An 8 Step Process For Designing A Chart of Accounts

Many business owners and bookkeepers are confused by what accounts should be used in their chart of accounts. When there is unclarity about the design of the chart of accounts, one of three things usually happen:

* There are not enough accounts. When this happens, there isn’t enough detail in the financial reports to get information about what is happening in the business.

* There are too many accounts. This leads to too much detail on the financial reports, so they are difficult to read and use for high level decision making. This can also cause bookkeeping errors as the bookkeeping staff can easily become confused about where to record transactions.

* The account names are confusing. This also can lead to confusion and inconsistency in recording transactions. In addition, accounting staff and business management may not be on the same page with how accounts are being used.

How do you design a chart of accounts to ensure you can get good, clear, and consistent reporting information? First, you must realize that you’re in control of the chart of accounts and it’s up to you to design it. You could just have one account on the profit and loss statement called “expense”, but that wouldn’t give you good information, would it? We have to find the balance between too little and too much detail. Here’s an 8 step process to help you determine what should be on your chart of accounts.

1. If you’re designing accounts for a new business, begin with a standard chart of accounts (QuickBooks has several to choose from for various industries) and then add to it as described below.

2. Add accounts for income that is specific to your business and occurs regularly. You can have just one revenue line, but chances are you earn revenue from more than one type of product or service. Use a more general account for anything that does not occur regularly.

3. Add cost of goods sold accounts that correspond with your revenue accounts. If you have web design revenue, you would also have web design cost of goods sold.

4. Add expense, asset, and liability accounts that are specific to your business and make sense to you.

Now you have a chart of accounts for your business, but we’re not done. You need to review it again while asking the following questions:

5. Do I really need this account or is there a similar account where the information could be gathered? If so, would viewing those two accounts together be more helpful?

6. Is it obvious what types of transactions would belong in this account? If your account name doesn’t make sense to you or the accounting staff, rename it to something that is logical to you.

7. Why will I need to see this information on my income statement or balance sheet? How will this information be used later? If you don’t really need to see it separately, perhaps the data belongs in another account.

8. Is there another way to get this information if I use a more general account type? For example, could you track departments by class in QuickBooks and eliminate accounts for specific departments? If so, set up the other tracking mechanisms and utilize the generalized account.

Each time you think you may need to add an account to your chart of accounts, ask yourself these questions first. Selectively adding accounts will lead to better visibility into your operations. If you’re unable to answer the above questions to guide your chart of accounts design, you should have an accounting consultant help you with the process. If you’re not getting the information you need from your financial reports, a redesign of how you gather and view information may be in order.

Copyright (c) 2010 Kelly Totten