Chart of accounts is a list of all the accounts that an entity has identified for recording business transactions using double entries. This list is not exhaustive and can be modified according to the needs of the business. For example, at the start of the business, an entity has no investment property and has no intention to purchase one as well. So, its chart of accounts initially has no account for investment property. After some years, there were some surplus funds accumulated due to high profits earned by the business over the years. The entity decided to purchase a building to earn rental income from it. To record this transaction, chart of accounts is modified to add investment property account and then transaction is recorded using that account. Similarly, new accounts can be added or can be removed from the chart of accounts of an entity as required.
As studied in the chapter “accounts”, there are five main categories of accounts in which all business transactions are classified:
- Income (or revenue)
Chart of accounts contains all the accounts falling in the above five categories along with relevant contra accounts. As explained at the beginning of this article that an entity can tailor its chart of accounts as it seems fit, so, an entity can opt for either using the above five categories of accounts only, or it can add as many categories as it likes. For example, asset accounts and liability accounts can be further categorized into non-current and current assets and liabilities. For income, operating and non-operating categories can be used. For expenses, direct and indirect expense categories can be used. Similarly, a large corporation with numerous departments can further break down and categorize its chart of accounts based on its departments. Chart of accounts of small companies will be relatively smaller and with less categories whereas multinational and large corporations with complex and diversified operations will have a large chart of accounts. However, one thing is common in all chart of accounts, i.e. it will be structured and organized according to its categories of accounts.
Chart of accounts is the comprehensive list of accounts which is used by the accountants to select relevant accounts and record business transactions. For recording business transactions, rules of debits and credits are followed and at least two accounts are used as required by double-entry accounting system. Our next chapter will show you a sample chart of accounts for further clarity of this topic.