Chart of accounts: basics and best practices

Whereas, if liabilities accounts are classified by numbers starting with the digit 2, then accounts payable might be labeled 201, short-term debt might be labeled 202, and so on. Keeping an updated COA on hand will provide a good overview of your business’s financial health in a sharable format you can send to potential investors and shareholders. It also helps your accounting team keep track of financial statements, monitor financial performance, and see where the money comes from and goes, making it an important piece for financial reporting.

That way if actual supplies and repairs total $2,700 for the month, you can see at a glance that indirect cost was overapplied to projects ($3,000 applied, compared to $2,700 actual). Most companies choose a metric such as labor hours and estimate a rate per labor hour that “uses up” these indirect costs over the course of a month or year. For example, consider a simple manufacturer who last month had $1,000 of manufacturing supplies and $1,000 of shop repairs, for a total of $2,000 of indirect expenses. Based on that, the company decides to allocate indirect cost to future projects at a rate of $10 per hour ($2,000 total costs/200 shop labor hours). That approach can work as long as you have custom reporting capability. In the absence of that, tax and audit CPAs have the custom reporting software to easily convert your management-oriented chart of accounts into their format.

Designing a Scalable Chart of Accounts

In certain industries such as advertising, farming, or consulting, most of the costs run together under the broad category of operating expenses. In that environment, it may not be necessary to separate costs between direct/indirect and operating, and there will be no gross margin on the financials. The current liabilities section will include short-term debt accounts like accounts payable, the account where you will record what you owe your suppliers. It also will include your accrual accounts, which include what you owe in payroll taxes and sales taxes.

Unfortunately, using a pre-fabricated chart of accounts is like trying to build a dream house on a one-size-fits-all concrete foundation. The house would end up very different from the dream, and not be very functional. Designing a chart of accounts is not a small task – it requires forethought and a lot of effort to design a scalable COA. https://www.bookstime.com/articles/chart-of-accounts-numbering If you’ve identified redundant or archaic accounts, it can be tempting to clean it up by deleting or by merging them. It’s a good rule of thumb to look at your system at the end of every fiscal year and ask yourself whether any accounts can be consolidated or removed. Staying on top of your finances as a small business can be challenging.

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This way the chart of accounts stays balanced, with the sum of the two entries being zero every time. The general ledger is the greater record keeper for a company’s financial accounts, with a trial balance validated debit and credit account records. Because most companies (and CFOs) only set up a chart of accounts maybe once per decade, it can be an ideal project to outsource. Contact Toptal if you would like assistance taking this simple but incredibly impactful step raising your organization to the next level. As an aside, for companies subject to US tax regulations, Meals is an example where you’ll want an easy way to give your tax accountant a stand-alone total amount at year-end. If you choose to spread Meals across relevant categories, you’ll want to still keep them in discrete accounts within each category.

• It has the authority to establish and interpret GAAP for all of these entities.
• This way you can compare the performance of different accounts over time, providing valuable insight into how you are managing your business’s finances.
• The uniform accounting code for a multimillion-dollar company would number division first, department second, and account last.
• These accounts track how much money has been gained or lost during the period of time in question.
• Whereas, if liabilities accounts are classified by numbers starting with the digit 2, then accounts payable might be labeled 201, short-term debt might be labeled 202, and so on.

The concept makes sense, but it gets confusing when this entry hits the financials. Unlike true wage expense, the $3,000 is a project costing entry that is not paid out in cash. Accordingly, the offset will not be cash, but rather a -$3,000 entry to an Indirect Expenses-Applied account.

What is a chart of accounts (CoA)?

For example, if depreciation is $50 per month and sales are $500 per month, depreciation is 10% of sales. If sales spike to $1,000 one month, depreciation is still $50 and is now only 5% of sales. In that situation, sales—not production efficiency or better estimating—has changed gross margin. That can be misleading, especially if production supervisors are compensated on margin metrics. For example, under GAAP, a fixed cost like equipment depreciation would be a direct cost for a manufacturer. However, in a managerial-focused environment, fixed costs are often kept out of gross margin, to keep it from being distorted by swings in sales.

Travel & Related, Sales & Marketing, Professional Services, Facilities & Related—these are all mainstays of the CoA and are fairly straightforward. For an accountant, it might be easiest to create multiple GL accounts. That way, they can automate payroll allocations with an HRIS and then prepare journal entries in a tool like Quickbooks or Xero for the separate accounts. This includes entering the umbrella categories and your chosen subcategories.

What is Chart of Accounts Numbering?

Your COA is a useful document that lets you present all the financial information about your business in one place, giving you a clear picture of your company’s financial health. The liabilities category is where you keep track of your company’s debt obligations or what your company owes or may owe in the future. Just like with the assets category, you want to follow the traditional form of the balance sheet in developing the liabilities section of the chart of accounts. You will have a current liabilities section and a long-term liabilities section. Each account in the chart of accounts is typically assigned a name. Accounts may also be assigned a unique account number by which the account can be identified.

• If you choose to spread Meals across relevant categories, you’ll want to still keep them in discrete accounts within each category.
• Sign up for Shopify’s free trial to access all of the tools and services you need to start, run, and grow your business.
• The standard chart of accounts is also called the uniform chart of accounts.
• The CoA structure includes numbered categories for assets, liabilities, expenses, equity, and more.
• As your company grows, the total number of accounts in your GL grows.
• You can and should always add new accounts later or delete those accounts that you will never use to keep yourself organized.

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If you want to take your company and yourself to the next level, then click here to learn more about the premier financial leadership development platform. This would include your office rent, utilities, and office supplies. The support team is equip with a special tool to import your favorite GL chart and then reassigned all 3 digit code into the 4 digit code structure. This way they can confirmed that every GL was reassigned from the old chart. Or you’ll spend too much time reconstructing old accounts, which can lead to mistakes and inaccurate data. This keeps you from creating too many specific accounts and spares you from a painful cleanup process at the end of the year.

Develop a Chart of Accounts for Your Small Business

But you have to go a step further and decide what level of granularity is necessary in each account category. The parent/child approach organizes your financial statements but comes with limitations. As your company grows, the total number of accounts in your GL grows. And as you add new accounts, it’ll become increasingly difficult to go back and slot new numbers into your CoA. Suddenly, you’re dealing with a mess of sub-accounts under your parent account and unnecessarily complicating your general ledger.

If you are going to use a computerized accounting system, use a four-digit numbering system. A block of numbers is usually assigned to each of the categories that make up the chart of accounts, and blank numbers are left at the end for additional accounts to be added in the future. This framework, called the chart of accounts, serves as an index of all the company’s financial accounts. Accountants use this chart of accounts to identify transactions as they record them in the company’s general ledger. For a SaaS company, hosting fees are a clear candidate for the cost of revenue account.

Give careful thought to indirect costs.

But if you are starting from scratch, then the following is great place to start. Department code – This is usually a two-digit code that identifies a specific department within a company, such as the accounting, engineering, or production departments. Looking at the COA will help you determine whether all aspects of your business are as effective as they could be. If you keep your COA format the same over time, it will be easier to compare results through several years’ worth of information.

For example, Sales-Hardware could be further broken out to Sales-Hardware-Computers and Sales-Hardware-Printers. Hardware-Printers could be further broken out in Hardware-Printers-HP and Hardware-Printers-Canon. At that point, further detail may be more harm than help and lead to inaccurate accounting. It is generally better to have less detail and keep it accurate than to have inordinate amounts of detail that tend to be inaccurate.

A chart of accounts is an index of all the financial accounts in a company’s general ledger (GL). Indirect costing applies to project-oriented companies, particularly manufacturers and construction contractors. Companies that are not project-oriented, such as retailers and restaurants, typically would not incorporate indirect costing into their accounting structure.