Setting Up a Chart of Accounts

beginner6 min read · updated 2026-06-20

Setting Up a Chart of Accounts

Your chart of accounts (COA) is the master list of every bucket your money flows into and out of. Every transaction your business ever records gets assigned to exactly one of these accounts. Get the structure right at the start and tax season, financing applications, and "where did the money go" questions answer themselves. Get it wrong and you spend years re-categorizing transactions.

The IRS does not mandate a specific chart of accounts, but it does require that your books "show your gross income, as well as your deductions and credits" and that the system summarize your transactions in journals and ledgers (gross income / deductions / credits). A well-built COA is simply the practical way to meet that requirement.

Educational content, not tax or accounting advice. Entity type (sole prop, LLC, S-corp, C-corp) changes how equity and tax categories should be structured. Confirm your setup with a licensed CPA.

The Five Core Categories

Every chart of accounts is built on the same five top-level types (5 categories). The first three form your balance sheet; the last two form your income statement (profit and loss).

• Assets - what the business owns: cash, bank accounts, accounts receivable, inventory, equipment.
• Liabilities - what the business owes: credit cards, loans, accounts payable, sales tax collected.
• Equity - the owner's stake: contributions, draws/distributions, retained earnings.
• Revenue (Income) - what you earn from operations: product sales, service income.
• Expenses - the costs of running the business: advertising, supplies, rent, utilities, contract labor.

Account Numbering

A numbering scheme lets you sort and group accounts predictably. A widely used convention assigns a thousand-number block to each category (1000-number blocks per category):

• 1000-1999 Assets
• 2000-2999 Liabilities
• 3000-3999 Equity
• 4000-4999 Revenue
• 5000-9999 Expenses (often split: 5000s cost of goods sold, 6000s+ operating expenses)

The SBA's own published chart of accounts for SBICs uses a layered digit scheme where leading digits denote the major category and trailing digits identify the specific ledger account (major-category-then-account digit scheme) - the same principle scaled to a regulated entity.

Leave gaps. If your first expense account is 6010 and the next is 6020, you can insert 6015 later without renumbering everything.

Step-by-Step Setup

• Pick your accounting basis. Cash or accrual. Most small service businesses start on cash basis; inventory-heavy businesses often need accrual. The IRS recommends recording transactions on a regular (ideally daily) basis regardless of method (record on a regular/daily basis).

• List your bank and credit accounts as assets/liabilities. One COA account per real-world account: business checking, business savings, each credit card. This makes reconciliation 1-to-1.

• Mirror your tax form's expense lines. This is the highest-leverage decision. If you file Schedule C as a sole proprietor or single-member LLC, create expense accounts that match its line items - Advertising, Car and truck, Contract labor, Insurance, Legal and professional services, Office expense, Rent or lease, Supplies, Travel, Meals, Utilities, and Wages (Schedule C expense lines 8-26). When your accounts mirror the form, your accountant pulls totals directly with no reclassifying.

• Add the IRS supporting-document buckets you actually generate. Pub 583 groups records into gross receipts, purchases, expenses, travel/transportation/entertainment/gift, assets, and employment taxes (6 record categories). Make sure each category that applies to you has at least one home in your COA.

• Separate Cost of Goods Sold from operating expenses. If you sell physical products, the direct cost of those goods is its own block (5000s) so you can see gross margin separately from overhead.

• Set up equity accounts for your entity type. A sole prop needs Owner's Contributions and Owner's Draws. An S-corp needs additional accounts for distributions and shareholder loans. This is where a CPA's input matters most.

• Keep it lean to start. Open only the accounts you will actually use in the first 90 days. An over-engineered COA with 200 accounts you never touch is worse than 30 accounts you maintain cleanly. Add accounts as real transactions demand them.

• Document a one-line rule per account. Write what belongs in each account ("Supplies = consumables under $200 used in operations"). This keeps categorization consistent month to month and across anyone who touches the books.

What to Avoid

• Catch-all "Miscellaneous." It hides deductions and triggers questions. If you use it more than rarely, you are missing a real account.
• Mixing personal and business. Keep separate bank accounts. Commingling muddies every report and weakens liability protection for LLCs/corps.
• Renaming or deleting accounts mid-year. It breaks year-over-year comparisons. Mark accounts inactive instead of deleting them.

Recordkeeping Beyond the COA

The chart of accounts is the summary layer; behind it sit the supporting documents. Keep receipts, invoices, deposit slips, and canceled checks - electronic copies are acceptable as long as they meet the same standards as paper (electronic records held to same standard as paper). Retain employment tax records for at least four years (4 years).

The Bottom Line

Build five categories, number them in blocks with gaps, and mirror your tax form's expense lines. That single alignment between your COA and your filing form removes the most painful, error-prone part of bookkeeping - and lets a financing application or audit be answered from a report instead of a shoebox.