A chart of accounts is the foundation of accurate financial reporting, so it needs to be set up correctly. A disorganized chart or one that lumps transactions into broad, undefined “buckets” of data can make it difficult for management to evaluate financial performance and identify unmet customer needs — or open the door to accounting errors and fraud. Here’s some guidance on how to create a robust chart that’s right for your situation.
Why it matters
A chart of accounts is a structured list of general ledger accounts that are used to record and organize financial transactions. An organized chart simplifies the preparation of tax returns and financial statements that comply with formal accounting standards, such as U.S. Generally Accepted Accounting Principles.
Additionally, a detailed chart provides insight into profitability and asset management. It can help you identify financial and operational areas in need of improvement and make better-informed strategic decisions.
In turn, these insights can help you communicate with stakeholders, such as lenders and potential investors, about your business’s financial performance. This can be useful, for example, when applying for new loans, seeking additional capital contributions, or selling your business.
Numbering and naming conventions
Essentially, the chart of accounts mirrors the financial statements; it includes major balance sheet and income statement accounts. Each account is assigned a unique identification number and an account name.
The following sequence is customarily used for account numbering:
- 1000-1999 for assets, such as cash on hand, undeposited funds, accounts receivable, equipment, machinery, vehicles, real estate, and inventory,
- 2000-2999 for liabilities, including accounts payable, accrued expenses and outstanding loans,
- 3000-3999 for equity, for example, retained earnings and capital accounts,
- 4000-4999 for revenue, such as contract revenue, change order revenue, reimbursements and retainage, and
- 5000-5999 for expenses, for instance, materials, labor, payroll and benefits, rent, utilities, equipment leasing, marketing, insurance, depreciation, and administrative costs.
Subcategories are generally created for key accounts within each main category. For example, current assets could start at 1100, fixed assets at 1200, and other assets at 1300. As your business grows or its reporting needs change, you might add more accounts within a range.
Following best practices
There’s no one-size-fits-all format for the chart of accounts. The appropriate structure will depend on the number, nature, and complexity of your company’s financial transactions. Most companies start with industry-specific templates provided by their accounting software packages. Then, they customize those templates to fit the company’s needs.
When setting up your chart, consider these best practices:
- Leave space between account numbers to accommodate business growth,
- Use simple, easy-to-understand naming conventions,
- Add a description for each account to help accounting personnel enter transactions into the correct general ledger account,
- Select the correct account type (asset, liability, etc.) to facilitate financial statement and tax return preparation and
- Review the chart at year-end and make any necessary adjustments.
A simple chart of accounts might work initially, but more complexity may be needed as your company evolves. For example, management might want to track results by department, project, or region. This may require additional account segments or layers to allow for segmentation in reporting. A new business line might also require changes to an existing chart. More complex charts are common in certain industries, such as health care or construction.
For more information
Setting up a chart of accounts isn’t a one-off task that produces a template you can use forever. Contact us for help setting up a new chart of accounts or reviewing an existing one. Our experienced accounting and bookkeeping professionals can help you capture the relevant information your business needs to succeed.
For more information on the above article or any outsourced bookkeeping services, contact Chris Earnest by calling (334) 887-7022 or leaving us a message below.
