Setting Up a Chart of Accounts Before You Import Anything
- The five groups
- A numbering scheme
- How detailed to go
- Tax accounts: keep them separate
- Accounts every small business needs and often forgets
- Mistakes that are hard to undo
- Where this fits
A chart of accounts is the list of every ledger account your business records transactions in, organised into groups. It decides what your reports can show. Set it up carefully before importing data or starting live entries, because restructuring it after a year of transactions means re-posting or re-mapping everything, and reports built on a poor structure never quite answer the questions you need.
The aim is an account list detailed enough to produce useful management reports and the statutory statements, and short enough that people post to the right account without guessing.
The five groups
Every account belongs to one of five groups. The first three appear in the balance sheet, the last two in the profit and loss account.
| Group | Examples | Normal balance |
|---|---|---|
| Assets | Bank, receivables, stock, equipment, deposits paid | Debit |
| Liabilities | Payables, loans, tax payable, advances received | Credit |
| Equity | Share capital or capital account, retained earnings, drawings | Credit, drawings debit |
| Income | Sales, service income, other income | Credit |
| Expenses | Purchases, salaries, rent, finance costs | Debit |
Within each, create sub-groups that mirror how the financial statements are presented, for example current and non-current assets. That makes the year-end mapping to statutory formats straightforward, and your accountant will thank you.
A numbering scheme
Many accounting packages let you give accounts codes. A simple scheme keeps the list ordered and makes it obvious where a new account belongs:
| Code range | Group |
|---|---|
| 1000 to 1999 | Assets |
| 2000 to 2999 | Liabilities |
| 3000 to 3999 | Equity |
| 4000 to 4999 | Income |
| 5000 to 6999 | Expenses: direct costs first, then overheads |
Leave gaps. If bank accounts are 1100 and 1110, a new bank account can be 1120 without renumbering anything.
How detailed to go
The test for creating a separate account is simple: will someone make a decision, or does a report or return need a figure, based on this amount separately?
- Split sales by line of business if you will analyse profitability by line.
- Split expenses that you manage separately: salaries, rent, marketing, software, travel, professional fees.
- Do not split for curiosity. Separate accounts for tea, coffee and biscuits add posting work and no decisions.
Where your software supports it, use cost centres, tracking categories or tags for dimensions such as branch, project or product line, rather than duplicating every expense account for each. A chart with “Rent – Delhi”, “Rent – Pune” and “Rent – Jaipur” becomes unmanageable when a fourth branch opens; one rent account with a branch tag does not.
There is no correct number of accounts. A small trading or service business can often run well with somewhere in the region of a hundred; the right figure is whatever the decision test above produces. What matters more than the count is that every account has a clear purpose that the people posting to it understand.
Write a one-line description for each account in the software, if it allows, or in a short shared document. “Professional fees: legal, audit and consultancy; not software subscriptions” prevents the drift that turns one account into a catch-all within a year.
Tax accounts: keep them separate
GST. Keep separate ledgers for output tax and input tax credit, and within each for the tax types you use, so the return figures come straight from the ledger balances. Keep any credit you are not entitled to claim out of the input tax ledgers altogether, in the cost of the related purchase or expense, so the ledger balance matches what can be claimed. Separate ledgers for tax payable under reverse charge are also useful if it applies to you.
TDS. Keep a TDS payable ledger, ideally with sub-ledgers or tags by the nature of payment, so the quarterly statements reconcile. Keep TDS deducted by your customers on your receipts in a separate asset account.
Other statutory dues. Provident fund, ESI and professional tax payable each get their own liability account, so a month-end balance tells you exactly what is outstanding.
Accounts every small business needs and often forgets
- Suspense or unallocated receipts, to be cleared monthly. See the suspense account.
- Prepaid expenses and accrued expenses, for month-end adjustments. See prepaid and accrued expenses.
- Advances from customers, kept apart from sales.
- Security deposits paid, such as rent deposits, kept apart from expenses.
- Bank charges and interest, separate from other expenses so finance costs are visible.
- Rounding off, which should stay close to zero.
Mistakes that are hard to undo
- Using the same account for different things in different years. Comparisons across years become meaningless.
- Recording owner withdrawals as expenses. Drawings in a proprietorship or partnership belong in the capital account, not in the profit and loss.
- Creating customer and supplier names as general ledger accounts instead of using the receivables and payables sub-ledger. It clutters the chart and breaks ageing reports.
- Letting everyone create accounts. Restrict account creation to one or two people, with a short written rule for when a new account is justified.
Where this fits
- The posting rules the chart supports: debits and credits explained
- How the accounts roll into the statements: trial balance to balance sheet
- Choosing the software to set it up in: choosing accounting software
- Profit by line, using tags: product line profitability