|Why Is The
Chart Of Accounts Important ?
Setting up a chart of accounts is
one of the first, if not the first, task you perform when
setting up an accounting system whether a manual or computerized
A business needs and should
want to know where the money is coming from and where it is going
!!! Your chart of accounts is a tool for gathering and organizing
this type of information.
A business must have useful
information in order to be able to survive in today's
competitive business world. You notice that I said
information - raw data is not very useful until it has been
"massaged" and summarized into meaningful information. Your
accounting system should be designed and used to provide much of
this detailed, summarized, and needed information. The information
available for your financial reports (summary and/or detailed)
often depends on how well you designed your chart of
One of the main keys to a
properly designed accounting system is your chart of
The chart of accounts is the
Foundation that your financial record
keeping system is built upon.
||What Needs To
Be Considered in Planning and Setting Up A Chart Of Accounts
Let's begin by listing and
discussing some considerations.
- What I call the Goldilocks and
the Three Bears Rule:
In the fairy tale, as most of you are aware, Goldilocks, a little
girl, ventured into the home of the three bears - Mamma Bear, Poppa
Bear, and Baby Bear. While there, amongst other things, she tried
Poppa Bear's porridge , Momma Bear's porridge, and Baby Bear's
porridge. Poppa's was too hot - Mamma's was too cold - and Baby
Bear's was just right. In setting up your chart of accounts, you're
trying to find the porridge that is just right - not too hot and
not too cold.
The too cold represents a simple
basic chart of accounts while the too hot represents a very
detailed and complex chart of accounts. What we're striving for is
the just right. In other words, try to keep your chart of accounts
as simple as possible yet designed with enough detail to provide
the information and reports needed for managing and controlling
your business. There is a trade-off between simplicity and the
amount of detailed information your business needs.
- The Easy Part - many accounts
that make up the chart of accounts are obvious and common to all
types of businesses such as Cash - Accounts Receivable - Accounts
Payable are needed and used by businesses both big and
- The qualifications and knowledge
of your accounting staff whether its just the owner, a bookkeeper,
or a full blown accounting department. If you set up a complex
system your staff may need special training.
- Your type of business (retail,
wholesale, service, manufacturing, etc.), your industry, and your
specific business. Even businesses that are the same type and
industry might have special or unique requirements. While a service
business may not have a need for a Merchandise Inventory Account a
retail or wholesale type of business normally would. In addition,
there are likely to be differences even among the same type of
business. One service business might have only one cash account,
regular checking, while another service business might have three
cash accounts such as - petty cash - regular checking - payroll
- Whether you use the Accrual or
Cash Basis of accounting. If you use the Cash Basis, some accounts
such as Accounts Receivable and Accounts Payable would not be a
part of your chart of accounts.
- Complexity of the structure of
the business. Is the business a small Ma and Pop operation or a
Super Corporate Conglomerate composed of many divisions, plants and
departments ? A complex structure will probably require a chart of
accounts that provides the capability of reporting on the results
of the business segments such as divisions, plants, departments,
- The reports you want, are
required, and/or need for internal use and to satisfy owners and
government or regulatory agencies. First define and determine what
reports are required and then determine and set up the chart of
accounts that will satisfy your reporting needs. What you're
actually doing is working backwards using the reports to determine
the structure of your chart of accounts that will be able to supply
the information needed for your reports.
Special consideration should be
given to any Governmental or Regulatory Reporting Requirements that
may pertain to your chart of accounts. An example for USA
businesses would be IRS requirements to have accounts for meals,
officer salaries, travel, and entertainment. Other Countries
usually have similar tax rules.
- The importance of a logical
numbering or coding system that provides the necessary detailed
information and is flexible enough to allow you to add accounts as
- Computerized or Manual
Keeping track of detailed information manually is time consuming,
and few small businesses have the staff to do it. The more detailed
the information your business requires, the more likely you are to
need a computer and accounting software. While a computer and
accounting software are not an absolute necessity for a small
business, with the low price and availability of computers and
accounting software (some free), I'm hard pressed to think of a
valid reason not to use these tools.
- Do It Right The First Time !
Even though you can always add or remove accounts, you should
attempt to initially do a good job of determining the accounts your
business needs. Adding and/or Removing accounts distorts
comparisons between periods. Monthly, Quarterly, Yearly, etc.
comparisons can be extremely beneficial in analyzing your
Let's make a simple list based on
our discussion to serve as a simple aid as to what to consider when
setting up your chart of accounts.
- Manual or Computer
- Financial information and reports
needed to manage your business.
- Financial reporting requirements
and to whom.
- Information needed to prepare tax
- Information needed for any
special regulatory reporting requirements.
- Type of business.
- Size and complexity of the
- Staff size and
- Need for a simple or more complex