Almost every accounting product ships with a default chart of accounts, and almost nobody looks at it until the reports come out wrong. The default list is built for an average business that does not exist. Ten minutes of setup at the start saves a year of reports that are technically accurate and practically unreadable.
What follows sets out a starter chart of accounts with numbering, the rule that governs whether an account should exist at all, the four mistakes that make a correct set of books impossible to read, and the point at which a restructure becomes worthwhile.
Key Takeaways
- A chart of accounts is the list of categories into which every transaction is sorted, organized across the five account types of assets, liabilities, equity, revenue and expenses.
- Most small businesses are served adequately by between 30 and 60 accounts, and a list that has grown beyond roughly 100 accounts ordinarily indicates that accounts are performing a job that classes or tags should be performing.
- Numbering by range, with the 1000s allocated to assets through to the 6000s allocated to operating expenses, causes reports to sort correctly and leaves room for accounts to be inserted later.
- The chart of accounts should be structured around the decisions the business makes each month rather than around the layout of the tax return, because the mapping to the tax return is performed once.
- An account that carries transaction history should be made inactive rather than deleted, because deletion orphans the transactions recorded against that account.
Definition
A chart of accounts is the list of categories into which a bookkeeping system sorts transactions. Every amount that moves is assigned to one of those categories, and the financial statements consist of those categories totalled and arranged.
The structure of the chart of accounts therefore determines what the financial statements are capable of reporting. An income statement can report only the distinctions that the chart of accounts was built to capture. Where every payment to a vendor is recorded within a single account described as operating costs, no report produced from that ledger will ever report the amount spent on software.
The five account types and the numbering convention
Numbering is a convention rather than a requirement, and the convention is worth adopting. Reports sort into a sensible order without intervention, and leaving gaps between numbers allows an account to be inserted later without any existing account being renumbered.
| Range | Account type | Reported on |
|---|---|---|
| 1000 to 1999 | Assets | Balance sheet |
| 2000 to 2999 | Liabilities | Balance sheet |
| 3000 to 3999 | Equity | Balance sheet |
| 4000 to 4999 | Revenue | Income statement |
| 5000 to 5999 | Cost of goods sold | Income statement |
| 6000 to 7999 | Operating expenses | Income statement |
| 8000 to 9999 | Other income and expense | Income statement |
Scroll sideways to see all columns.
A starter chart of accounts
The list set out below is a workable base for a small business carrying inventory or direct costs. A service business can omit the inventory account and the cost of goods sold accounts and substitute a cost of services section within the 5000 range.
Assets
| Number | Account |
|---|---|
| 1000 | Operating checking |
| 1010 | Savings |
| 1020 | Undeposited funds |
| 1100 | Accounts receivable |
| 1200 | Inventory |
| 1300 | Prepaid expenses |
| 1500 | Equipment |
| 1510 | Vehicles |
| 1590 | Accumulated depreciation |
Scroll sideways to see all columns.
Liabilities and equity
| Number | Account |
|---|---|
| 2000 | Accounts payable |
| 2100 | Credit card payable |
| 2200 | Accrued expenses |
| 2300 | Payroll liabilities |
| 2400 | Sales tax payable |
| 2700 | Loans payable |
| 3000 | Owner contributions |
| 3100 | Owner draws or distributions |
| 3900 | Retained earnings |
Scroll sideways to see all columns.
Revenue, cost of goods sold and operating expenses
| Number | Account |
|---|---|
| 4000 | Product sales |
| 4100 | Service revenue |
| 4900 | Refunds and allowances |
| 5000 | Materials and supplies |
| 5100 | Direct labor |
| 5200 | Freight in |
| 5300 | Merchant processing fees |
| 6000 | Advertising and marketing |
| 6100 | Wages and salaries |
| 6110 | Payroll taxes |
| 6120 | Employee benefits |
| 6200 | Rent |
| 6210 | Utilities |
| 6300 | Insurance |
| 6400 | Software and subscriptions |
| 6500 | Professional fees |
| 6600 | Repairs and maintenance |
| 6700 | Vehicle and travel |
| 6800 | Office supplies |
| 6900 | Depreciation |
| 7000 | Bank and service charges |
| 8100 | Interest expense |
Scroll sideways to see all columns.
The list set out above contains approximately 40 accounts, and a list of approximately 40 accounts will serve most small businesses for a number of years without amendment.
How many accounts a business should carry
The appropriate number of accounts is smaller than instinct suggests. An account should be created only where the amount reported in that account, seen on its own within a report, would change a decision made by the business.
The amount spent on software is a figure on which a business would act. The amount spent on printer paper as distinct from the amount spent on pens is not a figure on which a business would act, so printer paper and pens are both recorded within office supplies. The relevant test is whether the figure is capable of supporting a decision, and the relevant test is not whether the distinction between the two costs is real.
A chart of accounts that has grown beyond approximately 100 accounts ordinarily indicates that accounts are being used to answer questions that accounts were not designed to answer. The identity of the customer, the identity of the project, the location and the department are all questions answered by classes, tags or locations within the accounting system rather than by separate expense accounts. Creating an account described as rent for the Portland location and a further account described as rent for the Salem location operates adequately until a third location is opened and an amount is posted to the wrong account.
Structuring for decisions rather than for the tax return
Mirroring the lines of Schedule C or of the corporate return within the chart of accounts appears attractive on the basis that such a structure simplifies the preparation of the tax return. Such a structure simplifies the preparation of the tax return marginally and makes the remaining eleven months of the year materially worse.
The tax return is a compliance document designed by people who do not operate the business. The largest cost category in a business may occupy a single line on the return and may warrant six accounts on the income statement of that business. The chart of accounts should be structured around the figures the business needs to review each month, and the accountant can map the resulting accounts to the lines of the return. That mapping is performed once.
Four mistakes worth avoiding
Deleting an account rather than making the account inactive causes problems that are difficult to reverse. Deleting an account that carries transaction history either fails outright or orphans the transactions recorded against that account. Every accounting system provides an inactive or archive status, and the inactive status should be used in place of deletion.
Maintaining a catch-all account described as miscellaneous begins as a convenience and ends as an account holding several thousand dollars that nobody is able to explain. A cost that does not fit an existing account warrants an account of its own, or warrants correct classification within an account that already exists.
Renaming an existing account in order to repurpose that account carries the transactions recorded under the previous name into the reports produced under the new name, so that a report for the prior year reports office supplies under a heading describing subcontractors. A new account should be created and the previous account should be made inactive.
Leaving the default list supplied by the software in place produces a chart of accounts that is generic by design. Accounts that will never be used should be removed before a single transaction is posted, because removal becomes considerably more difficult once transaction history exists. That difficulty is more pronounced in some systems than in others, and the tendency of one system to reassert its own account structure is described in when QuickBooks Online deletes your custom chart of accounts.
When a restructure is warranted
A restructure should be performed at the start of a fiscal year rather than partway through one. Amending the account structure in July produces a comparative report in which the first half of the year and the second half of the year are not measuring the same categories.
Three signals indicate that a restructure has become warranted. Exporting reports to a spreadsheet in order to combine or separate accounts before the reports can be read indicates that the structure no longer matches the questions being asked. A single account holding more than approximately 15% of total expenses indicates that the account is concealing detail that warrants separation. The addition of a product line or a location that the existing structure cannot report separately indicates that the structure has been outgrown.
A chart of accounts is one of the few setup decisions that quietly determines how useful your books are for years afterward. GlassJar ships with a small, sane default rather than a sprawling generic list, and it keeps classes and tags separate from accounts so the list does not swell every time you want to see a new cut of the numbers. See how it works.
Frequently asked questions
What is a chart of accounts?
A chart of accounts is the master list of categories into which a business sorts its transactions, organized across the five account types. The financial statements are produced directly from those categories.
How many accounts should a small business have?
Most small businesses are served adequately by between 30 and 60 accounts. An account should be created only where the amount reported in that account, seen on its own, would change a decision made by the business.
What numbering should be used?
A common scheme allocates the 1000s to assets, the 2000s to liabilities, the 3000s to equity, the 4000s to revenue, the 5000s to cost of goods sold and the 6000s to operating expenses. Gaps should be left between numbers so that accounts can be inserted later.
Can an unused account be deleted?
An account may be deleted only where the account has never been used. Once transactions have been recorded against an account, the account should be made inactive, because deletion risks orphaning transaction history and corrupting reports for prior periods.
Should the chart of accounts match the tax return?
The chart of accounts should not be structured to match the tax return. The structure should reflect the decisions the business makes each month, and the accountant maps the resulting accounts to the lines of the return as a one time exercise.
