Whenever you compile financial statements for any reason, it will always have a bunch of financial accounts – graphs meant for different types of money transactions in and from the company, alongside the total size of all the payments made in the period under consideration for each account.
For instance, say you paid $10,000 for marketing during one particular month. Accordingly, the ‘marketing expenses’ will be listed as ‘-$10,000’ for that month’s balance. There are more financial transactions you’ll have to write up that may or may not contain marketing expenses or any other sort of expenditures or gains.
But where do you see which accounts (such as the ‘marketing expenses’ and others) should be used in these transactions? It’s not like you ought to make them up each time you make a journal entry. No, the account should only be added to the records if it’s on your Chart of Accounts.
What is a Chart of Accounts?
Chart of Accounts (or CoA) is a list where you keep all of your existing accounts (expenditures, revenues, and equity). If they are on the list, they’ll be on a statement.
It’s just for organizational and management purposes. The businesses aren’t strictly obligated to keep these Charts, but it will be infinitely easier and more convenient to have one – both for the accounting and those people who’ll want to look at the company’s financial health (such as investors or stockholders).
However, you are free to change the list if you want to. If you didn’t receive one of the sources of revenue mentioned there, you can strike it out. Additionally, you can add more if some new source of wealth appeared.
Just remember: it’s better to remove accounts at the end of a financial year. You’ll also want to compare your yearly expenses, and if there are tons of different accounts compared to your previous financial statements, it will be a pain.
Why use them?
It’s not really a difficult process. The logic is simple: in order to put some expense/revenue source into a statement, you’ll need to copy its title and other information from somewhere. It’ll promote homogeneity in your reports and make sure everything is neatly interconnected.
You can think of it as programming – you won’t be able to use a variable in your code if it doesn’t exist in the system. The software simply won’t understand what is that you’re giving it. If you don’t have a Chart, you’ll be just like the software after a while: you simply won’t understand parts of your previous statements.
It’s generally useful for management purposes. Even if it’s clear that ‘office paper’ and ‘office supplies’ expenses are the same, comparing reports where identical accounts have different names will be challenging.
How are they created?
In the Chart, each account usually has these characteristics for your convenience:
- Account type (revenue/expense/equity)
- ID number (for organizational purposes)
Before, you would put these on paper and copy this information onto the statements. Now, you can do both on your personal computer, which simplifies everything. What’s more, there are special accounting programs that allow you to create Charts within its database and then just easily copy them to a document. In fact, it works perfectly because software and accountants work in a similar way anyhow.
Structure a CoA
There’s really no one rule for making a Chart – you can do it your own way. There are standards of filing statements, however, and you’ll do well to make sure your Chart makes it easier for you to file reports. For instance, you’ll have to create some accounts that are bound to be in all financial statements, most notably – in the balance sheet and income report.
You’ll also do well to list the main accounts at the very top because that’s how they’ll be arranged in the statements anyway.
Name is a part where you describe what the account is. ‘Equipment’, ‘Cash’, ‘Research’ are all names, and the depth and details of each account are up to you. You can create one ‘Food’ account or divide it into ‘Lunches’ and ‘Animal food’. Even the last one can be divided into ‘Parrot food’ and ‘Cat food’, for instance.
Type also depends on you, although the most common examples are ‘Revenue’, ‘Expense’, ‘Equity’ (basically the value of anything compared to the previous reports), although there are also more.
ID number is an official marking meant for clarity and ease of accessing. If you change the name, the number will likely stay. The usual practice is to use a 4-digit code where the first number is indicative of the account’s type, although you can really do anything with that, it’s just for inner use.
Purpose is where the account will ultimately go. It’s usually ‘Balance sheet’ or ‘Income report’, but if the particular account is going to be featured elsewhere, you can put something else in this graph.
There are also more details you can add. You can add brief descriptions or do away with the codes, if you want to. What the structure is going to be is entirely up to you, but typically, the accounts are shown in the order they appear in financial statements.