Chart of Accounts: What No One Talks About

Accounting

Apr 12

If you’re a business owner, accountant, bookkeeper or accounting student, you most likely know what a Chart of Accounts is and if you don’t, there are a lot of resources out there that explains it.

You started reading this blog because you’re interested in the title.

Let’s start with a brief description of what it is then go into the meat and potatoes.

Let’s get started!

What is a Chart of Accounts?

Chart of Accounts, known as COA, is a list of all the general ledger accounts that a company uses to report financial information. Every single business has this because without it, all the transactions are just a mess. Think about a book, the binding would be like the Chart of Accounts, and without the binding, it’s just loose paper.

The best practice for creating a Chart of Accounts is to group accounts with a similar characteristics together and leave space for growth in the future in case more accounts are needed. It’s easiest to group them via a numbering system.

Here are the various groups with a sample numbering system:

Assets – 1000 to 1999
Liabilities – 2000 to 2999
Equity – 3000 to 3999
Revenue – 4000 to 4999
Expenses – 5000 to 5999
Other Income/Expenses – 6000 to 6999

Any accounts that start with 1000 or 10000 mean it’s an asset. This sample numbering system is common across a variety of companies and is the standard. If you need a refresher on what the groups are, you can refer to the links above.

Myth #1: Chart of Accounts needs to list every type of transaction

If you’re a small to medium sized business and you have 100 accounts, that could be a problem. If you’re a large business and you have 1000 accounts, that could also a problem. Just think about the reports you get every time, do you actually look at it? My guess is probably not since it’s too long.

Your next question is probably ‘what’s the ideal number of accounts?’. Every business is different so the answer to this is that it depends. Don’t have too many that you’re losing visibility into the numbers.

Here is best practice:

Have the minimum number of accounts to get enough valuable information about your business. I always say that less is more because having less accounts will ultimately help your company grow, if that’s what you’re trying to achieve. It sounds counter-intuitive but it’s true.

It’s better to use subledgers (called subsidiary ledgers) to track similar types of information that flow into the general ledger, rather than creating an account for each. You will get much better reporting in a timelier manner.

For example, if you’re a modular building manufacturer, you have inventory like drywall, framing or insulation. If you create an account for Inventory-Drywall, Inventory-Framing or Inventory-Insulation, you won’t be able to track these properly and the reports are essentially useless for any type of decision making. The better option is to have one general ledger account called Inventory and all your inventory items are set up in a subledger. Any changes to any of these inventory items will be reflected in the Inventory account. You can also run a report that tells you how much is left. Imagine that you have hundreds of inventory items, this method would prevent you from creating hundreds of accounts that have no reporting capabilities.

Do you agree with this myth? Let us know down in the comments.

Myth #2: You can create two subledgers for the same General Ledger account

I mentioned above how it’s better to have the minimum number of general ledger accounts, just enough to get valuable information about your company. It’s possible to create two subledgers that flow into the same general ledger account but it’s highly not recommended since it makes reconciliation and tracking a nightmare.

Here’s why you want only one subledger to go with only one general ledger account:

Ease of reconciliation (on a recurring basis, the subledger needs to be reconciled to the general ledger to ensure that the number matches; it should if it’s set up properly)
More visibility (transactions are easier to trace)

Just think of this example:

You have different currencies for bank account, accounts receivable account or accounts payable accounts. Let’s say each has both CAD and US dollar currency. It’s essential to have 1 subledger for each currency that flows to different general ledger account for easier reconciliation and more visibility.

For the bank accounts, you need to do bank reconciliations on a recurring basis (month, quarterly or some other interval) which essentially means you are reconciling your bank statement to the bank general ledger account. If you had both currencies and you’re trying to figure out why it’s not reconciling, it would be quite difficult to figure that out (just think if you have over 100 or 500 transactions a month).

Even if you had two bank accounts with the same currency, it’s best practice to set up a separate subledger.

Do you agree with this myth? Let us know down in the comments.

How to Create a Chart of Accounts

We just went through 2 myths on chart of accounts but how do you actually set up one? If you’re a business owner, you don’t need to do this yourself since your accountant or bookkeeper can set this up for you but your input is extremely important.

Before entering anything in your accounting software, you need to figure out what it is that you want to track. Anything that you think is important enough to know about the different areas of your business and want to track, that’s something to consider adding in the chart of accounts. Consider the assets, liabilities, revenue and expenses.

There are accounts that are common to each business and each industry so you don’t need to consider these. For example, Cash, Accounts Receivable, Accounts Payable, PPE, etc.

Next is to consider if there are groups of similar transactions that you can put on a subledger. For example, you issue invoices to your clients and the outstanding balance is considered Accounts Receivable. By putting your customers and invoices on a subledger, you can run an aging report as of a certain date to see who owes you money.

If you’re in a project/service-based company then your projects/services would be in a subledger. For example, a construction/engineering/architecture company with projects or a law firm offering different services to clients.

If you’re in a product-based company then your inventory would be in a subledger. For example, a manufacturing/retail company that manufactures/sells different items.

Also, if you have different departments in your company that you want to track costs for, it’s good to consider these too.

What Not to Create on Chart of Accounts

If you can put something on a subledger, there is no need to create an account on the chart of accounts. For example, if you’re a construction company, you are utilizing job costing which is tracked under a subledger. There is no need to create a general ledger account for steel supply, fence rental, electrical subcontractor, etc. Just think if you had 500 different job cost items, your chart of accounts would be huge!

If there are costs you intend to spend but the amounts are minimal, there’s probably no point in putting that on the chart of accounts. Would you want to track how many post-its or number of pens you are buying for general office supply items? Most likely not. Just group these costs under Office Supplies.

Your Turn

Do you have a better understanding of what a chart of accounts is, the myths of it, how to create one and what not to put on it? If not, go back up and review those sections.

If you need to create one, find an accountant or bookkeeper that has experience with accounting software set up so they can set this up properly for you. If done correctly, you will have visibility into the numbers and are able to make sound decisions!

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At JTL CPA, we are Ontario’s virtual accounting firm. Our goal is to automate your accounting and bookkeeping processes in a way that increases financial visibility. Pair that with our value-added approach and tailored advisory solutions gives you the ability to make sound decisions from good data. Check out our website here: https://www.jtlaccounting.com.

Thank you for making it to the end of the blog post. If there are topics that you would like to learn more about in the future, please let us know down in the comments.

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