5 Tips for Setting Up a Chart Of Accounts Correctly
(with a free Chart of Account Example!)
Meaningful data supports good decisions. To provide the financial information your organization needs to analyze performance and make informed decisions, you must first capture and categorize your company’s financial transactions. The foundation for doing so is your chart of accounts (COA), which lists all the financial accounts in the general ledger. The most common problem we see when engaging in accounting rescue work is a poorly structured chart of accounts that fails to organize financial information, making it difficult to prepare reports for evaluating financial performance.
What is a Chart Of Accounts (COA)?
Simply stated, the chart of accounts lists all the financial accounts in the general ledger. In an ideal set-up, the chart of accounts allows financial statements, such as income statements and balance sheets, to be organized in an easy to read manner and summarizes data at a meaningful level that helps you understand your business finances and supports decision-making.
Here are some tips for setting up or restructuring your chart of accounts.
1. Start with the End in Mind
How you capture data in your system will either enhance or limit your ability to provide meaningful reporting. Taking the time upfront to work with your organization to understand the needs and setting up your chart of accounts and other reporting dimensions to support this will help ensure you get the intended value from your system.
At its simplest level, most of our clients want the ability to report spending by departments such as customer support, product development, sales, marketing, and general and administrative. Others need the ability to report by product line, location, or project. Identifying the reporting needs upfront allows you to leverage the full capabilities of your system to streamline data capture while enabling more detailed reporting.
2. Use Account Numbers
We encourage using account numbers for your chart of accounts. Numbers allow you to group similar accounts. There are systems (Quickbooks is one) that allow you to use alpha instead of numeric naming conventions. We discourage this approach because it forces sorting your chart of accounts in alphabetical order. For example, Advertising would group with Amortization instead of other marketing-related expenses.
We generally recommend four or five-digit account numbers. This leaves ample room for many accounts in the range while minimizing the number of keystrokes required during data entry.
To start, develop a master account range, as shown in the example below, and build from there.
Master Account Range Example
|Account Range for Four-Digit Account Numbers:||Account Grouping:|
|5000-5999||Cost of Revenue/Cost of Sales|
As you assign account numbers to specific accounts within the ranges, leave room for new accounts as the need arises. We don’t recommend tight sequential numbers that don’t allow for adding new accounts to a group of similar existing accounts. For example, let’s say you use accounts 6100-6199 for travel and related expenses, and you chose to number your accounts as follows:
What happens when you want to break out meals into two accounts, one for travel and one for business entertainment? To do so, you would have to add a new account at the end of the sequence, 6106, and now the new account is not grouped logically with the other meals account. Leaving gaps in the numbering sequence of 5 to 10 will accommodate adding future accounts while maintaining the integrity of the numerical grouping.
3. Less is More
The biggest mistake we see is too many accounts. The purpose of your chart of accounts is to summarize data at a meaningful level, a level that helps you understand your business finances and supports decision-making. Ask yourself what is essential to understand and consider using a dollar threshold to determine when an item is of sufficient significance to require a separate account. Keep in mind that the greater the number of accounts, the higher potential for error and inconsistent data capture, making the data over time less meaningful. Finally, balance sheet accounts should be reconciled every month as part of your close process, so minimizing the number of accounts also minimizes the reconciliation effort each month.
We recommend starting with a minimum set of well-thought-out accounts that cover the basics of your reporting needs. You can always add accounts down the road as your business grows and needs change; however, we encourage you to be judicious when doing so.
4. Use Dimensions to Support Analysis
The accounting systems we see used most frequently – QBO, NetSuite, Intacct, and Dynamics – all provide the ability to associate transactions with other dimensions, such as location and department. Dimensions allow you to report and analyze information more granularly. A good example is salary and wage expense. We recommend using one account to record all salaries and wages. This allows you to understand the total amount you are spending. However, it is also important to know how much you spend by department, such as product development. Using dimensions allows you this ability. If you have multiple locations, you may also want to analyze your salary and wage expense by location or by department and location. Again, dimensions enable reporting at this level without setting up multiple accounts.
At a minimum, we encourage our clients to set up dimensions for departments to enable the creation of a classified income statement in addition to a natural income statement. A classified income statement reports expenses by function (product development, sales, etc.), while a natural statement reports by type of spending (salaries and wages, office expense, etc.). In a subsequent post, we will discuss the importance of the classified income statement.
Finally, applying dimensions to transactions as you enter them is the key to successfully using dimensions to provide meaningful reporting.
5. Avoid Rescue Work
As previously mentioned, poorly structured chart of accounts is a common issue we see when doing accounting rescue work. Unfortunately, we frequently find that our clients have not set up their accounting systems, processes, and teams to support the organization’s needs. The information cannot be relied upon to tell the story of the business or help set the future course. While we appreciate the work, we would much rather help clients avoid accounting rescue work.
To that end, we encourage you to download our free example Chart Of Accounts for SaaS companies. While there are many similarities, there will be variances for other industries, such as manufacturing. We are happy to help you customize this example to fit your needs and set yourself up for accounting success.
Need Help Reviewing Your Chart of Accounts?
We are happy to help. Reach out to schedule a free consultation.