How to Set Up a Chart of Accounts in Xero

Welcome to the Fit Small Business Xero training course! In this lesson, we’re going to cover how to set up a chart of accounts in Xero.

You can follow along on your own Xero account. If you don’t have one already, click here to sign up for a free 30-day trial. Fit Small Business readers also receive 50% off their first three months if they decide to subscribe.

To complete this lesson, you can either watch the video below, read through the step-by-step instructions, or do both. Let’s begin!

Why Is it Important to Set up a Chart of Accounts?

The chart of accounts is the heart of an accounting software system like Xero. Every transaction that is recorded in Xero is assigned to an account behind the scenes so that financial statements like your Income Statement (Profit and Loss), Balance Sheet, and General Ledger reports can be created. The General Ledger report shows all transactions from all accounts for a specified time period. If you don’t take the time to properly set up the chart of accounts, you will end up with inaccurate and unreliable financial statements.

Below is an illustration of the chart of accounts as a five drawer filing cabinet. Each drawer represents one of the five account types:

1. Assets
2. Liabilities
3. Owner’s equity
4. Income
5. Expenses

Below each account type are examples of the accounts that would fall within each type. For example, when you purchase products to sell to your customers (inventory) it is classified as an asset, as indicated in the chart below.

The first step to setting up the chart of accounts is to decide if you are going to bring over your existing chart of accounts or start fresh and use the default chart of accounts list. We will discuss this next.

Xero’s Default Chart of Accounts vs. Importing a Custom Chart of Accounts: Which should you use?

If you are switching from another accounting program, then you can import your existing chart of accounts list into Xero or just make modifications to the default chart of accounts. If you have an accountant that you work with, then you should seek their guidance with this decision. However, if you manage your own books then I recommend that you use the Xero default chart of accounts; you can add, delete or modify accounts to meet your business’s needs.

In this lesson, we will show you how to create new accounts and modify them as needed. If you want to import your existing chart of accounts from another program, we cover how to do that in the How to Import a Chart of Accounts lesson.

How to Add an Account

The Xero default chart of accounts list includes about 50 plus accounts. The first thing you should do is compare the chart of accounts list from your old accounting software to the accounts listed on the Xero chart of accounts. Make a notation of the accounts that are on your chart of accounts list but not on the Xero chart of accounts list.

For the remainder of this lesson, we will use a fictitious company called Acme Web Pros Plus to demonstrate how to customize the chart of accounts for your business.

Example: Acme Web Pros Plus would like to set up an account to track income from website design. Let’s walk through the steps to set this account up in Xero next.

Step 1 – From the Settings menu, select General Settings as indicated in the screenshot below.

Step 2 – Select Chart of Accounts and then click the Add Account button as indicated in the screenshot below.

Step 3 – Below, you will find a screenshot and a brief description of each field. The required fields are indicated with an asterisk (*) below.

1. *Account Type – In this field, you will select the type of account you are setting up. Some of the options here are: sales, expense, and liability. In the screenshot above, the section entitled “how account types affect your reports” shows you what financial report each account type will appear on. If you aren’t sure which account type to use, refer back to the chart of accounts diagram we discussed previously.
2. *Code – Each account must be assigned a unique number (up to 10 characters). Ideally, you want to group similar accounts together. For example, use a range of accounts like 4000-4199 for all sales accounts.
3. *Name – Each account must have a name. This will help you to easily identify what type of transactions it should be used for.
4. Description – Adding a description is optional but I do recommend that you include a description for every account. This will make it much easier for you or a bookkeeper to know what the account should be used for.
5. *Tax – In this field, select from the drop down the appropriate sales tax rate. If the account is not subject to sales tax, leave the default rate of 0%.
6. Show on Dashboard Watchlist – By selecting this option, the account will appear on your Xero dashboard which displays immediately after you log into your Xero account. You should mark this box for any account that you want to keep an eye on. Below is a snapshot of the Account Watchlist:

7. Show in Expense Claims – By selecting this option, you will make this account available for use when filing an expense claim. An expense claim is created when you need to be reimbursed for expenses that were paid with personal funds. You will learn more in the How to Create and Manage Expense Claims lesson.
8. Enable payments to this account – By selecting this option on an account, you will be able to record payments using accounts other than a bank account.
   For example, let’s say a business owner spends personal funds to purchase something for the business. The owner can submit an expense claim for reimbursement. Instead of receiving cash back, the payment can be coded to the owner’s contribution account (also known as owner’s equity) provided this account has been enabled for payments.
9. Save – Be sure to save all of your changes.

Step 4 – Once you have successfully added a new account, you should see a message similar to the one below.

Before we discuss how to edit accounts, there are a couple of concepts we need to discuss. Within the Xero chart of accounts list, there are locked accounts and system accounts. Let’s discuss each of these in more detail next.

What is a Locked Account

There are several accounts created by Xero for basic accounting purposes, like accounts payable and accounts receivable. Because these accounts are essential to reporting for any business, you will be restricted in the changes that you can make to them. You can edit these “locked” accounts but you cannot delete or archive them. We will discuss how to edit and how to delete or archive an account later on in this lesson.

You can easily identify locked accounts on the list because they have a picture of a padlock in the first column to the left of the account code as indicated in the screenshot below.

What is a System Account?

System accounts are a subset of locked accounts. They are used for specific reporting or accounting purposes. Unlike locked accounts, you won’t see every system account listed on the chart of accounts. Some system accounts are used in the background, or used to create reports. For example, if you use the multi-currency feature in Xero, there are accounts that are used specifically for multi-currency transactions like realized/unrealized currency gains.

Some system accounts are restricted from being used in a transaction. Below is a list of system accounts that are automatically created in Xero. We have also indicated whether or not the account can be used in a transaction or manual journal entry:

How to Edit an Account

After you begin to enter transactions into Xero, you may need to make changes to an existing account. You can easily edit the accounts that you have set up anytime. However, as we discussed in the previous section, you can only make limited changes to locked and system accounts.

Example: Acme Web Pros Plus recently purchased general liability insurance. There is an existing account titled “Insurance” on their chart of accounts list. This account has not been used in a previous transaction so we will rename it General Liability Insurance and add a description. Let’s walk through the steps to edit this account next.

Step 1 – From the Settings menu, select General Settings as indicated in the screenshot below.

Step 2 – From the Chart of Account menu, click on the account that you want to make changes to, as indicated in the screenshot below.

Step 3 – Make the necessary changes that you want to make, as indicated in the screenshot below & click the “save” button.

How to Change Tax Rates for an existing Account

When you first set up an account, you may not know whether or not it should be tracked for sales tax. The good news is that you can change the tax rate for an account at anytime. Follow the steps below to change the tax rate for an existing account.

Note: The tax rates set up here are default rates that you can override when you are entering a transaction (i.e. invoice, purchase order).

Step 1 – From the Settings menu, select General Settings as indicated in the screenshot below.

Step 2 – From the Chart of Accounts menu, put a checkmark to the left of the account that you would like to modify the tax setting for and click the “change tax rate” button as indicated in the screenshot below.

Notice the number of accounts you have selected will appear to the right of the Change Tax Rate button.

Step 3 – From the dropdown, select the sales tax rate that should be assigned to this account and click the “save” button to make the change.

How to Delete or Archive an Account

To keep your chart of accounts list up to date, you may need to delete or archive accounts periodically. Before you start entering transactions into Xero, I recommend that you go through the chart of accounts list and delete accounts that you do not plan to use. This will ensure that your chart of accounts does not get cluttered with a bunch of accounts that you never use and it will ensure that accounts are not accidentally selected.

You can delete an account that has never been used before. However, if an account was previously used (even once) it cannot be deleted because it will impact your financial statements. If an account will no longer be used you can archive it which will remove it from the chart of accounts list and any account dropdown while working in Xero. However, it will still appear on financial statement reports. Let’s walk through how to delete an account first and then we will cover how to archive an account.

Delete an Account

Follow these steps to delete an account in Xero.

Step 1 – From the Settings menu, select General Settings as indicated in the screenshot below.

Step 2 – From the chart of accounts menu, put a checkmark in the box to the left of the account and then click the “Delete” button as indicated in the screenshot below.

Step 3 – You will see the following message. Click the “OK” button to proceed or the “Cancel” button if you have changed your mind. As indicated below, there is no undo button. If you accidentally delete an account, you will have to follow the steps to add the account back to chart of account list.

Archive an Account

As we discussed earlier, you cannot delete an account that has been used in a transaction but you can archive it. (This is the equivalence of making an account inactive in QuickBooks) Follow the steps outlined below to archive an account.

Step 1 – From the Settings menu, select General Settings as indicated in the screenshot below.

Step 2 – From the chart of accounts menu, put a checkmark in the box to the left of the account and then click the “Archive” button as indicated in the screenshot below.

Step 3 – The following message will display. Click the “OK” button to proceed or the “Cancel” button if you don’t want to archive the account. Notice that there is no warning message like we saw when deleting an account. This is because if you archive an account you can undo it. Next, we will walk through the steps to restore an account that was previously archived.

How to Restore an Account that was previously archived

If you decide to start using an account that you previously archived, you can easily unarchive it. Follow the steps below to restore an account.

Step 1 – From the Settings menu, select General Settings as indicated in the screenshot below.

Step 2 – From the chart of accounts, click the Archive tab, put a checkmark to the left of the account that you want to restore and click the “restore” button as indicated in the screenshot below.

Step 3 – Once you have restored the account, the following message will display.

Wrap Up

That wraps up the section on how to set up a chart of accounts. The next lesson in our Xero Training Course will be how to import a chart of accounts list. In this lesson, we will walk you through the steps to import a custom chart of accounts from your current accounting software. To access this lesson or any of the others in the series, click here. For a free 30-day trial of Xero, click the link below.