Chart of Accounts -
What is it?
What does it do?
Why do I need it?
How do I make it?
The Chart of Accounts - What Is It?
The Chart of Accounts is essentially a list of all the accounts you need to use in your bookkeeping. While several account or line items are normal to all businesses, some are industry specific. That is why all Chart of Accounts are not created equal.
What Does It Do?
The Chart of Accounts is the road map for your accounting.
This "road map" is the guide to how all your business transactions are categorized. The Chart of Accounts is also a factor on how your financial statements will look. It gives you or your accounting professional a designated space to put like transactions in.
Why Do I Need it?
If your Chart of Accounts is not set up properly, then transactions (also known as income, expenses, journal entries, payroll) can be entered into the wrong accounts, thus making your accounting records inaccurate.
This can create all kinds of havoc like overstating or understating your income and/or expenses, not properly accounting for payroll taxes and more. It can also hurt your overall dollar amount in possible tax deductions when it comes to filing your taxes. If you have $800 in office supplies, however, only $500 is coded to Office Supplies, then you could possibly lose $300 of tax deductions. In the same way, overstating your income could cause unnecessary income taxes.
For the tax deductions, you may be thinking it will all even out, however, that may not be true. Though I used a standard tax deduction in my example above (office supplies) there are many rules for tax deductions. In simple terms, some businesses can deduct items that other business can't. Here is an example:
Sue runs a luxurious spa that offers facials and body massages. For Sue to run her business successfully, she needs many towels, slippers and robes. She also needs to keep these items clean and sanitary for her clients, so she employs a laundry service that picks up and delivers her freshly laundered supplies. This service is probably a Cost of Services Sold and would be a tax deduction for Sue. If the expense for the laundry is accidentally recorded into another account that does not qualify for a tax deduction for Sue, she could be losing money.
However, Joe runs a video store down the street from Sue. He wants to also have his laundry picked up and delivered. This is not a service that is necessary to Joe running his business. This would not be considered a tax deduction for Joe's business, even if he pays for this service through his business account. (More on this subject in another blog post.)
How do I make it?
If you use a program like QuickBooks, Xero, Wave accounting, etc., when you first set up your accounting books, the program will help you (sort of) by asking you questions and giving you a general Chart of Accounts. Honestly, this is an ok start but not ideal.
So, you see, the Chart of Accounts is truly a road map for your accounting. Setting the accounts up correctly or having an accounting professional set them up can lead to you having a happy relationship with your bookkeeping. And don't you want a happy relationship with your business bookkeeping?
If you have any further questions about this or other bookkeeping subjects, please contact me at Rebecca@RHBizSolutions.com. I look forward to talking to you about your bookkeeping needs.
Here's To Your Success!
RH Business Solutions
Any accounting, business or tax advice contained in these articles, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. Please seek consultation from the appropriate accounting/tax professional.