has accounts to record the net income or loss for the period, and accumulated earnings (or losses). In a sole proprietorship or partnership, the title accumulated earnings is probably more common. A partnership should have accounts, or supporting records showing each partner’s share of the earnings. In a corporation, the title retained earnings is generally used. A corporation may also have accounts set up for interim dividends and dividends reserve.

Income and Expense Accounts

The chart of accounts generally lists income and expense accounts starting with revenue accounts, with accounts for operating revenue and non-operating revenue; then cost of sales accounts, followed by operating expenses, and finally, non-operating expenses. These are the accounts from which the income statement will be generated, and will be the accounts needed to prepare tax returns.

Revenue

The revenue, or income accounts that are set up on the chart of accounts will depend on the nature of your business. Sales is a general account, and you may want to break it down into separate sales accounts by product, market, type of job or work, or any criteria that is meaningful to you. What is important is to record sales in the way you want to analyze and report them. Offsetting accounts, which would generally carry a debit balance include sales returns and allowances, and sales discounts.

Some other commonly used operating revenue accounts include rentals, services, commissions, fees, and royalties.

Non-operating revenue accounts include all types of income that you receive that are not part of your main line of business. These include interest income, dividends, and gains or losses on investments (unless you are in the financial business, in which case these would be operating revenue accounts), equity in income or loss of affiliates, if applicable, gain or loss on the sale of assets, scrap sales, translation gains or losses, and miscellaneous or other income, for any income that doesn’t fit into another account.

Cost of Sales or Cost of Goods Sold

Some of the accounts that make up cost of sales are purchases, purchase returns and allowances, trade discounts, freight, and transportation charges. In a production environment, manufacturing cost may be broken down into raw materials, direct labor, indirect labor, small tool replacement, spoilage, shrinkage, production supplies, maintenance supplies, repairs, utilities, property taxes, research and development, depreciation and amortization. If a standard cost accounting system is used, there will be standard and variance accounts set up in this section of the chart of accounts.

Expenses

Some of the general categories of operating expenses on a chart of accounts include:

• Selling expenses
• Personnel-related expenses
• Materials
• Repairs and maintenance
• Rents
• Insurance
• Marketing, advertising, and promotion
• Professional fees
• Property operating expenses
• Utilities
• Depreciation and amortization

The accounts your business will need for selling expenses will probably depend on how the majority of your sales are handled – whether they are cash sales, credit card sales, open credit sales, for instance. Some possible accounts include doubtful accounts or bad debt expense, credit card charges, commissions, and cash overage and shortage.

Personnel-related expenses would include salaries and wages, or employee compensation, which can be broken down into regular pay, overtime pay, vacation pay, severance pay, incentive pay, holiday pay, sick pay, commissions, bonuses, and profit sharing. Employee benefit accounts include workers’ compensation, supplemental health insurance, life insurance, disability insurance, pension plan contributions, and employee meals. Expense accounts are also needed for the employer’s payroll taxes, including FICA, and federal and state unemployment tax. Other personnel-related expenses include dues and subscriptions, employee housing, employee relations, recruitment, relocation, training, and travel and entertainment.

Expense accounts for materials (aside from the materials accounts that are set up in the cost of goods sold section) could include spare parts, production supplies, operating supplies, maintenance supplies, cleaning supplies, and office supplies.

Separate repairs and maintenance accounts could be set up for labor and materials, for example, or repairs and maintenance accounts could be set up by class of equipment, in a capital-intensive business. Rent expenses could be separated into land, buildings, equipment, and vehicles.

Some examples of insurance expense accounts including buildings and contents, business interruption, earthquake, flood, fire and theft, fraud, life, lost or damaged goods, products liability, professional liability, and public, or third-party liability.

Marketing, advertising and promotion expenses include commissions, travel, point-of-sale materials, print materials, radio and television advertisements, and franchise fees.

Professional fees include legal, auditing, accounting, tax consulting, and other consulting.

A breakdown of separate property operating expenses could be beneficial in a business with significant infrastructure. Some accounts include building supplies, electrical and mechanical equipment, elevators, engineering supplies, grounds and landscaping, painting and decorating, and waste removal.

Utilities include electricity, fuel, water, and telephone.

Expense accounts for depreciation and amortization should be broken down the same way as the accumulated depreciation and amortization accounts in the assets section.

Non-operating Expenses

This section of expenses on the chart of accounts will probably include interest and financing charges, taxes, and other accounts as needed.

Interest accounts may be set up according to the type of debt, such as mortgage interest, interest on bank notes or loans, interest on capital leases, and amortization of deferred financing costs.

Taxes will include real estate and personal property taxes, excise taxes, and federal, state, and local income taxes. Sales taxes paid are normally included in the expense account to which they relate (materials and supplies, for instance).

Other non-operating expense accounts that could be used include licenses, contributions and donations, losses and damages, inventory obsolescence charge, and gain or loss on currency exchange.