Chart of Accounts:
A Road Map for Numbers
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How do numbers know which financial statement to go to? If they make it to the correct statement, how do they differentiate between sections; are they an asset, liability, equity, revenue or expense? A road map or GPS system in travel lets you lock-in your destination drilling down from a macro view of an area, Dallas for example, to a section of town then to a single street and finally the correct address. A chart of accounts is the road map or GPS system that lets your business numbers lock-in on a specific location, Balance Sheet, drilling down to an area, Asset, and finally to the correct address, inventory. This simple tool assigns specific locations to your numbers personally guiding them to the correct destination.
Understanding the make-up of your financial statements still leaves you with the job of figuring how each number gets to these statements. Prior to automated accounting systems ledgers and journals with lots of columns were used to capture business transactions. These journals were divided into the various financial sections corresponding to a financial statement, each transaction was then hand recorded. Adding up the bottom lines from these pages for a specific period of time monthly, quarterly, or annually produced a set of financial statements. Financial reporting was an extremely labor intensive task, one that in practical terms was not calculated daily but reserved for specific time-frames.
Have you ever thought what it was like recoding inventory in a grocery store before computers and scanners? Every transaction was recorded in ledgers by hand can by can both coming into and going out of the system. In financial reporting inventory simply makes up one category in the asset section of a balance sheet. Bar coding inventory has greatly simplified the process reducing costs, increasing accuracy, and producing real-time reports. The technology used to scan the codes automates the recording process but still depends on the chart of accounts to direct this information to the proper address.
Automated accounting systems are affordable and relatively easy to use. A business of any size can quickly justify the cost both in time and money for this investment. The problem for many small businesses and organizations is not understanding the importance of the chart of accounts and the fundamental role it plays in financial reporting. A chart of accounts simply is a name given to your accounting numbers. These names correspond to specific financial statements and sections within these statements. This simple list, see Sample 1, has categories entitled cash, inventory, payroll, sales, and rent expense. For example your checking account is part of the asset section of your balance sheet and can be labeled, or coded, “Cash”. Every deposit received or payment is initially recorded in the “Cash” section and then recorded to another section, double entry bookkeeping. Cash received from a customer would go into your checking account as cash received and then be coded to the sales category. In this case an entry is made to “Cash” on your balance sheet and to “Sales” which is part of your income statement.
All entry level accounting software packages offer the use a standard chart of accounts based on the type of business or organization. The selection of a chart of accounts that matches your company type is important and the software developers make this an easy selection during the installation process. These suggested formats will produce accurate financial reports. The need for more detailed financial information can lead to the addition of more categories or even sub-categories. Numbers can be added to category names which help with the coding process instead of “Cash” you may use 11000 for “Cash” and then use 11001 as s specific bank account if more than one banking account is used.
The chart of accounts for a retail store would have some different categories listed in their chart of accounts as compared to a construction company, dry cleaners, machine shop, or non-profit organization. The confusing part is that financial statements contain the same categories. Each type of business or organization uses certain accounts more than others a retail store owner/manager must control inventory to remain profitable and will focus on resale inventory while a contractor focuses on labor material costs with minimal concern for inventory and a service company may not even have inventory.
Matching the account structure to the correct business type is important for accuracy and timely financial reports. Quality of financial reports gives owners/managers a better tool for making decisions and measuring business success. Using accounting software selecting the correct chart of accounts is a great start but assigning or coding transactions is the step that makes the whole process work. The assigning or coding process is like turning onto the right road. If you don’t follow the map or GPS system then you will not get to the correct address. It is true with maps or GPS systems stopping and asking for directions is an option that can get you back on course. With a few simple instructions your accountant can walk through the coding process so that you get your numbers on the correct path.
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Library of Congress Cataloging-in-Publication
Business/News & Views® / by David. W. Weatherholt
ISBN: 978-0-9823041-1-2 (electronic format)
Published in the United States of America through www.waconsult.com
Published in an electronic format by Weatherholt & Associates, LLC
First Trade Publishing: October 2008
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