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Suppose that you’re the accountant for a corporation and you’re faced with the daunting task of preparing the annual federal income tax return for the business. The Internal Revenue Service (IRS) requires that you report the following expenses (and this list contains just the minimum!):

 Advertising

 Bad debts

 Charitable contributions

 Compensation of officers

 Cost of goods sold

 Depreciation

 Employee benefit programs

 Interest

 Pensions and profit-sharing plans

 Rents

 Repairs and maintenance

 Salaries and wages

 Taxes and licenses

You must provide additional information for some of these expenses. For example, the cost of goods sold expense is determined in a schedule that also requires inventory cost at the beginning of the year, purchases during the year, cost of labor during the year (for manufacturers), other costs, and inventory cost at year-end.

Where do you start? Well, if it’s March 1 and the corporate tax return deadline is March 15, you start by panicking — unless you were smart enough to think ahead about the kinds of information your business would need to report. In fact, when your accountant first designs your business’s accounting system, they should dissect every report to managers, the external financial statements, and the tax returns, breaking down all the information into basic account categories such as those we just listed.

For each category of information that you need to include in an accounting report, you need an account (or a group of accounts), which is a record of the activities in that category. An account is basically a focused history of a particular dimension of a business. Individuals can have accounts, too — for example, your checkbook (physical or digital) is an account of the cash inflows and outflows and the balance of your checking account (assuming that you remember to record all activities and reconcile your checkbook against your bank statement). We doubt that you keep a written account of the coin and currency in your wallet, pockets, glove compartment, and sofa cushions, but a business needs to keep track of all its cash, no matter where it is. An account serves as the source of information for preparing financial statements, tax returns, and reports to managers.

The term general ledger refers to the complete set of accounts established and maintained by a business. The chart of accounts is the formal index of these accounts — the complete listing and classification of the accounts used by the business to record its transactions. General ledger usually refers to the actual accounts and often to the balances in those accounts at some particular time. The chart of accounts, even for a relatively small business, contains more than 100 accounts. Larger business organizations need thousands of accounts. The larger the number, the more likely that the accounts are given number codes according to some scheme — for example, all assets may be in the 100 to 300 range; all liabilities, in the 400 to 500 range; and so on.

As a business manager, you should make sure that the controller (chief accountant) or perhaps an outside CPA consultant reviews the chart of accounts periodically to determine whether the accounts are up to date and adequate for the business’s needs. Over time, income tax rules change, business economic models evolve, the company goes into new lines of business, the company adopts new employee benefit plans, and so on. Most businesses are in constant flux, and the chart of accounts has to keep up with these changes.