What is a chart of accounts? Definition with examples

Keeping your transactions organized takes a lot of time and effort. Every transaction you post to your books is an opportunity for a mistake like miscategorizing expenses or creating duplicate categories.

A chart of accounts helps organize assets, liabilities, equity, revenue and expenses so you can avoid mistakes.

What is a chart of accounts?

The chart of accounts (COA) is a listing of all accounts that appear in your accounting system’s general ledger. At a glance, it provides a transparent and digestible overview of the structure of your accounts and similar groupings of accounts. 

It doesn’t include account balances, so you can’t use it to analyze your company’s financial position or results of operations as you can with financial statements, like a balance sheet or income statement.

However, it does offer a bird’s eye view of all of the categories of financial transactions you might use at a glance.

Why create a chart of accounts?

Because the chart of accounts lists all of your company’s accounts, it helps you organize every transaction into categories. 

It typically uses a numbered system to organize accounts into broad categories, such as assets, liabilities, revenue, or expenses..

For example, all asset accounts might start with the number 1, all liabilities with the number 2, all equity accounts with the number 3, and so on.

Think of it as a filing cabinet for your company's accounting system: The level of organization and clarity that a chart of accounts affords your business means you’re in a better position to keep your finger on the pulse of your company's finances.

Depending on the size of your company, the chart of accounts may have only a few accounts or hundreds.

Why is the chart of accounts important?

A chart of accounts matters because it helps simplify your accounting and easily record all financial transactions.

Here’s why you need to become familiar with your chart of accounts:

Reason #1: Gain clarity on a company level

The chart of accounts helps break down all financial transactions into categories. The more organized the chart of accounts is, the more useful the information presented in it. 

Many business owners make the mistake of creating duplicate categories or having too many accounts, which makes preparing useful financial statements difficult.

Reviewing the chart of accounts before adding new accounts or categories helps you clean up your books and ensure your financial statements are concise and useful.

Reason #2: Organize finances better

The chart of accounts provides a complete listing of all accounts, which you can structure according to your needs. For example, you can have different revenue and expense accounts based on the business function, product type, or company division.

This makes it easier to find particular accounts across hundreds and thousands of them. You can run a profit and loss report that just shows the net income from a particular location or division and better understand which products or services are most profitable if you have organized the chart of accounts that way.

Reason #3: Adhere to financial standards 

The chart of accounts provides a standardized way to break down finance. With subcategories, you get a better idea of what’s going on financially than with financial statements that don’t offer enough detail. And with the help of accounting software, managing a large number of accounts becomes easier.

Translation: Less human error. 

It improves reporting standards by driving consistency across the entire company and different business units. This consistency then translates into comparability, which is essential when expanding with new product lines or growing into new verticals.

How does the chart of accounts lay the foundation for double-entry accounting?

A chart of accounts showcases all accounts according to the order they follow in the financial statements. So it starts with assets, liabilities, and equity for balance sheet accounts, followed by revenue and expenses for the income statement accounts.

Since the chart of accounts creates a listing of all accounts as found within the general ledger, it supports the double-entry bookkeeping system.

In double-entry bookkeeping, each transaction affects at least two accounts, one for the debit and one for the credit. Double-entry accounting makes it easy to spot mistakes because if your debits and credits aren’t equal, the books won’t balance, and you’ll know you need to find the error and make the necessary corrections. 

Some of the main features of the double-entry method include:

• Two sides to every transaction: Each transaction has at least two parts: a debit and a credit.
• Equal effect: Books should be balanced with the sum of each debit and accompanying credit being equal to zero.

So, for example, if a business owner withdraws $10,000 from the business bank account for their personal use, the cash (the asset) is credited $10,000, and the owner draws (an equity account) is debited $10,000.

At first glance, it might seem like the double-entry system is an unnecessary extra step or yet another thing to learn and keep track of. But there are plenty of reasons why expert bookkeepers worldwide depend on this system: It produces fewer errors, offers more detailed data, and is more efficient in the long run.

• Fewer errors: It helps accountants reduce mistakes and detect fraud early on.
• More detailed information: It provides complete information about a transaction, which enables better decision-making for all stakeholders, including management, investors, creditors, and auditors.
• More efficiency: It’s a recommended system for most businesses due to better efficiency in recording different financial transactions.

It becomes important to the chart of accounts as the information provided results in an accurate listing of all accounts and related revenues and expenses.

Double-entry rules 

The double-entry method is based on the principle that every debit must have an opposite credit with two accounts for every financial transaction.

Here are a few rules to keep in mind regarding debit and credit:

Debit:

1. Recorded on the left side of the ledger sheet 
2. Increases asset accounts
3. Decreases equity and liability accounts
4. Decreases revenue
5. Increases expense accounts

Credit:

1. Recorded on the right side of the ledger sheet
2. Decrease the asset accounts
3. Increases equity and liability accounts
4. Increases revenue
5. Reduces expense accounts

Example 1

You have an online store, and you’ve just sold 20 products. You received $20 cash for these products.

To record the transaction, you debit cash for $20 and credit revenue for the same amount. You’ll also need to adjust your inventory on hand and the cost of goods sold for your cost to buy or create the products.

Example 2

You pay your monthly rent of $1,200 in cash. Every time you do this, you credit the cash asset account because that cash is no longer in the business. And every time you do that, you also debit your expense account for rent.

Quick Tip: Worried about keeping track of this? If you involve automation in this process, the credit and debit accounts update accordingly.

Chart of accounts in practice 

Let’s imagine you have a small business called Crumbs Bakery. Your chart of accounts for Crumbs Bakery might look like this:

As you can see from the example above, a chart of accounts has four parts: Account number, account description, account type, and the financial statement that each sub-account belongs to. Let’s break each section down to understand it better:

Account number

First, you need to determine the numbering system since it helps identify and link accounts. The first digit showcases the account type or broad category—assets, liabilities, equity, revenue, or expenses.

Then the sequential number indicates the specific account or subcategory. The Crumbs Bakery example shows that the cash account corresponds with 101. The equipment account is number 103. Both of these subcategories fall under the umbrella of assets, the broad category linked to numbers that start with 100.

(But keep in mind that, as your business grows, you may need larger account numbers to accommodate your chart of accounts. Large businesses have account numbers that are four or five digits long.)

Creating an organized number system for all your account categories and subcategories helps you and your accountant see how all the areas of your business involved with making or spending money fit together.

Account description

Each account needs to have a corresponding description. This helps identify the relevant item or subcategory. For example, the Crumbs Bakery account number 201 shows the business has accounts payable (a liability), while studio supplies (an expense) is account number 504.

Account type 

Each account type is divided into five main account types: Assets, liabilities, equity, revenues, and expenses. All subcategories—the specific account descriptions—fall within one of these account types.

Statement

All the account types are either part of income statements or balance sheets. In this instance, the assets, liabilities, and equity accounts listed in Crumbs Bakery’s chart of accounts belong to the balance sheet statement.

Balance sheet accounts 

Balance sheets provide a snapshot of a company’s financial position—what it owes and what it owns. Companies typically prepare a balance sheet at the end of a specific period—such as a month, quarter, or year.

Three different types of balance sheet accounts are required to create a balance sheet: Assets, liabilities, and equity.

Asset accounts

Asset accounts refer to anything your business owns and considers of value. Main accounts may be cash, accounts receivable, prepaid insurance, inventory, and fixed assets. Sub-accounts existing under asset accounts may include:

• Raw material
• Finished goods 
• Checking
• Savings
• Money market accounts
• Property 
• Vehicles
• Software

Liability accounts

Liability accounts are the debts your company owes. Main accounts might be Accounts Payable, Notes Payable, Payroll Liabilities, and Accrued Expenses. Sub-accounts existing under liability accounts include

• The company’s credit card balance
• Wages payable
• State taxes payable
• Rent payable

Income statement accounts 

Income statement accounts are used to create another important financial statement. Companies can generate income statements—also called profit and loss statements—monthly, quarterly, or annually to report the company's profitability during a given time.

Revenue accounts

Revenue accounts keep track of the income your company brings from revenue sources like:

• Sale of goods
• Delivering services

Expense accounts

Expense accounts include what your business spends on overhead and operating expenses. This includes:

• Wages
• Licenses and Insurance
• Utilities

How to set up your chart of accounts 

You know that a chart of accounts is an important way to organize your finances.

When pitching to an investor or lender, you must ensure that you have all your documentation accurately prepared—and an organized chart of accounts helps support complete and accurate financial statements.

Luckily, setting up your own chart of accounts can be pretty straightforward if you follow these steps:

Step #1: Create business account names

Make sure you create clear account names—and stick to them. Naming your accounts prevents confusion about the transaction, thus making it easier to provide accurate financial report insights.

Step #2: Assign unique account numbers 

Each category should get a unique number used in the corresponding financial statement. For example, all assets can belong to the range of 1001-1099; liabilities can be 2001-2099, and so forth.

Step #3: Organize account names into account types 

Each account name should belong to one of the five main account types: assets, liabilities, equity, revenue, and expenses. This way, you can distinguish between specific accounts as needed.

Step #4: Use automated software to keep track of your accounts

Manually tracking every bit of income and expense can be daunting, especially if you’re just starting out and don’t have a bookkeeper yet. Automated tools like expense management software can create essential documents, including charts of accounts, income statements, and balance sheets.

Save time with financial software that makes staying organized easy

As your business grows, you need quick and accurate reporting—and the chart of accounts offers a bird’s eye view of all the accounts involved in your business operations, allowing you to easily add accounts as your business grows and your accounting becomes more complex.

But keeping track of all your accounts and paying bills on time can be challenging if you don’t have the right tools. The good news? BILL can help you create and pay bills, send invoices, and get paid—all in one platform. Start using BILL today!