A client pays you. The software asks which account gets the money. You pick a category at random and the profit report lies to you for the rest of the year.
A simple chart of accounts stops that guess. Each dollar gets a name you can read in December.
Key Takeaways
- A chart of accounts is the list of names you use to record every transaction. AccountingCoach calls it the listing available in the general ledger.
- Five types cover the list. Bench names revenue and expenses and assets and liabilities and equity.
- Start with a short list and delete what you will not use. AccountingCoach's small-company sample is a starter. A department-level chart belongs to a larger company.
- Name the account for the work. An unmarked lunch receipt does not tell you after six months whether the meal was for a client. Bench uses that test.
- Add a missing account during the year. Bench says to wait until year end before you delete one. A mid-year delete can scramble the books.
Table of Contents
What a chart of accounts does for you
A chart of accounts for a small business is the menu of buckets in your books. AccountingCoach defines it as the account names a company makes available for the general ledger. You can tailor the list. You can add an account when the work needs one.
Bench describes the same list as a bird’s-eye view of where the business makes money and where it spends money. Someone who reads the names should get a rough idea of the business. A design studio and a shop that sells goods should not share an identical menu.
The IRS does not hand you that menu. IRS Publication 583 says the law does not require a specific kind of records except in a few cases. Any system that shows your income and your expenses is allowed. The books have to show gross income and your deductions and your credits. A ledger holds the totals from your journals and organizes them into accounts.
SCORE treats the daily work as five verbs. You categorize. You organize. You track. You record. You balance. Memory is not the system. SCORE says owners who skip written records can learn about trouble after the chance to fix it has passed.
Those bookkeeping categories feed two reports. Bench splits the accounts by the statement they support.
Balance sheet accounts are assets and liabilities and equity. The balance sheet is a snapshot. IRS Publication 583 says it shows assets and liabilities and your equity on a given date.
Income statement accounts are revenue and expenses. The income statement shows income and expenses for a period of time.
Bench states one link between the two reports. Revenues increase equity and assets. Expenses decrease assets and equity. AccountingCoach writes the relationship as an equation. Assets equal liabilities plus owner’s equity. For a corporation the equity side is stockholders’ equity.
The five types and what belongs in each
Use these business accounting categories as the frame. The line items under them are the accounts. Bench says the right accounts follow the business. A sample name from another industry is a clue. It is not your list.
Assets
An asset is a resource the company owns. AccountingCoach says it needs future economic value you can measure in dollars. Cash qualifies. So do investments and accounts receivable and inventory and supplies and land and buildings and equipment and vehicles. Bench adds intangibles you can measure, such as patents and trademarks and software.
Reputation and a customer list and a brand and a strong team stay off the balance sheet when you cannot measure them in dollars. AccountingCoach is direct about that limit.
AccountingCoach says the balance sheet reports assets at cost or lower. Current assets are the ones you expect to turn into cash or use up within one year. If the operating cycle is longer than a year, that longer cycle is the window. AccountingCoach lists them in liquidity order. Cash comes before receivables. Receivables come before inventory.
Liabilities
A liability is an amount the company owes. AccountingCoach points to lenders and suppliers. The word payable shows up in many titles. Unearned revenue is a liability too. The customer paid before you delivered the goods or the service. The liability shrinks when you deliver.
Equity
Equity is what remains after you subtract liabilities from assets. Bench calls it the value left for the owner or the shareholders. AccountingCoach’s small-company sample uses two owner accounts. One is Capital. It holds what the owner invested plus earnings the owner has not taken out. The other is Drawing. It holds personal withdrawals for the current year. At year end the drawing balance moves into Capital.
Those two names in the sample belong to a sole proprietor. AccountingCoach labels them with a sample owner name. Rename them for the real owner. A corporation sample on the same site uses common stock and retained earnings and treasury stock. An LLC should ask a preparer which equity accounts match the tax election. IRS Publication 583 says that election can be a disregarded entity or a partnership or a corporation. This guide does not pick the equity titles for you.
Income
Income categories for a business track what you earn. Bench includes sales of goods and services and rent. AccountingCoach’s small-company sample starts with Service Revenues. A cash job increases Service Revenues and Cash. A job on credit increases Service Revenues and Accounts Receivable.
Interest you earn on a bank account sits apart from operating revenue in that sample. AccountingCoach files it under non-operating revenue.
Expenses
Expense categories for a small business are the costs of producing that revenue. Bench names utilities and wages and rent as the plain examples. AccountingCoach separates operating expenses from costs that sit outside the main work. A retailer’s interest cost is non-operating in that explanation. A bank’s interest cost is operating because lending is the main work. Match the label to the company’s main work.
A cost has to be ordinary and necessary before it is a deduction. IRS Publication 583 defines both words. Ordinary means common and accepted in your field. Necessary means helpful and appropriate. The expense can qualify without being indispensable. The category name does not create the deduction. A receipt has to show a business cost. Publication 583 says proof of payment alone is not enough.
A basic chart of accounts you can start with
AccountingCoach publishes a partial small company chart of accounts with three-digit numbers. The first digit marks the type. In that sample a 1 is an asset and a 3 is a revenue account. Treat the list as a starter for a simple service business or a small shop. Delete every account you will not use. Add accounts that match the work. Bench makes the same cut. If you do not drive for work, drop an auto account. If a cost you pay is missing, add it.
The numbers below are AccountingCoach’s sample. Some small-business software does not require numbers at all. If you assign numbers yourself, pick one pattern and keep it. AccountingCoach’s large-company sample uses a 1 for assets and a 5 for operating expenses. Bench describes a different pattern. A 1 is an asset. A 2 is a liability. A 3 is equity. The two patterns disagree on what 3 means. Your books need one pattern.
Assets
| No. | Account | What it holds |
|---|---|---|
| 101 | Cash | Checking balance plus currency and coins and customer checks you have not deposited |
| 120 | Accounts Receivable | Amounts clients owe for services or products |
| 140 | Merchandise Inventory | Cost of merchandise bought and not yet sold |
| 150 | Supplies | Supplies on hand. Used supplies move to Supplies Expense |
| 160 | Prepaid Insurance | Premiums paid that cover a future period |
| 170 | Land | Cost to acquire and prepare land |
| 175 | Buildings | Cost to buy or construct buildings |
| 178 | Accumulated Depreciation – Buildings | Building cost allocated to Depreciation Expense since purchase. This account increases with a credit |
| 180 | Equipment | Cost to acquire and prepare equipment |
| 188 | Accumulated Depreciation – Equipment | Equipment cost allocated to Depreciation Expense since purchase. This account increases with a credit |
Skip land and buildings when you do not own them. Skip merchandise inventory when you sell time rather than goods. A manufacturer tracks a wider inventory than this merchandise line. AccountingCoach says that inventory includes raw materials and work in process and finished goods. Include the costs to acquire the items and to get them ready for sale.
Customers who pay late may never pay. AccountingCoach uses a contra account called Allowance for Doubtful Accounts against Accounts Receivable. The receivable minus that allowance is the net realizable value. The sample does not give you a percentage to book. Ask a preparer before you record one.
Liabilities
| No. | Account | What it holds |
|---|---|---|
| 210 | Notes Payable | Principal on a formal promise to pay. Bank loans sit here |
| 215 | Accounts Payable | Suppliers you have not paid yet |
| 220 | Wages Payable | Hours worked that you have not paid |
| 230 | Interest Payable | Interest owed on notes through the balance sheet date |
| 240 | Unearned Revenues | Cash received before you deliver |
| 250 | Mortgage Loan Payable | A loan with a lien on real estate |
A service business with no employees and no loan can live with accounts payable and unearned revenue. Add wages payable when you have people on the clock. Add the note and the mortgage when a lender is in the picture.
Equity
| No. | Account | What it holds |
|---|---|---|
| 290 | Owner Capital | Money or other assets the owner put in plus earnings not taken out |
| 295 | Owner Drawing | Personal withdrawals for this year. The balance moves into Capital at year end |
Use common stock and retained earnings when the company is a corporation and the large-company sample fits the return. Do not copy a sole proprietor drawing account onto a corporate return because the sample listed it.
Income categories
| No. | Account | What it holds |
|---|---|---|
| 310 | Service Revenues | Amounts earned from services for cash or on credit |
| 810 | Interest Revenues | Interest or dividends on bank accounts or investments or notes. Non-operating in this sample |
A shop that sells products needs a sales account of its own. AccountingCoach’s large-company sample splits sales by division and product line. A new company can start with one sales account and split it when the lines deserve separate totals. Bench’s naming example is specific on purpose. One revenue account might be ice cream sales. The point is the name. It should say what you sell.
Rent you collect from someone else is revenue. Bench lists rent among revenue sources. It is not the same account as the rent you pay.
Expense categories
| No. | Account | What it holds |
|---|---|---|
| 500 | Salaries Expense | Fixed pay for salaried employees |
| 510 | Wages Expense | Hourly pay |
| 540 | Supplies Expense | Supplies used up this period |
| 560 | Rent Expense | Cost of rented space for the period |
| 570 | Utilities Expense | Electricity and heat and water and sewer |
| 576 | Telephone Expense | Phone cost for the period |
| 610 | Advertising Expense | Ads and promotions and other selling costs besides salaries |
| 750 | Depreciation Expense | Long-term asset cost allocated to this period |
SCORE’s expense ledger lines up with part of this list. It names accounts payable and payroll and rent and other recurring costs. Your ledger should be able to show those.
Goods you buy in order to sell need their own bucket. Bench separates that cost from ordinary expenses. Bench says retailers use the name cost of sales. Manufacturers use the name cost of goods sold. AccountingCoach says cost of goods sold is the main expense for a company that sells goods. Under a perpetual inventory system it is a ledger account. Under a periodic system there is no cost of goods sold account. You compute it. Start with beginning inventory. Add net purchases. Add freight in. Subtract ending inventory.
Insurance that expires this period belongs in an insurance expense account. The small-company sample shows the prepaid asset. AccountingCoach’s discussion of expenses names Insurance Expense as the amount that matches the period. Advertising Expense is the cost of ads that ran during the period. It sits with selling expenses.
What to leave off the first list
AccountingCoach shows a second partial chart for a large corporation. Account numbers run five digits or more. A small local retailer may need as few as one hundred accounts. An international company with divisions may need thousands. The large sample is a warning about size. It is not the day-one list for a new LLC.
That larger sample adds payroll checking and petty cash and allowance for doubtful accounts and vehicles and credit lines and bonds and treasury stock. It splits sales and cost of goods sold by division and product line. It gives each department its own salaries and payroll taxes and supplies and telephone. AccountingCoach says a company organization chart can outline the accounts. Ten departments can mean ten phone accounts.
You do not need that split on day one. Add a department account when a manager has to answer for the spend. Until then one telephone account tells the truth.
Petty cash is the exception worth adding if you pay small costs in cash. IRS Publication 583 describes a petty cash fund for small payments. Write a petty cash slip and attach the receipt. AccountingCoach’s large sample gives petty cash its own asset number.
A gain or a loss on the sale of an asset other than inventory is its own account in both samples. You use it in the year you sell equipment or a building for more or less than book value. You do not need it on the morning you open the checking account.
How a transaction picks an account
IRS Publication 583 says a journal is where you record each transaction from a supporting document. The ledger then holds the totals by account. Supporting documents include sales slips and paid bills and invoices and receipts and deposit slips and canceled checks. Organize them by year and by type of income or expense.
Two habits keep the categories honest. Record the expense when it happens. Identify the source of each receipt. Publication 583 says a daily record is the better habit. Reconcile the business checking account each month so the statement and the checkbook and the books agree. For most small businesses that checkbook is the main source of the entries.
You choose cash or accrual when you file the first business return. The books and the return use the same method. A change after that first return needs IRS approval in most cases.
Cash reporting puts income in the year you receive it and expenses in the year you pay them. Accrual reporting puts income in the year you earn it and expenses in the year you incur them. The account name can stay the same. The timing changes. Rent shows the difference. Under accrual, Rent Expense is the cost of the space for the period on the income statement. Rent paid before the period arrives sits in Prepaid Rent. AccountingCoach draws that line.
Inventory can force the method. Publication 583 says an accrual method applies to purchases and sales when inventory is needed to account for your income. Certain small taxpayers may use the cash method. The publication points that exception to Publication 538. Confirm it before you choose. This guide does not set the dollar test.
Single-entry or double-entry
Publication 583 says you pick one. Single-entry is the simpler system. It follows the income statement. It can work at the start through a daily summary of cash receipts and monthly summaries of receipts and payments. Bench says that fit is a new owner doing the books alone. Assets and liabilities such as inventory and equipment and loans sit in a separate record.
Double-entry uses at least two accounts for every transaction. One is a debit. One is a credit. AccountingCoach states the rule. After you post, total debits equal total credits. A mismatch is an error you can find. IRS Publication 583 uses a rent illustration. Rent Expense is debited for $780. Cash is credited for $780. That pair is an example of the form. Your rent is whatever the lease says.
AccountingCoach gives the balance rules in plain language.
- Expense accounts carry debit balances. A debit increases them.
- Revenue accounts carry credit balances. A credit increases them.
- Asset accounts normally carry debit balances. Debit to increase them. Credit to decrease them.
- Liability accounts normally carry credit balances. Credit to increase them. Debit to decrease them.
Most accounting software uses double-entry. Bench says a hired bookkeeper or accountant uses it too. The software can ask for only one account when you write a check. AccountingCoach explains why. The program reduces Cash on its own and asks you to name the other account. That other account might be Rent Expense or Advertising Expense. The category you pick is the one that lands on the profit report.
Close the income and expense accounts at the end of each tax year. IRS Publication 583 says to keep the asset and liability and net worth accounts open. Next year starts with those balances. The income and expense accounts start fresh.
Build the list around the work
SCORE says every business should be able to produce a short set of facts. Sales and operating results. Fixed costs and variable costs. Profit or loss. Inventory levels. Credit and collection totals. A comparison of the plan with the actual result. A profit and loss statement and a cash budget and a balance sheet. Tax returns and reports to the government.
The day-to-day files behind that list are concrete. SCORE names a daily summary of cash receipts and an expense ledger and an inventory record and an employee record and an accounts receivable record for credit sales. If your chart cannot feed those files, the chart is missing an account.
A practical pass looks like this.
- Write down the ways money comes in. Services. Product sales. Rent you collect. Interest. Give each stream its own income account when you make decisions from the split. Keep one account when you do not.
- Write down the costs you pay every month. Rent. Utilities. Phone. Payroll if you have it. Supplies. Advertising. Those are the track expenses categories for month one.
- List what you own and what you owe. Cash. Equipment. Unpaid supplier bills. Customer prepayments. Loans.
- Delete sample accounts you will not touch. Bench’s test is simple. No driving means no auto account.
- Leave number gaps if you use numbers. AccountingCoach leaves gaps so a new account can sit beside related accounts.
- Ask a bookkeeper or a CPA to read the list before you post a year of transactions. Bench recommends that conversation so the accounts match your field and match what the preparer expects. SCORE says the accountant does not have to post the daily entries. The bookkeeper needs enough skill to keep the records. The accountant helps you decide which records to keep. Bring that review in before the year piles up.
Accounting software includes sample charts. AccountingCoach expects you to change the sample. After the transactions become routine, add accounts you need and delete accounts you never use. Bench adds a timing rule. Add an account any time in the year. Wait until year end to delete one. A delete in the middle of the year can mess up the books.
Bench illustrates the mid-year add with a fictional clinic. The owner sees one supply cost growing and wants it alone. She adds a new expense account. An adjusting entry debits the new account for two thousand dollars. It credits the old supplies account for the same two thousand dollars. The costs move. The total expense does not change. Copy the form of the entry. Use your own account names and the amount you spent.
Accounts that protect the tax return
Some costs feel like expenses and belong on the balance sheet first. IRS Publication 583 says property with a useful life well beyond the purchase year is not fully deducted in that year. Office furniture and buildings and machinery and equipment are the examples. You spread the cost. That spread is depreciation. You may elect a section 179 deduction for a limited amount in the year you place the property in service. Publication 946 is the IRS guide for the rules.
The asset file has to support the deduction and the sale. Publication 583 says the records should show when and how you acquired the asset. They should show the purchase price and improvements. They should show section 179 and depreciation taken. They should show how you used the asset and the sale price and the expenses of the sale. Accumulated depreciation and Depreciation Expense are how the chart carries that story. A single office-expense bucket hides it.
A computerized system has a matching duty. Publication 583 points to Revenue Procedure 98-25 for computerized records. Those records must reconcile with your books and your return. They must identify the source documents. You keep a chart of accounts and a description of the system. The description covers what the software does and the controls that protect the records.
A corporation has one more file. Publication 583 says a corporation keeps minutes of board meetings. The chart does not replace the minute book.
SCORE notes the inspection rule in plain language. The IRS does not require one branded system. It does require permanent records that show taxable income and expenses and deductions. Those records have to be available for inspection.
Where a short list breaks
These are the misses the sources point to.
- One bucket called miscellaneous. You cannot see rent or payroll or ads. SCORE’s expense ledger exists so those costs stay visible.
- A sample chart you never edit. AccountingCoach expects you to modify the sample. Unused accounts add noise. Missing accounts shove real costs into the wrong name.
- A deleted account in March. Bench says the deletion can mess up the books. Add now. Delete at year end.
- Personal withdrawals posted as an expense. AccountingCoach puts them in a drawing account that closes into capital. They are not rent.
- Customer prepayments posted as revenue on the day the cash arrives when you have not done the work. Unearned revenue is the liability until you deliver. The books have to use the same method as the return. Publication 583 ties the books to that method.
- A truck or a laptop dumped into supplies. Long-lived property belongs in an asset account. Depreciation or section 179 handles the deduction. Publication 946 covers the election.
- Two numbering systems in one file. Pick AccountingCoach’s small-company pattern or Bench’s 1-2-3 pattern. Do not mix them.
- A lunch with no category. Bench says the receipt will not explain the meal. Client meals and staff meals are different accounts if you need the split.
- Cost of goods sold ignored by a shop. The gross profit number stays hidden. AccountingCoach treats that cost as the match for sales.
- Equity copied from the wrong sample. Sole proprietor capital and drawing are not common stock. Ask the preparer which titles match the LLC election.
Set the categories up this week
You can put a usable LLC chart of accounts in place before the next deposit.
- Open a page with five headings. Assets. Liabilities. Equity. Income. Expenses.
- Copy only the AccountingCoach small-company lines you will use this year. Rename Capital and Drawing if a preparer gives you different equity titles.
- Add one income account per stream you sell. Add one expense account per recurring cost.
- Write a one-line description under each name so a future entry picks the same account. AccountingCoach’s sample includes those descriptions for this reason.
- File receipts by year and by the account name. Publication 583 wants the type of income or expense on the file.
- Record each transaction on the day it happens. Reconcile when the bank statement arrives.
- Review the list at the first month end. Add a missing account. Leave unused accounts in place until year end if they hold entries.
- Book a short review with a bookkeeper or a CPA. Confirm the names will support the return and the balance sheet.
A handful of transactions can live in a spreadsheet. Bench treats each account as a category on that sheet. Income is money in. Expense is money out. A longer feed is harder to keep consistent by hand. AccountingCoach notes that the software can post the cash side of a check and ask you for the expense. QuickBooks Online is one place to keep those small business account categories in one list. Use the first month as setup. Match each name to a real cost. Tie each entry to a receipt.
Bench warns that a cloud tool creates a long cleanup when the setup is wrong and the error runs for a year. A review in that first month prevents the rewrite. If the names are drifting, put the business accounts in QuickBooks Online or a similar system only after the preparer agrees with the names.
The chart is finished when a stranger can read a deposit and an expense and know what the company did. Next month uses the same names. The profit report starts to mean something.
