In plain English
It groups accounts into assets, liabilities, equity, income and expenses. A short, clear list makes reports easier to read.
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Add accounts only when you will act on the detail.
Why it matters
Your chart of accounts decides what your reports can tell you. If everything lands in a catch all category, you cannot see how much you spend on marketing or which revenue stream is growing. If you have hundreds of accounts, reports become too long to read and transactions get sorted inconsistently.
A clean chart also makes tax prep smoother. When your accounts roughly follow the lines on your return, your preparer can map them quickly. Changing the chart in the middle of a year makes comparisons harder.
Worked example
A small service firm might use checking, receivables, a credit card, sales tax payable, owner equity, service income, rent, software and insurance: 20 to 30 accounts is plenty for most.
How to handle it
- Export the current chart of accounts and mark any accounts with no activity in the past year.
- Merge or make inactive the duplicates and unused accounts, rather than deleting ones with history.
- Group expense accounts so they make sense on a one page profit and loss.
- Write a short guide listing which kinds of transactions go to each account.
- Review the chart with your accountant once a year, ideally before the new year begins.
Common mistakes
- Creating a new account for every vendor, which bloats reports and hides the bigger picture.
- Using an account like miscellaneous or ask my accountant for large amounts, which leaves the profit and loss hard to trust.
- Deleting accounts that have past activity, which can move old transactions into a default account.
- Renaming an account so its meaning changes, which mixes old and new types of transactions under one label.
Not the same as: General ledger
The chart of accounts is the list of account names and types. The general ledger is the full record of the transactions posted to those accounts. See General ledger.
Go deeper
- Chart of accounts for a small business: how to set one up: What a chart of accounts is, how many categories you actually need, and a clean starting structure for a small business.
- Expense Categorization Rules of Thumb: Practical rules for categorizing business expenses consistently: how to choose categories, handle gray areas and keep tax time simple.
Related terms
- Clearing account: A temporary account that holds money or entries until they are matched to the final destination.
- Cost of goods sold (COGS): The direct cost of the products or services you sold during a period.
- Chargeback: A reversal of a card payment forced by the cardholder's bank, usually after a dispute.
Common questions
What is a chart of accounts?
The list of accounts a business uses to sort its transactions.
Can you give an example of chart of accounts?
A small service firm might use checking, receivables, a credit card, sales tax payable, owner equity, service income, rent, software and insurance: 20 to 30 accounts is plenty for most.
Should I use the default chart of accounts my software provides?
It is a reasonable starting point, but it usually includes accounts you will never use. Trim it and adjust names so they fit your business.
When should I add a new account?
Add one when you will make a decision with that detail, such as tracking a new revenue stream. If you would never look at it separately, a class, tag or memo may be enough.
General information, not tax, legal or accounting advice. Confirm rules with the IRS, the NJ Division of Taxation or a licensed professional.
