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 started to make this topic a "Quick
Insight" and treat it as a red-headed step child, but caught myself
and decided I needed to treat this topic with the respect that it
deserves and made it into a full fledged tutorial.
A menu of all the lessons is presented at the top and bottom of all
the lessons. A back and next arrow also allow you to go back to the
prior lesson or on to the next lesson.
This Introduction defines,
explains, and discusses what the chart of accounts is, how it's
organized by major account types and balance sheet and income
statement accounts and its purpose. In addition, codes are
introduced and defined.
Lesson 1 - How Codes Are Used
in Conjunction with Building The Chart Of Accounts introduces
you to how to use account numbering or account identifiers to
uniquely identify the accounts that make up the chart of
Lesson 2 - Types of Coding
Systems defines,explains, and illustrates some of the different
types of coding systems that are used in conjunction with the chart
Lesson 3 - Importance of the
Chart Of Accounts discusses and explains why the chart of
accounts is so important and what needs to be considered in
planning and setting up a good chart of accounts.
Lesson 4 - Show Me presents
an example of commonly used Balance Sheet and Income Statement
accounts that are included in a Chart Of Accounts as a guide to use
in developing your own. Also, you're introduced to how the chart of
accounts is used with accounting and bookkeeping software and what
to look for, and where to find additional help.
Lesson 5 - Review and Final
Thoughts summarizes what we covered and what you should now
know about the Chart Of Accounts.
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:
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.
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.
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.
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.
Sales of Goods and Services - revenue directly related to
Other Income - revenue not directly related to daily
operations such as Interest and Dividends.
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.
Cost of Goods Sold - the cost of the products being sold by
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.
||How Are They
The chart of accounts is typically
organized and listed in a special order. Balance Sheet
Accounts are listed first followed by the Income Statement
Note: This USA Order may
vary depending on your country.
- Owner's (Stockholders')
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
Revenue and Expenses
- Operating Revenues
- Non-operating Revenues and
- Cost Of Sales
- Operating Expenses
- Non-operating Expenses and
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
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
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
Motor Vehicle Expenses (Main -
Parent - Summary Account) 210-000
Sub-Accounts (Children Accounts)
of Motor Vehicle Expense:
|Fuel and Oil
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
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
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.
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
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
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
- Expandable or Adaptable To
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