Defining your Chart of Accounnts correctly can save you from accounting headaches later!

A Chart of Accounts is a list of the account names and accounts codes that you have which are categorized according to your five major accounts which are the following:

1. Assets
2. Liabilities
3. Equity
4. Revenue
5. Expenses

Under Assets, you may have sub-accounts like:

Cash
Receivable
Inventory
Equipment

Your "Cash Account" can be further subdivided into another level of sub-accounts like:

Cash in Bank
Cash on Hand

Just like Cash, your other Asset accounts, liabilities, equity, revenue and expense accounts can have sub-accounts and sub-accounts can have accounts under them.

When you make a journal or accounting entry, you deepest level of sub-account. Take the example below:


What is a Chart of Accounts?

As you can see Cash has two (2) sub-accounts which are Cash in Bank and; Cash on Hand.

Further, the Cash in Bank account has another level of sub-accounts which are Cash in Bank, Savings and; Cash in Bank, Checking.

Thus, when you make an accounting entry for Cash in Bank, you must either use Savings or Checking, you cannot just use Cash in Bank, since the balance for Savings or Checking must be automatically be part of Cash in Bank and the Cash in Bank balance must be automatically part of the Cash balance. You can do this manually, but if you purchase off the shelf accounting software like Peachtree or Quickbooks, this things are done automatically.

Different types of businesses have different sets of accounts in their Chart of Accounts.

Now that you have an idea of what is a Chart of Accounts, be sure to define your chart of accounts properly before using them. Make sure you have sub-accounts where they are needed.

Failure to correctly define the proper accounts for your business could result to problems later on if you want to change them. Accounts with balances can be difficult to change or transfer to other accounts that you will add later. Such change would result to numerous adjusting entries. In addition, if your accounts does not represent the accounts you need for Financial analysis, your financial information would have limited information for Financial decision making.

If necessary consult an Accountant in creating your Chart of Accounts.

In my next post, I will discuss Account Codes for your accounts and suggested accounts for various businesses.