A well-structured chart of accounts is essential for accurate financial reporting. A poorly organized chart, or one that groups transactions into vague, undefined categories, can hinder management’s ability to assess financial performance, address customer needs, and may even lead to accounting errors or fraud. Here are some tips for designing a robust chart tailored to your specific needs.
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.
While a simple chart of accounts may suffice in the early stages of a business, greater complexity might become necessary as the company grows. For instance, management may need to track performance by department, project, or region, which could require adding account segments or layers for detailed reporting. Similarly, launching a new business line might call for adjustments to the existing chart. Industries like healthcare and construction often use more complex charts to meet their unique reporting needs.
For more information
Setting up a chart of accounts isn’t a one-off task that produces a template you can use forever. Contact an Axley & Rode advisor 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.
