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We’ll break down what a COA is and why you need one, give you some pointers on how to create a COA, provide an example of a chart of accounts for you, and give you some helpful reminders to be aware of as you create your own COA. Let’s get started talking about accounting chart of accounts fundamentals:
What is a Chart of Accounts?
A chart of accounts is a tool that companies use to break down their financial transactions into records that are easier to understand. It is an index of everything included in a company’s general ledger over a specific period – like an accounting filing cabinet. The goal with creating a COA is separate revenue, liabilities, assets, and expenses into categories and subcategories using unique records to provide better insight into where money is coming into and going out of your business.
Why Use a Chart of Accounts?
A COA gives key stakeholders (owners, management, partners, investors, etc.) a clear view of what is happening in the company financially to better analyze things like operating expenses and current debt. This information not only informs strategic cash flow management decisions but also helps to mitigate fraud. Lastly, separating out items that appear on a company’s balance sheet and income statement also helps to ensure that accounting functions are in compliance with reporting standards.
How to Create a Chart of Accounts
When creating a COA your accounts should be organized in the order that they would appear on your financial statements starting with your balance sheet and ending with your income statement. So, the proper order would be assets, liabilities, shareholder’s equity, revenue, and then expenses. These categories will be your five primary accounts and then each will have subaccounts under them.
As you might expect, larger companies will typically have more subaccounts than smaller companies because they often have more sophisticated financial needs. The more subaccounts your company has, the more important your code numbering system will be. For organizations with hundreds or thousands of subaccounts, the first digit usually indicates what its parent account is to keep accounts better organized. In addition to an identification code each account and subaccount will have a name and description to provide additional clarification.
An Example Chart of Accounts
The goal when creating COA subaccounts is to have enough to be able to enable effective financial management but not so many that it makes your accounting functions harder. Your COA may look include some or all of the following subaccounts:
The best COA reminder we can give you is that subaccounts are not set in stone. They should be pruned regularly as part of an annual accounting review. Look for opportunities to delete old accounts or consolidate similar accounts at the end of tax season to make your accounting functions easier. Just be aware that significant changes to your COA can make ongoing financial analysis and financial performance comparisons difficult. Try to keep your COA as consistent as possible, making changes where needed but avoiding frivolous or too frequent changes, both of which can negatively affect reporting.
The “right” COA will be whatever is right for your organization’s needs. For instance, some companies may choose to organize their accounts by business function or division because that makes the most sense for their operations. Every company’s COA will be slightly different to reflect the nature of their unique business, but all COAs must abide by FASB (Financial Accounting Standards Board) and GAAP (Generally Accepted Accounting Principles) standards.
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