What Is Chart of Accounts And How Does It Work?

The chart of accounts is a numbered list of all accounts used to record and summarize business transactions. Each account has a unique descriptive title. Although the chart of accounts is considered a complete listing, it changes over time as you add new account numbers. This article explains how the chart of accounts is organized and includes an example of possible account numbering in the chart of accounts.

To learn even more about the chart of accounts or to discover additional information about the topic please refer to this guide by Wikipedia. 

How the Chart of Accounts is Organized

Most of the modern accounting solutions have features allowing you to set your chart of accounts. What accounting software solution do you use - and does it have this function? Let us know in comments below.  

The number of digits used to construct a chart of accounts matches the complexity and organization of the business. In very small businesses, a chart of accounts may be built with a three-digit numbering pattern.  In larger companies, four or more digits may be needed to more accurately capture business data necessary to budget, analyze, and evaluate business performance by department and entity (corporate, division, or subsidiary unit). 

When designing a chart of accounts, be sure that the numbering system will produce desired data for business results tracking. For example:

•  does the chart of accounts include separate sub-accounts for major product lines or are all products combined in one account? 
• Are expense accounts identified by the department in sub-accounts, letting you track expenses on a budget vs. actual basis?

The following example and the corresponding Table use four-digit account numbers for the chart of accounts. The first number corresponds to each section of the financial statements. The chart of accounts is numbered in the order of balance sheet accounts, followed by income statement accounts:

1000’s Assets

2000’s Liabilities and Equity

3000’s Revenue

4000’s Cost of Goods Sold

5000’s to 9000’s Expenses, Other Income (Expenses), Gains (Losses), Income Tax Expense, and Other Comprehensive Income

The remaining digits are used to create sub-accounts for each type of account. Using sub-account numbers (or account numbers) from the chart of accounts, accountants code debits and credits in a double entry system (using two or more accounts that balance on the debit and credit sides). Accounting systems summarize sub-accounts at each higher level by combining account numbers to create the general ledger. The general ledger is used by the accounting software to prepare financial statements and financial reports. 

To number asset accounts using the 1000s range, assign the account number:

• 1100 to cash, which is further divided into sub-accounts like 1111 for checking account  -  bank name  
• If your company has more than one checking account, number the first checking account with an identifying description in its title as 1111 
• Number the second checking account with a different identifying description in its title as 1112
• 1200 to accounts receivable

• 1210 for accounts receivable - trade
• Number the allowance for doubtful accounts, which is an offsetting contra-account as 1220

• 1300 to prepaid expenses
• 1310 to prepaid insurance

To assign account numbers to liability and equity accounts use the 2000’s range. For liabilities, assign the account number:

• 2100 to accounts payable
• 2110 to accounts payable - trade
• 2200 to accrued liabilities
• 2400 to a revolving line of credit
• 2500s to notes payable - short term portion
• 2600s to notes payable - long term portion

For equity accounts, assign the account number:

• 2800 to Equity
• 2810 to (total) Capital     
• 2811 to Par value of stock
• 2812 to Paid-in capital    
• 2813 to (Less) Treasury stock
•  If the company does not issue stock, you can set up a Capital account and Draw account instead of in the Equity Section.
• 2840 to Retained Earnings
• 2841 to Beginning balance - Retained earnings
• 2842 to Net income (Loss)
• 2843 to Gains (Losses)
• 2860 to Accumulated Other Comprehensive Income (Loss)  (which is a total)
• 2861 to 2869 to each type of Other Comprehensive Income (Loss)

To create income statement accounts in the chart of accounts, use the 3000s through 9000s range of account numbers. Assign the account numbers:

• 3000s to Revenues
• 4000s to Cost of Good Sold and Cost of Services
• 5000s and above to Operating Expenses
• In the higher ranges up to 9000s to non-operating expenses, gains and losses, income taxes, and other comprehensive income or loss ( when using a four-digit number design for the chart of accounts) 

Chart of Accounts Example - Table   

Key Takeaways

When designing and constructing your chart of accounts, plan the structure and the accounts and sub-accounts needed by your specific company. Thoughtful planning and implementation will allow you to track and record items related to your business through useful sub-account fields that can be data mined through a drill-down feature, report, or data analytics.

You can and should always add new accounts later or delete those accounts that you will never use to keep yourself organized. 

At the beginning of the article, we asked you to check if your accounting solution can create and manage the chart of accounts. Can it?

In case no, check out ZarMoney - low cost, yet super powerful cloud accounting solution.

With ZarMoney accounting software, you have flexibility when creating your custom chart of accounts. Your chart of accounts is efficiently built within the accounting system and safely stored in the cloud for you to reach from anywhere. 

A well-designed chart of accounts will help you plan, analyze, and control your business results. The account details tell you how your actual results compare to your forecast and budget by line item, allowing you to make decisions and manage your company better.