Chart of Accounts Best Practices

Chart of Accounts: Definition, Guide and Examples

Notes from this article from Nerd Wallet:

What is the chart of accounts?

• Chart of accounts is a list of accounts available for recording transactions in a company’s general ledger
  • Like the filing cabinet for your accounting system
• Most QuickBooks Online plans support up to 250 accounts
• Typical charts of accounts have five primary accounts: assets, liabilities, equity, expenses and revenue
  • Income statement includes transactions from expense, revenue accounts
    • Overall profitability
  • Balance sheet includes transactions from assets, liabilities, and equity accounts
    • Financial health at a point in time

How a chart of accounts works

• Every time a transaction is logged, basic double-entry accounting dictates two entries are made, a debit and a credit
  • Ex: Grocery store that sells \$20 in produce would debit cash account \$20, credit the revenue account \$20
• Each line in a typical chart of accounts includes an account number, title, description, and balance
  • Accounts can generally tell which account a transaction belongs to based on first digit of the account number
  • Ex: assets start with 1, liabilities may start with a 2
  • Some businesses create categories based on department - one for sales, accounting, etc
    • Within each department, there may be a subcategory expense for wages, utilities, etc
• Suggested setup:
  • Balance Sheet Accounts:
    • 100-199: Assets - any resource your company owns that provides value:
      • Cash, accounts receivable, inventory, equipment, real estate, vehicles
    • 200-299: Liabilities - any debt your company owes
      • Accounts payable, wages payable, accrued liabilities, taxes payable
    • 300-399: Equity - what’s left after subtracting your company’s liabilities from its assets
      • Common stock, preferred stock, retained earnings
  • Income Statement Accounts:
    • 400-499: Revenue - money your business brings in from sale of goods and services
      • Investment income, sales, sales returns
    • 500-599: Expenses - all the types of money and resources your business spends to generate revenue. To calculate net income, subtract expenses from revenue
      • Paying employees, rent, travel expenses, utility bills
  • Examples:
    1. Buy a ladder for roofing company: Credit \$300 to bank account (falls under cash assets), debit \$300 to equipment account (falls under fixed assets)
    2. Paying \$1000 rent in cash: Credit \$1000 to cash asset account, debit \$1000 expense account for rent
    3. Receive a \$15,000 small-business loan: credit \$15,000 to loan account (liabilities) and debit \$15,000 to checking account (assets)
• Best practices:
  • Wait to delete old accounts for the end of the year, to avoid tax headaches
  • Don’t go overboard with accounts. Idea is to create a chart of accounts that gives you important information. You probably don’t need separate accounts for every product or each utility - some items can be lumped together
  • Aim for consistency. Create a chart of accounts that doesn’t change too much over time, so you can compare performance of accounts over time.
  • Prune your accounts. Review annually to see if there’s an opportunity for consolidation.

How to set up a chart of accounts

Notes from this article from QuickBooks Blog:

• Chart of accounts, or COA, is a list of account numbers and names relevant to your company
• Four primary account types: assets, liabilities, income, expense
  • 1000-1999: Asset accounts could include:
    • Anything you own that has value, like: Buildings, Land, Equipment, Vehicles, Valuables, Inventory
    • Liquid assets, such as: Checking accounts, Other bank accounts
    • Additional asset accounts would include items like: Accounts receivable, Notes receivable
  • 2000-2999: Liability accounts could include:
    • Current or short-term liabilities: Accounts payable or bills, Payroll taxes, Income taxes payable, Bank loans, Credit card balances
    • Non-current or long-term liabilities: Mortgages, Deferred tax liabilities, Personal loans
  • 4000-4999: Income accounts could include:
    • Sales income, Rental income, Dividend income, Contra income
      • New owners generally start with the broad categories, above, but over time it may make sense to create separate line items in your chart of accounts for different types of income:
        • Income from food sold, income from books sold, etc
  • 6000-7999: Operating expense accounts could include:
    • Cost of sales, Advertising expense, Interest expense, Depreciation expense, Salaries or wages, Interest expense
• Best practices:
  • Use simple account names
  • Create sub-accounts. Examples:
    • Instead of creating a new line in your chart of accounts for “PayPal fees,” create a sub-account under “bank fees”
    • Instead of creating a new lines in your chart of accounts for “building rent” and “equipment rent,” create a parent account “rent expense” with sub-accounts “building rent” and “equipment rent”
  • Keep in mind which financial statement each account rolls up to
  • Track account movement - add accounts as they come in, but wait until the end of the year or quarter to remove any old accounts

Account Numbering Suggestion from QuickBooks Online Help

You can assign any number to your accounts. But if you’re looking for recommendations, these account number ranges might help. These ranges are based on account types and follow Generally Accepted Accounting Principles (GAAP).

4 Keys to the Best Chart of Accounts Structure

Notes from this article posted on Mosaic Tech’s blog page:

1. Don’t (Over-) Stress on Parent-Child Account Structure
   • From an accounting perspective, a parent-child account structure adds layer of organization to the chart of accounts. The four-digit numbering system for accounts generally matches the following:
     • 1000s: Current asset accounts including all cash accounts (savings/checking accounts) as well as accounts receivable, prepaids, and fixed assets.
     • 2000s: Liabilities including anything in accounts payable, accrued expenses, notes payable, and other liability accounts.
     • 3000s: Owner’s equity accounts including common stock as well as preferred stock and any funding-related capital.
     • 4000s: Income statement accounts that cover sales and revenue.
     • 5000s: Cost of revenue accounts including things like support, hosting expenses, and third-party transaction fees.
     • 6000s: Accounts for operating expenses from salaries, rent, etc.
     • 7000s: Other income from interest, rent gains on the sale of assets, and gains from foreign exchange transactions.
     • 8000s: Other expenses from income taxes and interest.
   • Example: Accounts Receivable (1100) may be a parent account with sub accounts for Subscription Customers (1101) and Service Customers (1102)
2. Align Your Chart of Accounts with How You Want to View the Business
   • Best chart of accounts structure perfectly aligns with how your business operates and how you want to analyze it. Note there’s a fine line between too granular and too high level:
     • Facilities and Related - should include accounts for office expenses, rent, repairs, and utilities, but probably not separate accounts for gas and water bills
     • Sales and Marketing - should include accounts for advertising, swag, and conferences, but probably not separate accounts for every conference
       • Leverage project codes or another system to tag expenses to more granular units (such as tags in quickbooks)
3. Make Department Tagging a Top Priority
   • Two approaches let you disaggregate data:
     • Multiple general ledger accounts - Ex: different payroll accounts for Sales & Marketing, Engineering, R&D, G&A, etc.
     • Single general ledger account - one main payroll account with individual financial transactions tagged by department
   • Again, possibly leveraging tags in quickbooks
4. Nail Down Cost of Revenue versus Operating Expense
   • Decisions about mapping cost of revenue and operating expenses in your chart of accounts impacts your gross margin and gross profit.
     • Cost of Revenue, in particular, is more complicated than most general ledger accounts
     • Ex: If payroll for support team is 100% mapped to OpEx, cost of revenue may be understated and reported margins overstated
     • Department Tagging would let you reclass a portion of payroll from OpEx to cost of revenue to more accurately report margins
       • 40% of support’s time goes to revenue-related tasks whereas the other 60% belongs in OpEx because its more administrative

Designing a Scalable Chart of Accounts

Notes from this article posted on FMT Consultants' blog page:

Designing a chart of accounts is not a small task - it requires forethought and a lot of effort to design a scalable COA.

1. Best Practices
   • COA should use standard accounting principles, but also incorporate items specific to the business
   • Order of accounts should align with financial statements, then by account type, then by liquidity. The common order is:
     • Assets
     • Liabilities
     • Equity
     • Revenue
     • Cost of Goods Sold
     • Operating Expenses
     • Other Income and Expenses
2. Start by making a requirement list and then develop a blueprint
   • COA sets the framework of the financial system so the data is organized into meaningful categories
   • Need to start with a reporting requirements, business metrics, KPIs and a description of any required financial reports
     • Then, start high-level and work down to parent accounts and finally individual accounts
3. Use Account Segments or Dimensions and Statistical Accounts for Reporting
   • Account segments (or tags in quickbooks) allow for a different way of grouping related transactions - this can make the COA more dynamic
4. Design for scalability and flexibility
   • An extra digit in the account number may pay off later
5. Use Logical Account Numbering
   • Best practices is Asset accounts start with 1, Liabilities start with 2, Equity accounts start with 3, etc.
   • Sub-groups and sub-accounts in logical ranges too. Examples:
     • Current Assets: 1000-1499
       • Cash Equivalents: 1000-1049
       • Short Term Investments: 1050-1099
       • Accounts Receivable: 1100-1149
6. Use standardized account numbering logic and descriptions
   • Standardized account numbering and descriptions are essential
   • Avoid vague descriptions
   • Business should have a single COA owner
   • Time spent developing the COA will pay off in the long run

Chart of Accounts: The Basics & Best Practices

Notes from this article posted on Cube Software’s blog page:

• Main Takeaways:
  1. Chart of accounts is an index of all financial accounts in a company’s general ledger
  2. Leading digit on each account should indicate the type of account it belongs to
  3. 5 major account types: assets, liabilities, equity, income, expenses
  4. Best practice is to never delete accounts in the COA until the end of the year
• Chart of Accounts is essential to good bookkeeping - makes it easy for anybody to come into your business and quickly understand its finances
  • Should make it easy to look up numbers
  • If well-designed, will make it easy to follow accounting and reporting standards
• Example:
  • 1000 Assets
    • 1200 Receivables
    • 1300 Inventories
    • 1400 Prepaid expenses & other current assets
    • 1500 Property plant & equipment
    • 1600 Accumulated depreciation & amortization
    • 1700 Non-current receivables
    • 1800 Intercompany receivables
    • 1900 Other non-current assets
  • 2000 Liabilities
    • 2100 Payables
    • 2200 Accrued compensation & related items
    • 2300 Other accrued expenses
    • 2500 Accrued taxes
    • 2600 Deferred taxes
    • 2700 Long-term debt
    • 2800 Intercompany payables
    • 2900 Other non-current liabilities
  • 3000 Owner equities
  • 4000 Revenue
  • 5000 Cost of Goods Sold
  • 6000-7000 Operating Expenses
• Account Descriptions - Table should have an account number, name, type, and brief description
• Don’t delete/merge/rename accounts until the end of the year
  • But, you can add new accounts as the need arises
• Chart of Accounts is an index, but should also be a quick lookup table. Don’t create too many.
• Its best the COA doesn’t change dramatically year over year
  • May result in too much time reconstructing old accounts, which can lead to mistakes and inaccurate data
  • GAAP states regularity and consistency as the first two rules

Designing a Scalable Chart of Accounts

Notes from this article posted on TopTal Finance’s blog page:

• Design the COA thoughtfully, for managers
  • Accounting teams tend to focus on doing things the “right way” instead of asking the readers of financial statements what they want
  • Often not enough thought has gone into developing the chart of accounts - the foundation of financial reporting
  • Accounting teams tend to do things the “right way” rather than asking readers of financial statements what they want to see - building a house for someone without asking how they want it built
  • Not developing the chart of accounts thoughtfully - building a house on dirt instead of concrete
  • Updating a chart of accounts is the single best and most effective way to improve your company’s financial reporting
• Why is the COA important?
  • Chart of accounts is like a framework for a system of shelves and bins in a warehouse. Accounts are the specific “bins.”
  • Month end financial statements summarize and group the balances that are in the individual accounts at month end
  • So, financial statements can be no more detailed or informative than the underlying structure of the chart of accounts
  • If a company has seven revenue streams, and they all flow to a single sales account, then the financials will not be able to disaggregate them
    • Sales versus Sales-Laptops versus Sales-Laptops-Dell Laptops
  • 90% of business owners have probably never looked at their chart of accounts. Many controllers and CFOs are weak on structuring them as well.
  • Accounting software companies generally automate the setup of the chart of accounts, which is like building a dream house on a one-size-fits-all foundation
• Steps to improving the chart of accounts
  1. Build the accounts for management, not GAAP and taxes
     • IE, design the COA to facilitate Managerial as well as Financial accounting
     • Goal is financial reports that provide metrics you need to run the operation
     • Tax and audit CPAs generally have the custom reporting software required to easily convert a management-oriented chart of accounts into their format
  2. Define gross margin and direct costs correctly
     • Gross margin = sales - direct costs
       • Defining direct costs is the big question. For example, should equipment depreciation be included as a direct cost?
         • If a company only considers direct labor and materials when setting prices, then those should be the only direct costs shown on monthly financials
         • If indirect items (depreciation, supplies) are included, then you should include them in the gross margin calculation
       • Not every company and industry uses gross margin (like farming), so most costs can run together under the broad category of operating expenses. Then, it may not be necessary to separate costs between direct/indirect and operating, and no gross margin will be reported
  3. Define indirect costs thoughtfully
     • Direct costs are traceable to specific projects or services
       • Ex: project materials, direct labor, subcontracted services, shipping expense
     • Indirect costs are overhead expenses that relate directly to sales, but cannot be traced directly to a specific product or job
       • Ex: factory supervisor wages, supplies, machinery repairs, shop building insurance, shop rent, equipment depreciation, purchasing manager salary, utilities, packaging materials
     • Operating or General/Admin Expenses are a third category
       • Ex: tax preparation fees, marketing, legal expenses, etc
  4. Organize operating expenses with the level of detail appropriate to how the business budgets
     • COA, the budget, and management preferences must align in an effective accounting system
  5. Use account numbers
     • Five-digit numbers work well (four for simple setup)
       • 10000 - asset accounts
       • 20000 - liabilities
       • 29000 - equity
       • 30000 - sales
       • 40000-50000 - direct/indirect costs
       • 60000-70000 - operating/overhead expenses
       • 80000-90000 - non-operations accounts like interest and taxes
     • Space out account numbers to leave room for growth:
       • 10000 - Checking Accounts
         • 10100 - Business Checking
         • 10200 - Payroll Checking
       • 11000 - Accounts Receivable
     • Income and expense accounts should use parent-child arrangements to facilitate simultaneous summary and detail reporting:
       • 30000 - Parent-Level Sales
         • 31000 - Sales-Web Design
         • 32000 - Sales-Server Management
         • 33000 - Sales-Hardware
           • 33100 - Sales-Hardware-Computers
           • 33200 - Sales-Hardware-Printers
             • 33210 - Hardware-Printers-HP
             • 33220 - Hardware-Printers-Canon
     • For elegance, keep numbers and descriptions consistent and align direct cost account numbers with corresponding sales account numbers
       • 43000 COS-Hardware could align numerically with 33000 Sales-Hardware (child accounts would align as well)
  6. Use separate accounts for key month end entries
     • Month-end financial reports are made accurate with large non-cash journal entries
       • Can be helpful to funnel these entries to separate accounts. Examples:
     • 45000 Direct Labor (Parent Account)
       • 45100 Production Labor
       • 45200 Change in Accrued Labor
       • 45300 Change in WIP Labor
  7. Maximize functionality of your accounting software
     • Chart of accounts functionality is probably the most important attribute of accounting software and financial reporting
     • Entry level software with robust COA functionality can be made to work for many years

Standard Chart of Accounts & Account Types

Notes from this article posted on QBK Accounting’s blog page:

• Standard account number ranges:
  • 1000–1999 Assets
  • 2000–2999 Liabilities
  • 3000–3999 Equity
  • 4000–4999 Income or Revenue
  • 5000–5999 Job Costs/Cost of Goods Sold
  • 6000–6999 Overhead Costs or Expenses
  • 7000–7999 Other Income
  • 8000–8999 Other Expense
• Chart of accounts is the backbone of your accounting system
  • Accounts are usually listed in order of their appearance on the financial statements
    • Starts with the balance sheet and continuing with the income statement
    • Cash, liabilities, equity, revenues, then expenses
    • Expense accounts are commonly separated out by department: sales, engineering, and accounting all may have the same set of expense accounts
  • Assets are generally divided into two groups:
    • 1000-1499: Current assets - assets that you can easily turn into cash
      • Checking, savings, money markets, CD, accounts receivable, inventory
    • 1500-1999: Fixed assets - items with a minimum cost (like $500) that you would have to sell to generate cash
      • Cars, equipment, land, computer systems
  • Liabilities - funds your company owes
  • Equity - For LLC’s, Common Stock account, which represent the total sum of stock the company has issued
  • Direct Costs - cost of goods sold. Includes the costs incurred in producing or building a product.
  • Expense or Overhead Costs - fixed costs you have even if you run out of work
    • Rent, telephone, insurance, utilities
  • Other Income - income earned outside the normal way the company does business
    • Interest income, gain on sale of an asset, insurance settlement, stock sale, rents from buildings
  • Other Expense - expense that is outside the normal way the company does business
    • Loss on sale of an asset or stockbroker fees
      
      
• Example Accounts:
  • Expenses
    • 6901 - Interest Expense
    • 6902 - Depreciation & Amortization
  • Other Income and Expense
    • 8010 - Interest Income
    • 8020 - Other Non-Operating Income
    • 8030 - Capital Gains
    • 9020 - Other Expenses
    • 9030 - Capital Losses