The sales and purchasing processes affect the chart of accounts and financial reports.
The chart of accounts structure can help you present financial reports in a clear and structured way.
The chart of accounts is an index of all G/L accounts used by a business.
The documents in the sales and purchasing processes create automatic journal entries that are registered in the Journal Entry file and affect the account balances. The account balances are also affected by manual journal entries and other accounting transactions.
A chart of accounts arranges a company's general ledger accounts in a hierarchical structure by levels. Level 1 is the top title and there are maximum of 10 level 1 titles. Level 1 consists of sections or groups for different types of accounts (e.g. assets, liabilities, capital and reserves, turnover). You can change the first level title if required. The updated name will then appear in the financial reports.
In the General Ledger, we distinguish between Balance Sheet accounts and Income Statement accounts, also called Profit and Loss.
- Balance Sheet Accounts: the first 3 level 1 titles: Assets, Liabilities, and Equity (or Capital and Reserves) typically hold the Balance Sheet Accounts, such as the Sales Tax and the Accounts Payable Account. The bookkeeping balance of these accounts is kept from one fiscal year to the next. The Balance Sheet Accounts – reflect the Monetary value of the company - stock, assets, debt, etc.
- Profit and Loss accounts: the next 5 level 1 titles: Revenues (or Turnover), Cost of Sales, Expenses (or Operating Costs), Financing (or Non-Operating Income and Expenditure), and Other Revenues and Expenses (or Taxation and Extraordinary Items) typically hold the Profit and Loss accounts, such as the income or expense accounts. The bookkeeping balance of these accounts has to be cleared at the end of each fiscal year during the Period End Closing process. The Profit and Loss accounts reflect the changes in the company's value, such as: when you sell stock – the cost of goods sold account is affected and increases revenues.
Lastly, there are two optional purpose profit and loss Level 1 titles.
These level 1 titles have no fixed predefined purpose and in most cases are empty, depending on localization and chart of account template. If needed, each company can designate the additional level 1 titles to a certain accounting area.
In this video, we’ll explore the chart of accounts structure.