Building a Better Chart of Accounts: The Backbone to Accounting
Would you build a home without a solid foundation and roof? Of course not! Like a home’s foundation and roof, a Chart of Accounts is the basic infrastructure that businesses use to organize and record its historical data. This financial data and information is used to generate financial statements, file taxes and provide analysis for business owners or operators to make business decisions. However, a lot of times when entrepreneurs and business owners start out, they have so many things on the go that sometimes the Chart of Accounts doesn’t get a lot of attention and just becomes a make-work system to record information and is created on the fly without much thought.
Over the years, I have observed many Chart of Account issues that build up over time that cause business owners heartburn and anxiety because these issues impact the bookkeeping and accounting. The best practices to employ when building a Chart of Accounts can be summarized below:
The actual line items of the Chart of Accounts represent the assets, liabilities, revenues, and expenses of the business. Ask yourself:
What assets and liabilities does the business have?
What revenues and expenses does the business have?
The answers to these questions above will start to form the lines of the Chart of Accounts
Not every item needs its own Account Name or Number. Consider whether certain transactions can be grouped together.
One of the most common inefficiencies I see in Chart of Accounts is too many accounts.
For example: instead of having accounts for:
Auto – Insurance;
Auto – Parking;
Auto – Maintenance; and
Auto – Financing
Consider having a main account for Automobile Expenses in total with sub-accounts so the details aren’t lost, but this way, the Chart of Accounts isn’t bogged down by individual line items:
Automobile Expenses
Auto – Insurance;
Auto – Parking;
Auto – Maintenance; and
Auto – Financing
Unless your business is a multi-million dollar and multi-jurisdiction corporation, the Chart of Accounts should fit on two sheets of 8” x 11.5” letter-size paper.
Consistency of grouping and recording transactions should be maintained or else any data run in reports may not be accurate. Some bookkeepers and accountants create cheat sheets to remind themselves of what types of transactions should be recorded on certain line items of the Chart of Accounts.
Over time, as business grows and evolves the Chart of Accounts may no longer be able to fully meet the needs of the business. Instead of forcing new transactions to be recorded into existing line items, it is recommended to consider if creating new accounts might be more efficient.
To ensure that the Chart of Accounts doesn’t limit the evolution of business, it is important to review the Chart of Accounts on a regular basis (at a minimum annually) to ensure that all business transactions can be appropriately recorded.
The Chart of Accounts is essentially the backbone of how data is entered, stored, and reported to provide business owners with the key information required for running their businesses efficiently and effectively, so it shouldn’t be onerous to maintain and use.
Share any problems or questions you may have about building Charts of Accounts below.