How to Build your Chart of Accounts

The Chart of Accounts is like a file cabinet for your transactions. There are a variety of reasons to use the information generated by properly recording your transactions. And how you structure your Chart of Accounts can impact not only the presentation of your financial statements, but also the value of the information which you derive from it.

Consider the users

The financial statements are designed to be used by business owners, management, and stakeholders, who could include banks and regulatory agencies. As a result there are a variety of different groups whose needs will need to be considered. So, it is important to strike a balance between detail and common sense. It is possible to go into excruciating detail, but this creates a burden upon your bookkeeper, and increases the possibility of error.

We believe that you should be detailed, but no more than necessary. An example of this is here.

Keep it Simple

As Albert Einstein said, “Everything should be made as simple as possible, but not simpler.”

We also recommend not to stray too far from the standard model, this is because financial statement users have a certain expectation of where things should be within a financial statement. And unless you want a lot of questions being asked, support those expectations.

At Wilson Lake we have worked hard to ensure our clients have a reasonably standardized format for the chart of accounts. This is because as we move from client to client, we don’t want to drop the ball, and if every chart of accounts is different, and every account name is different than we waste valuable time trying to remember which transaction goes where. Every business is unique, but there are a lot of similarities among them as well.

By the Numbers

Account numbers can be a tool for developing your chart of accounts. They are designed to show at a glance hierarchy, and placement within the financials. For most small businesses, this may not be necessary. Because if your account is named “Truck Repairs and Maintenance,” we can pretty easily guess, this is an expense.

Numbers may become useful if there are similar names, but in multiple places. For example:

5200 Truck Repairs and Maintenance 

6200 Truck Repairs and Maintenance

The 5000 series are Cost of Goods Sold, these would be the repairs to trucks that are used in the production of your good or service. Where the 6000 series may be your sales, and that could be new tires for a salesman’s truck. They belong in separate lines, but are similar in name.

For account names, we recommend at a minimum 6 numerals. Numbers would be assigned based upon hierarchy. Some number are more standard:

010000 – Assets

020000 – Liabilities

030000 – Owners Equity

040000 – Revenue

050000 – Cost of Goods Sold

060000 – Operating Expenses

070000 – Non-Operating Expenses

080000 – Non-Operating Income

090000 – Extraordinary Items

The structure is simple, but not at a glance. The numbers are broken up into 2 digit sets. The further to the right you move, the lower within the hierarchy the account is.

060000 – Operating Expenses

060100 – Selling Expense

060101 – Sales Salaries and wages

Keep in mind that this is a simple numeric structure for a small business, and it allows 99 sub accounts at each level 01-99 for each 2 digit string. If there was a greater need for complexity, an 8 digit code may be necessary.

Greater complexity within your organization will require a greater amount of complexity regarding account the account numbers, but that is something that would require more specialized attention.

Devil is in the Details

As much as we want to keep it simple, details can be helpful as well. As an example consider a construction company. They have vehicles that are used for multiple purposes. And the expenses related to those vehicles needs to be monitored. Using the Chart of Accounts can be a powerful and easy way to do this. Consider two separate vehicles, a construction Crew’s Backhoe, and a Salesman’s truck.

The Backhoe will be on the balance sheet, as well as the income statement and at a glance management may want to know how much it is worth, and how much it is costing during a period. Same with the Salesman’s truck.

So, within the balance sheet under Assets:

Equipment

Construction Equipment

Backhoe – 1

Sales Equipment

Truck – 1

Accumulated Depreciation

Acc Dep – Construction Equipment

Acc Dep – Backhoe – 1

Acc Dep – Sales Equipment

Acc Dep – Truck – 1

Within the Income Statement:

Cost of Goods Sold

Construction Equipment Expense

Fuel

Depreciation Expense

Dep Exp – Backhoe – 1

Repairs and Maintenance

Repairs and Maint – Backhoe – 1

Sales Expense

Sales Vehicles Expense

Fuel

Depreciation Expense

Dep Exp – Truck – 1

Repairs and Maintenance

Repairs and Maint – Truck – 1

At a glance, you can now see, these vehicles impact the financials in a variety of ways, and by breaking them out as separate accounts, it is easy to see if one vehicle is costing more or less than others. Also, by making them sub accounts within other areas it is easy to view things as a batch. This way questions can be answered based upon high level or detailed level analysis.

We also want to point out that we didn’t break out fuel by vehicle. This is not an accident. Not every account needs to be explicitly specific. And the needs of your financial statement users needs to be considered for each account.

Summary

Remember, Consider the users, Keep it Simple, and the Devil is in the Details. Also, the chart of accounts is a living structure and don’t be afraid of change, if a need arises, consult the other users of the financials and make a change if needed. Businesses evolve, and the chart of accounts should change with it. The more thought you put into it up front the less change will be necessary but that planning reduces the need for change later on, it doesn’t eliminate it.

Best of Luck.

Disclaimer: The information contained in this document is provided for informational purposes only and should not be construed as financial or tax advice. It is not intended to be a substitute for obtaining legal, accounting, or other financial advice from an appropriate legal professional, financial adviser or for the purpose of avoiding U.S. Federal, state or local tax payments and penalties.

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