There are several key principles that all accountants should always keep in mind. No matter what kind of business you may be bookkeeping for, your books should be consistent, easy to understand, easy to read, and objectively useful.
These principles are especially important for anyone who is creating a chart of accountants. The purpose of a chart of accounts (COA) is to enable organizations to easily identify every class of items that they will either spend money on or receive money for. These charts are essential for financial decision-makers to make objectively good decisions regarding expenses, revenue streams, and long-term strategies. They also make it significantly easier for outside evaluators to understand a company’s current financial decision.
Contrary to some financial statements, creating a chart of accounts involves a significant amount of subjective decision making. In this article, we will discuss the most important things you should keep in mind when creating a COA and how you can use this to give your business a competitive advantage.
What should be included in a Chart of Accounts (COA)?
As your business continues to evolve over time, naturally, the number (and type) of accounts you possess will evolve as well. This means that in order to create a useful COA, it should be directly scalable along with the growth of your business.
Charts of Accounts are not regulated by FINRA or any other accounting organization, meaning that the exact dynamics of your chart will ultimately be up to you. Typically, a COA will have at least three columns. The first column will list all of the account names that are involved, the second column will list the specific type of account (accounting category), and the third column will usually contain a general description of the kinds of transactions typical to that account. Some COAs may also include a “status” column where they list whether the account is active or not.
In order to make your COA easier to organize and to use, you should likely develop a scalable number system. The most common number system will categorize your accounts by type: asset accounts (1000 to 1999), liability accounts (2000 to 2999), equity accounts (3000 to 3999), sales and cost of goods sold accounts (4000 to 4999), and expense accounts (5000 and above). Usually, this numbering system will make it much easier to effectively make decisions.
What are some of the most common mistakes made when creating a COA?
Because the practices involved in creating a COA are only loosely standardized, it can be very easy to make mistakes. Many businesses turn to outsourced ecommerce accounting services to reduce small mistakes that can compound and have a tremendous impact on their business’ financial well-being.
In order to avoid any problems in the future, it is a good idea to actively keep these common mistakes in mind:
- Information that is inconsistent with tax and regulatory needs
- Various units of your business using different COA standards and norms
- Failing to identify who is responsible for maintaining the COA
- Creating a COA that does not contain key performance indicators—remember, your COA is something that needs to be useful for your business
Fortunately, by taking the time to develop a codified plan, your business can avoid these common mistakes and create a COA that actually adds value.
How can my business improve its COA?
In order to begin improving your COA, you should think about the underlying objective of this chart and work backwards from there. For example, while some businesses will primarily use their COA in order to identify potential ways to increase revenue streams, others will use their COA in order to run a cost-benefit analysis of keeping certain accounts.
In order to improve your COA—which, again, is something very specific to your business—you should begin by consulting all of the individuals who use the COA on a regular basis. Naturally, this will probably include the CEO and CFO of your company, but it may also include various other stakeholders as well.
Changes that can be easily made include adding new columns (contact information, account values, etc.) and either expanding or condensing various columns that already exist. Furthermore, you should evaluate any changes that have recently occurred in your business and decide if these changes ought to be reflected in your chart of accounts. For example, readjusting your equity situation (changing business structures) may be a reason for change.
Important Principles to Keep in Mind
Not every answer to your financial questions can necessarily be found in your COA, which is why many firms make the decision to keep multiple different charts (thin ledger, thick ledger, management ledger, etc.). However, regardless of what you intend to use the COA for, you will want to keep some important principles in mind.
- Whatever design you choose to use, make sure that it remains entirely consistent throughout
- Try to create a COA that will minimize the amount of work you need to do with tax returns and creating financial reports
- Your business will change in size over time—create a COA that can easily be scaled
- Always think about the target audience (users) and your overarching objectives
As long as you can adhere to these principles, your business will find itself in a much better position to succeed.
Creating a Chart of Accounts is one of the most useful things your business can do. Though there will certainly be many subjective decisions involved along the way, adhering to these best practices will put your business in a position to succeed.