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What is Chart of accounts?
It is list of the accounts used by a business entity to define and record each class accounting transactions in business’s accounting systems. It is used to organize the finances of the entity and to segregate assets and liabilities, revenue and expenditures.
Each account in the list is typically assigned a name and a unique code (numeric or alpha numeric) by which it can be identified. It is preferable to use numeric codes instead of alpha numeric codes.
An account in the list represent a nature of accounting transactions, for example Salaries & wages, Rent, Electricity etc.
Why chart of accounts is important?
It is critical part of accounting systems of a business entity and the form part of data dictionary of the business. A properly defined chart of accounts will be beneficial to a business in many ways:
1. It defines the flow of information into the general ledger, which is the center part of the business’s accounting systems.
2. It helps preparation of financial statements in order to give interested parties a better understanding of the financial health of the entity.
3. Analysing the business will become very easy. It helps to write reports and automate the analysis more efficiently in the accounting systems.
4. It will help to query information from the accounting systems quickly and efficiently to help decision making.
How to prepare chart of accounts?
It is very easy to prepare one, however maintaining a logical order is very important. It should best represent business entity information and reporting needs. It should also be simple and easy to understand.
You should consider the all the different functions of the business, they way internal management is structured and internal and external reporting requirements.
Generally, start with the 4 broad categories of accounts, Assets, Liabilities, Income and Expenses. And carefully expand to the specific needs of the business.
Many accounting software comes with the char of accounts and modifying them to suite the business needs is essential before implementing one. It’s often a costly exercise to alter as you might loose historical data attached to an account.
By adding dimensions to chart of accounts like cost centers/profit centers or locations information you can improve the efficiency of it depending of the complexity of your business.
It is important to have proper control over adding and deleting items from the chart of accounts. Establish internal control system for authorising changes to the chart. It is critical part of your financial management and control.
Review your chart of accounts on a regular basis (at least annually) to ensure it’s relevance, accuracy and completeness. A proper chart will help you monitor the business activities and optimise use of accounting systems monitor and improve performance.