What is a Chart of Accounts?

Definition of Chart of Accounts

A chart of accounts is a hierarchical arrangement of financial accounts used in an accounting system. It is considered an organizational structure that provides a comprehensive view of the various financial accounts used in an institution or company.

Method of Preparing Chart of Accounts

Preparing a chart of accounts is a systematic process that requires careful planning and deep understanding of the business nature and its accounting requirements. The process begins by identifying the main account categories which include assets, liabilities, equity, revenues, and expenses, as these categories form the foundation upon which the accounting structure of the organization is built.

After identifying the main categories, each category is divided into more detailed subcategories to facilitate classification and monitoring. For example, assets can be divided into fixed assets and current assets, while expenses can be divided into operating expenses and administrative expenses. This division helps obtain a clearer view of the financial position and performance of the organization.

In the final stage of preparation, detailed accounts are created under each subcategory, which represent specific elements such as cash in banks, inventory, and machinery and equipment. These detailed accounts are what receive actual accounting transactions and provide the accurate data necessary for preparing financial reports.

Companies usually adopt account numbering as follows:

• Assets: (1)
• Liabilities: (2)
• Equity: (3)
• Revenues: (4)
• Expenses: (5)

Under each main account, its sub-accounts are listed. Illustrative examples:

Illustrative Example (1): Company Cash Accounts to the Third Level

• 1 Assets
  • 11 Current Assets
    • 1120 Cash
      • 11201 Main Bank Account
      • 11202 Secondary Bank Account
      • 11203 Cash Box

Illustrative Example (2): Fixed Assets Accounts to the Second Level

• 1 Assets
  • 12 Fixed Assets
    • 1201 Office Furniture
    • 1202 Equipment and Machinery

Illustrative Example (3): Revenue Account for Company's Main Branch to the Second Level

• 4 Revenues
  • 41 Main Branch Revenues
    • 4101 Service Revenues
    • 4102 Product Sales Revenues
    • 4103 Other Revenues

General Note: No transactions can be entered into main accounts because they are summary accounts for last-level accounts. For clarification, as in example (1), accounts numbered 1, 11, 1120 are all main summary accounts. However, accounts 11201, 11202, 11203 are non-main accounts that accept transactions because they are non-summary accounts.

Basic Accounts

The classifications and size of chart of accounts vary according to each organization, but all organizations share 5 main accounts:

1. Assets - All resources owned by the company
2. Liabilities - All debts and financial obligations
3. Equity - Capital and shareholders' rights
4. Revenues - All income and returns
5. Expenses - All costs and expenditures

Importance of Chart of Accounts

Chart of accounts plays a pivotal role in the success of accounting and financial operations of any organization, serving as the backbone of the accounting system relied upon for making financial and administrative decisions. The importance of chart of accounts is reflected in the following points:

• Easy access to the organization's financial data
• Organization of financial data
• Facilitating the preparation of reports and financial statements
• Ability to monitor and review accounts easily
• Obtaining accurate data based on the existence of account coding which prevents number duplication
• Easy recording of journal entries

Chart of Accounts in Mizan

When subscribing to the Mizan system, our support team helps you establish the chart of accounts in the correct manner suitable for your needs and business activity. We can also help transfer your existing chart of accounts from your current system to the Mizan system.

Frequently Asked Questions

1. What is the difference between a main account and a sub-account?

A main account is a summary account that does not accept direct accounting transactions, while a sub-account (last level) is the account that accepts recording actual financial transactions.

2. Can the chart of accounts be modified after starting to use it?

Yes, new accounts can be added or account names can be modified, but it is recommended not to delete accounts that contain balances or previous transactions to avoid data loss.

3. How many levels are appropriate for a chart of accounts?

This depends on the size and nature of the organization, but usually ranges between 3-5 levels. Small companies may be satisfied with 3 levels, while large companies may need 5 levels or more.

4. Are there specific standards for account numbering?

There are no mandatory standards, but the commonly accepted practice is to use (1) for assets, (2) for liabilities, (3) for equity, (4) for revenues, and (5) for expenses.

5. What if I need to add a new account that wasn't originally planned?

New accounts can easily be added at any time, and it is recommended to number them in accordance with the existing hierarchical sequence to ensure organization.

6. Does the chart of accounts vary according to the type of business activity?

Yes, the details of the chart of accounts differ according to the nature of the activity. A manufacturing company's chart of accounts differs from a service or trading company in some specialized accounts.