The Reporting Automation Playbook for Private Equity Funds
Chart of Accounts Examples, Template, and Tips
Do you remember that two-inch-thick history textbook you loathed in high school? The one that was so dense that, if it wasn’t for the index in the back, you’d get lost in the small-font woods looking for information on the Magna Carta?
Well, that’s exactly how someone looking through your financials would feel if it wasn’t for the accounting equivalent of that life-saving index – the chart of accounts (COA).
Obviously, that makes your chart of accounts essential to a host of different people and groups, from your decision-makers and stakeholders to potential investors and lenders. So, yes, your COA is a big deal. But just because it’s important doesn’t mean it’s intuitive or straightforward, at least without true expertise guiding the way.
That’s where Embark enters the picture, ready to provide CFOs, CAOs, controllers, and their teams with our collective decades of experience on the accounting frontlines. And as you’re about to see, we’re leaving no stone unturned, answering questions and discussing topics like:
- What is a chart of accounts? Why is it important?
- How does a chart of accounts work? How is it used?
- Types of accounts in a COA
- How to set up, adjust, customize, and improve a chart of accounts
- COA examples for large and small companies
- Tips on using identifier numbers and other best practices
Upping the ante even more, we’re also including a COA template to provide you with a handy jumpstart to your own chart of accounts. So on that note, let’s jump right in because clearer, more organized financials and improved decision-making are just around the corner.
What Is a Chart of Accounts?
Think of your chart of accounts as a roadmap across your operations, indexing all of your different financial accounts in an organized, consumable way. A COA breaks down your transactions during a particular accounting period into specific account categories, helping people quickly gain clear insights into your organization’s financial health.
Now, according to the standard definition of a COA, it should focus on the many different accounts tying into your company’s general ledger. And while your GL certainly plays a significant role, our advice is not to be so hyper-focused on the GL that you fail to integrate other dimensions and company attributes into your COA.
For example, additional information like company and cost center lists flesh out simple transactional data, providing more nuanced insights that your leadership will undoubtedly benefit from. We’ll go into greater detail in a bit but, for the time being, just remember that you have a large degree of flexibility when it comes to building your COA and tailoring it to your specific needs.
That said, just because you can customize your COA doesn’t mean there aren’t certain best practices to abide by. Typically speaking, you want to include certain accounts as a footing for your COA, including:
- Balance sheet accounts – assets, liabilities, and owner’s equity
- Income statement accounts – operating revenues, operating expenses, non-operating revenues and gains, non-operating expenses and losses
From there, you can get even more detailed, further categorizing items by their business function, company divisions, product and service lines, and more. Therefore, while every COA uses the same building blocks – balance sheet and income statement accounts – how deep you delve into each of those blocks is up to you.
Why Is a Chart of Accounts Important?
Imagine someone plops you down into the middle of a massive city and asks you to find a particular address. Even if you know that city fairly well, without a GPS or map to direct you, you’re either going to spend an awfully long time finding that address or not find it at all.
That’s what your company faces without a well-organized chart of accounts. It’s like wandering through a complex and sprawling city in search of a financial needle in a haystack. And what does that mean for your leadership? For starters, your accounting data can quickly become unreliable and outdated, which is an especially poor turn of events when timely insights are essential.
In the bigger picture, it also makes it difficult to accurately gauge your organization’s financial health. Sure, anything is better than nothing. But when it comes to effective management, a lacking COA – or one just designed for compliance or income taxes – usually doesn’t provide leadership with the nuanced information it needs to guide your enterprise forward in the best possible manner.
Even worse, if your competition has a highly efficient and streamlined COA, they will always have a competitive advantage over you. Simply put, without an informative chart of accounts that’s customized to your particular needs, your decision-makers are leading your organization with blinders on.
Your COA Is the First Step in Your Financial Data’s Journey
As a slight aside, it’s also important to keep in mind the relationship between your COA, GL, and financial statements. It’s actually your COA that comes first in the data chain, where your categories and identifiers funnel transactions into the ledger, which classifies them accordingly.
In other words, it all starts with the chart of accounts, flows into the ledger accounts, and finally into your ERP system. Therefore, a well-formed and organized COA allows you to draw a direct line between a transaction and how it flows into your financial statements.
Granted, by the time they hit your financial reports, you’re probably grouping them in a line item anyway. However, the chart of accounts plays a critical role in how your revenue accounts, for instance, flow into the profit and loss statement.
Types of Accounts in a Chart of Accounts
Now that we have the high-level information behind us, let’s roll up our sleeves a bit and zero in on building the ideal chart of accounts for your company. As we said before, an effective COA begins with two essential building blocks – balance sheet accounts and income statement accounts.
Balance Sheet Accounts
There’s nothing special about the balance sheet accounts you use within your COA since they flow into the balance sheet you already know and love.
This is simply a list of the different categories of assets your company owns, including non-current and intangible assets like IP and proprietary software, as well as current assets like cash sitting in a checking account, prepaid expenses, petty cash, accounts receivable, and more.
Similarly, your liability accounts are a list of the debts your business owes to creditors. Naturally, items like accounts payable, invoices payable, interest payable, accrued liabilities, sales tax payable, and other current liabilities fall within this list.
Owner’s Equity Accounts
These accounts equate to the equity value remaining in your business after deducting your liabilities from your assets. In short, this is a way to measure how valuable your organization is to its owners.
Income Statement Accounts
All of those financial transactions generating operating revenue for your company fall into the P&L (income statement) category. Just remember, this only includes revenues stemming from the core functions of your business, not items falling outside of your main activities. As you’ll see, those have their own section to call home.
As the saying goes, you need to spend money to make money. The expense accounts category captures all of the money you spend generating revenues for your company – advertising expenses, employee benefits, office supplies expenses, rent, utilities, and endless more. And like their counterpart in operating revenues, these expenses tie directly to the products or services that generate revenue for your company.
Non-Operating Revenues and Gains
Let’s say you sell an asset – not including inventory – for greater than that asset’s book value. These are the types of gains – as well as interest income, assuming you’re not a bank – that fall within this COA category, the ones you generate outside of your typical operations.
Non-Operating Expenses and Losses
The opposite side of the non-operating coin occurs when you, for instance, sell an asset – again, not including inventory – for less than book value. You capture this sort of loss in the non-operating category to separate it from typical operating expenses.
Yes, we understand we’re venturing into Accounting 101 territory here, stopping just short of a refreshing dip into the magical world of debits, credits, and double-entry bookkeeping. However, we assure you such detail is for good reason. As a matter of fact, this high-level review provides a perfect segue into our next topic.
How to Set Up Your Chart of Accounts
When it’s time to either set up a new COA or improve an existing one, it’s important to remember the running theme you’ve seen up to this point – organization. Classifying your different types of transactions into set categories is the backbone of an effective COA and, thus, general ledger and financial statements.
But tasked with recording transactions of such variety and flowing into so many account types, where do you begin categorizing the mountains of data?
Well, most companies borrow a page from your local library and the Dewey decimal system, assigning account identifiers when booking entries rather than wordy, cumbersome, text-based descriptions. We recommend beginning this process with your balance sheet accounts and then adding your income statement and other necessary accounts.
Although most decent accounting software packages will generate and maintain these identifying numbers for you, it’s still a good idea to have a solid understanding of the underlying system. For instance, if the software uses a four-digit account number system to track transactions, the first digit will designate which account it belongs to – maybe 1 stands for assets, 2 for liabilities, 3 for equity accounts, and so on.
Example Chart of Accounts Numbering For Large and Small Companies
It’s safe to assume larger companies will typically have more transactions and accompanying GL accounts than smaller ones. Thus, a five-digit numbering system – rather than three or four-digits – gives a large company more room to break out detailed accounts. These could include accounts like COGS, depreciation on fixed assets, sales returns, common stock, and others that small business owners might not need, at least in such detail.
Sample Large Company COA Identifier Numbering
- Assets: 10000-19999
- Liabilities: 20000-26999
- Shareholder’s equity: 27000-29999
- Revenue: 30000-39999
- COGS: 40000-49999
- Expenses: 50000-59999
- Other (ex. gain/loss on asset sale): 90000-99999
In this sample chart of accounts numbering system, the company breaks its cost of goods sold (COGS) off into its own account name and number group, allowing it to categorize transactions with greater detail. Thus, an identifier like 44120 might signify a COGS transaction (the first digit) from sales division #4 (the second digit) and product line #120 (the final three digits).
Sticking to the expense side of the income statement, let’s assume the company uses a 7 to designate the marketing department. Therefore, it might use subcategories for marketing expenses like:
- 57100 Marketing Salaries
- 57150 Marketing Payroll Taxes
- 57200 Marketing Supplies
- 57600 Marketing Internet
Small Company COA Identifier Numbering
A small business will likely have fewer transactions and accounts than a larger one, meaning a three-digit system of identification codes might suffice.
- Assets: 100-199
- Liabilities: 200-249
- Shareholder’s equity: 250-299
- Revenue: 300-399
- Expenses: 500-599
- Other (ex. gain/loss on asset sale): 900-999
Whereas a larger company needed enough detail to break out salaries by department – marketing, HR, etc. – a smaller company could simply categorize them using sub-accounts in the 500 group. For example, expenses in this company’s COA could include:
- 500 Salaries
- 520 Supplies
- 540 Rent
- 550 Utilities
- 555 Internet
Adjusting and Customizing Your Chart of Accounts
Much of the heavy COA lifting occurs during the initial design. Specifically, you want to use an identifier numbering system that provides plenty of real estate for you to add account categories down the road without having to reinvent the COA wheel.
Once you have an adequate system in place, then it’s not a problem to tweak your COA by adjusting account categories when needed. We suggest proceeding with caution with your adjustments, however, as you want to make sure you are consistent and logical. For example, if you have unneeded categories in your COA, it’s usually not a good idea to eliminate them mid-period due to possible orphaned data in your financial statements.
Speaking of your statements, they can play a major role in how you customize your chart of accounts. For instance, if there’s a particular area you want to provide deeper insights on in your financials, you’ll want to include sufficiently detailed account categories in your chart of accounts.
Of course, your particular industry will also determine how you customize your COA. While account identifier categories for the tangible costs of wells and development make sense for an upstream oil and gas company’s COA, they’d obviously be irrelevant for a chain of bakeries.
Therefore, it pays to be meticulous when either setting up, adjusting, or customizing your chart of accounts. At the risk of sounding repetitive, being thorough on the front-end will save you much heartache on the backend.
Other Tips and Insights on the Chart of Accounts
That about covers the basics of the chart of accounts. As you might guess, however, real-world applications have twists and turns that go beyond a well-categorized numbering system.
So on that note, since we’re thorough if we’re anything here at Embark, we also wanted to provide a few best practices we’ve collected over the years to make your COA as comprehensive, efficient, and enlightening as possible.
Business Transactions and Your Chart of Accounts
Of the many things to consider during a business transaction and integration, the GL accounting systems and charts of accounts should be near the top of the list. Ideally, the enterprises involved will adopt a standardized COA to streamline the integration, booking revenue and expenses to similar accounts.
Without this standardized approach, you’re essentially performing the same effort twice, routing transactions across different accounts between the entities. Suffice it to say, repetitive work is slower, more inefficient, and less reliable, all traits working directly against what your chart of accounts is supposed to accomplish in the first place.
Create Your Chart of Accounts With an Eye to the Future
We said it before and we’ll say it again – a thorough, comprehensive approach to setting up your chart of accounts will prevent headaches and panic attacks down the road. A big part of that task is initially assembling your COA with an eye toward the future.
Put another way, don’t build your COA for what your company looks like today. Instead, set it up for what you anticipate three to five years down the road, even if some of the elements you use aren’t applicable yet.
For example, what if there’s a significant change in a technical accounting standard coming up in a couple of years? If you build out your COA according to the current standard, you’re going to be left scrambling to integrate the new standard in a very short amount of time.
Similarly, suppose you are drastically expanding your lines of business in the near future. In that case, it just makes sense to set up your COA to incorporate those new lines – or even new accounts, if necessary – even if they aren’t operational for another year or two. This way, you’ll have room in your numbering system to add multiple cash accounts, cost accounts, or whatever else you might need.
Build a COA Reference Document
Although this one might seem like common sense, you’d be surprised how many companies end up with a gnarled, twisted COA that flows as well as a dry river. Thus, be logical when developing your account groups and create a reference guide that will allow anyone to pick it up and make sense of your chart of accounts.
Without crystal clear directions, there will inevitably be mistakes in your chart of accounts, often out of confusion. Once that occurs, you immediately damage trust in your chart’s accuracy and reliability, usually necessitating a COA rebuild. And that’s not great for anyone.
Going forward, be sure to revisit the document regularly – perhaps quarterly or annually at the latest – just as you would with accounting policies. As new buyers, team members, and systems enter the fold, it’s crucial your COA documentation is always up-to-date for employees, not to mention your auditors.
Isolate EBITDA and Non-Recurring Items
You can make life much easier for your controller when you group EBITDA and non-recurring or one-off items like acquisition expenses, integration expenses, and others. This way, looking at normalized accounts doesn’t feel like a mighty chore when, for example, converting from a GAAP income statement to a management income statement.
Embark’s Chart of Account Template
Finally, the moment you’ve been waiting for. To ensure you start out on the right foot, we’re providing you with a COA template to download and customize to your heart’s content. Ideally, you’ll take our template and bend it to your specific needs.
Don’t forget, however, that the template is just that – a template. Every company is different so, depending on your operations, industry, and other critical factors, the template is only as good as you make it. Now, that said, we’d be remiss if we didn’t boast a bit and say that Embark’s COA template is a heckuva starting point.
But ultimately, how effective it is in informing your decision-makers and ensuring an efficient record-to-report process is up to you. So take our template, along with the many insights and tips we’ve discussed, and build a COA that drives real success for your organization.