The chart of accounts specifies how accounting data is organised. Because a properly constructed chart of accounts makes it much easier to collect and report data, the account structure is something that the bookkeeper is quite interested in. In this tutorial, we’ll go over the chart of accounts and the most typical accounts, as well as account coding structures for two different sorts of businesses. We wrap up with a discussion of ways for decreasing the chart of accounts’ complexity.
Overview of the Chart of Accounts
A chart of accounts is a list of all accounts in the general ledger, usually ordered by account number in ascending order. Typically, the accounts are numeric, but they can also be alphabetic or alphanumeric. Accounting software uses the account numbering system to aggregate information into a company’s financial statements.
Accounts are normally included in the financial statements in the order in which they appear, beginning with the balance sheet and ending with the income statement. As a result, the chart of accounts starts with cash, moves through liabilities and shareholders’ equity, and then moves on to revenue and expense accounts. Many businesses, such as consulting firms, have their chart of accounts set up so that spending data is compiled by a distinct department. The expense accounts for the sales department, engineering department, and production department are all the same.
Typical accounts found in the chart of accounts include:
• Cash. Contains the amounts of petty cash and bank account balances. There is usually a separate account for each bank account and a separate account for all petty cash.
• Marketable securities. Contains the valuations of any investments that the company has made in marketable securities. In a smaller business, excess funds may be kept in a savings account at the bank, in which case these funds appear in a cash account.
• Accounts receivable. Contains the balances of trade and non-trade receivables. Trade receivables are with customers, and non-trade receivables are with everyone else, such as employees. Trade receivables arise when sales are made on credit, with customers promising to pay as of a later date.
• Allowance for doubtful accounts. Contains a reserve against expected future losses on accounts receivable, which is in line with the Singapore Financial Reporting Standards (SFRS) 9. The account has a negative balance.
• Prepaid expenses. Contains the unconsumed balances of any payments made, such as prepaid rent and prepaid insurance.
• Inventory. Contains the balances of raw materials, work-in-process, and finished goods inventory.
• Fixed assets. Contains the amounts paid for fixed assets, such as machinery, furniture and fixtures, and computer equipment. This account may be subdivided into a separate account for each classification of fixed asset.
• Accumulated depreciation. Contains the grand total accumulation of depreciation charged against fixed assets over time. The account has a negative balance.
• Intangible assets. Contains the purchase costs of non-tangible assets, such as purchased patents, licenses, organization costs, and copyrights.
• Accumulated amortization. Contains the grand total accumulation of amortization charged against intangible assets over time. This concept is quite similar to accumulated depreciation. The account has a negative balance.
• Goodwill. Contains any excess amount paid to the owners of an acquired business that exceeds the fair value of the assets and liabilities acquired.
• Other assets. Contains all other assets that do not fit into the descriptions for the preceding asset accounts.
Note: Most of the preceding assets are considered to be current assets, which means that they will be liquidated within one year. If an asset is to be held longer than one year, it is considered a long-term asset, or non-current assets.
• Accounts payable. Contains the complete set of all payables owed to suppliers, based on invoices submitted by the suppliers.
• Accrued liabilities. Contains estimated liabilities for which no documented supplier invoices have yet been received.
• Taxes payable. Contains the liabilities for all types of taxes owed, including sales and use taxes, property taxes, payroll taxes, and income taxes. There is usually a separate account to track each of these types of taxes.
• Wages payable. Contains the estimated amount of wages owed to employees that have not yet been paid.
• Notes payable. Contains the remaining balances of loans owed to lenders. There may be a separate account for each loan owed, so that payments are not confused among the different loans.
Note: Most of the preceding liabilities are considered to be current liabilities, which means that they will be settled within one year. If a liability will not be paid for more than one year, it is considered a long-term liability, or non-current liability.
• Share Capital. This account is used by corporations, which issue shares. It contains the amount of funds received by a business in exchange for the sale of its stock to investors.
• Additional paid-in capital. This account contains any additional amounts paid to the organization by an investor for shares in the business, which exceeds the par value of the shares.
• Retained earnings. Contains the accumulated amount of any earnings generated by a business.
• Drawing account. This account is associated with the capital account that was just referenced. It contains the amounts of funds withdrawn from the business by its owners.
• Other Comprehensive Income. This account can include the foreign exchange differences if the company deals with currencies other than its functional currency.
• Revenue. Contains the gross amount of all sales recognized during the reporting period.
• Sales returns and allowances. Contains the amount of any credits granted to customers for sales returns and allowances. This account balance offsets the revenue account.
• Cost of goods sold. Contains the cost of all direct labour, direct materials, and factory overhead associated with the sale of goods and services.
• Advertising expense. Contains the recognized cost of advertising expenditures.
• Bank fees. Contains the fees charged by a company’s bank to process transactions.
• Depreciation expense. Contains a depreciation charge that reflects the consumption of assets over time.
• Payroll tax expense. Contains the cost of all taxes associated with the payment of salaries and wages.
• Rent expense. Contains the cost of the rent associated with the facilities used by a business.
• Supplies expense. Contains the cost of all supplies consumed by a business.
• Utility expense. Contains the aggregated cost of all utilities, which may include water, heat, electricity, waste disposal, and so forth.
• Wages expense. Contains the cost of salaries and hourly wages incurred by a business to compensate its employees.
• Other expenses. Contains a variety of incidental expenses that are individually too small to warrant the use of a separate account.
There are a number of ways to structure the chart of accounts, as noted in the following sections that describe three-digit and five-digit charts of accounts.
The Three-Digit Chart of Accounts
A three-digit chart of accounts allows a company to build a numerical account sequence that can contain up to 1,000 accounts. Small enterprises that do not break out the results of any departments in their financial statements most typically employ the three-digit format. The following is an example of a three-digit chart of accounts:
020 Petty cash
030 Accounts receivable
040 Allowance for doubtful accounts
050 Marketable securities
060 Raw materials inventory
070 Work-in-process inventory
080 Finished goods inventory
090 Reserve for obsolete inventory
100 Fixed assets – Computer equipment
110 Fixed assets – Computer software
120 Fixed assets – Furniture and fixtures
130 Fixed assets – Leasehold improvements
140 Fixed assets – Machinery
150 Accumulated depreciation – Computer equipment
160 Accumulated depreciation – Computer software
170 Accumulated depreciation – Furniture and fixtures
180 Accumulated depreciation – Leasehold improvements
190 Accumulated depreciation – Machinery
200 Other assets
300 Accounts payable
310 Accrued payroll liability
320 Accrued vacation liability
330 Accrued expenses liability – other
340 Unremitted sales taxes
350 Unremitted pension payments
360 Short-term notes payable
370 Other short-term liabilities
400 Long-term notes payable
500 Capital stock
510 Retained earnings
700 Cost of goods sold – Materials
710 Cost of goods sold – Direct labor
720 Cost of goods sold – Manufacturing supplies
730 Cost of goods sold – Applied overhead
800 Bank charges
825 Office supplies
830 Salaries and wages
845 Travel and entertainment
855 Other expenses
860 Interest expense
Download the 3-digit chart of accounts in excel here.
Each block of related accounts in the example starts with a different set of account numbers. A numbering scheme aids the bookkeeper in remembering where accounts are located in the chart of accounts. The report authoring module in many accounting software systems also requires this type of account range format.
Tip: Leave plenty of room in the numbering assigned to accounts, so that additional accounts can be inserted between existing accounts.
The Five-Digit Chart of Accounts
Organisations that want to track information at the departmental level utilise a five-digit chart of accounts. They can generate a different income statement for each department using a five-digit code. This style mirrors account codes seen in a three-digit chart of accounts, but adds a two-digit code to the left to denote individual departments. The three-digit codes for expenses (and, in certain cases, income) are then copied for each department where management needs to keep track of data.
See below for a sample of the five-digit chart of accounts format which uses the accounting and production departments to show how expense account codes can be duplicated:
00-020 Petty cash
00-030 Accounts receivable
00-040 Allowance for doubtful accounts
00-050 Marketable securities
00-060 Raw materials inventory
00-070 Work-in-process inventory
00-080 Finished goods inventory
00-090 Reserve for obsolete inventory
00-100 Fixed assets – Computer equipment
00-110 Fixed assets – Computer software
00-120 Fixed assets – Furniture and fixtures
00-130 Fixed assets – Leasehold improvements
00-140 Fixed assets – Machinery
00-150 Accumulated depreciation – Computer equipment
00-160 Accumulated depreciation – Computer software
00-170 Accumulated depreciation – Furniture and fixtures
00-180 Accumulated depreciation – Leasehold improvements
00-190 Accumulated depreciation – Machinery
00-200 Other assets
00-300 Accounts payable
00-310 Accrued payroll liability
00-320 Accrued vacation liability
00-330 Accrued expenses liability – other
00-340 Unremitted sales taxes
00-350 Unremitted pension payments
00-360 Short-term notes payable
00-370 Other short-term liabilities
00-400 Long-term notes payable
00-500 Capital stock
00-510 Retained earnings
00-700 Cost of goods sold – Materials
00-710 Cost of goods sold – Direct labor
00-720 Cost of goods sold – Manufacturing supplies
00-730 Cost of goods sold – Applied overhead
10-800 Accounting Bank charges
10-805 Accounting Benefits
10-810 Accounting Depreciation
10-815 Accounting Insurance
10-825 Accounting Office supplies
10-830 Accounting Salaries and wages
10-835 Accounting Telephones
10-840 Accounting Training
10-845 Accounting Travel and entertainment
10-850 Accounting Utilities
10-855 Accounting Other expenses
10-860 Accounting Interest expense
20-800 Production Bank charges
20-805 Production Benefits
20-810 Production Depreciation
20-815 Production Insurance
20-825 Production Office supplies
20-830 Production Salaries and wages
20-835 Production Telephones
20-840 Production Training
20-845 Production Travel and entertainment
20-850 Production Utilities
20-855 Production Other expenses
20-860 Production Interest expense
Download the 5-digit chart of accounts here.
The sample chart of accounts reflects accounts for the departments listed. Since some departments have accounts for which they are the only probable users, this does not reflect all real accounts. Some accounts can be avoided by flagging them as inactive in the accounting system. As such, they do not appear under the formal chart of accounts.
Chart of Accounts Reduction
Hundreds, if not thousands, of accounts make up a typical chart of accounts, with the majority of them devoted to expenses. The accounts for most departments are generally the same, and they are duplicated into any new department that a corporation develops. As a result, the following concerns arise:
• Misuse of the account. When the first draft of the financial statements is produced and reviewed, it is extremely typical for an expense to be charged to the wrong account within a department. As a result, someone will need to make a journal entry to shift the inaccurate charge to another account.
• Intangible balances The vast majority of accounts have minor balances that have little impact on the reader’s comprehension of a company. Readers are more likely to concentrate on a limited number of accounts that contain the majority of all transactions.
• Education. Before new bookkeepers are comfortable recording transactions into the correct accounts, they may need substantial training.
• The cost of the audit. A large chart of accounts takes longer for outside auditors to audit, which can drive up the cost of an audit.
• Links to financial statements. Mapping chart of accounts can be difficult if there are multiple account numbers. These accounts are then combined into a logical set of financial statements. Financial statements that do not accurately reflect the contents of the general ledger may result if the mapping chart of accounts is not done appropriately.
It may be possible to drastically shrink the number of expense accounts in use. In particular, consider using just the following mega-accounts:
• Direct expenses. This report includes the expenses of materials and supplies utilized in the manufacturing process, as well as freight charges, but not much else.
• Costs that have been allocated. Overhead costs must be allocated according to the major accounting systems. As a result, create a single account for all factory overhead charges that must be assigned. Because production labour is not a direct cost of goods or services in most businesses, it would be included in the account.
• Rewarding employees. Hourly wages, salaries, payroll taxes, and employee perks are all accumulated in this account.
• Managing a business. This account includes all of the day-to-day costs of running a business, such as non-factory rent, utilities, legal fees, and office supplies.
Additionally, a small number of accounts with aggregated data for tax reporting or other specific uses, such as entertainment spending, may be required.
Be careful that lowering the number of accounts makes comparing a company’s financial statements to its historical financials more complex. For example, an account may have been merged with another, which is now reflected in a different line item in the financial statements than before. This is especially problematic if accounts are closed in the middle of a fiscal year, causing financial statement line items to no longer to reflect consistent outcomes throughout the year.
There is no simple solution to this problem other than shutting accounts at the start of each fiscal year. Those bookkeepers who are used to dividing down spending into a myriad of buckets, which makes expenses easier to examine, may be outraged by the idea of a huge reduction in the number of accounts.
Take into account the following:
• Account analysis is used. Is anyone acting on the information once the bookkeeper has delivered a full variance analysis of the contents of each account to the management? They usually don’t.
• Are you a helper or a stumbling block? How much time does the bookkeeper spend analysing accounts and reporting discrepancies to management, and how much time does management spend investigating these discrepancies without taking any major corrective action? Is account analysis, in other words, a never-ending loop of identifying “problems” and then explaining them away?
• Accounting standards requirements. Accounting standards do not provide for a diverse set of accounts. The standard-setting organisations, on the other hand, have typically avoided demanding the use of specific accounts. At Tianlong Services, we can also design a standard chart of accounts.
Even if these arguments aren’t persuasive enough to result in a wholesale reduction in the number of accounts, at the very least use them as talking points whenever someone wants to add more – hopefully, these ideas will keep the standard chart of accounts from becoming even more bloated than it is now.
The bookkeeper should exercise a high degree of control over the chart of accounts. Accounts should not be added or subtracted without first considering how these changes will impact the recordation of transactions, the structure of the financial statements, and how information is compared between periods. The likely result is that changes to the chart of accounts are only made with caution and in an incremental manner over a long period of time.
Here at Tianlong Services, we provide services for clients from different industries such as the preparation of chart of accounts for consulting businesses. During the preparation, we make sure to take into consideration everything that is vital to ensure that we can help you create the best chart of accounts for you.
Contact us for a free consultation on creating your chart of accounts.