Designing a Chart of Accounts

A well designed chart of accounts makes financial reporting easier while keeping bookkeeping tasks as simple as possible. Over the last few months conversations with friends, work projects, and reflection on prior jobs have lead me to document the following guidelines to keep in mind when designing a chart of accounts. Some of these are learned firsthand, but many are gleaned from the helpful links at the bottom of the post. So, when developing a Chart of Accounts. . .

Do:

• Follow your financial statement presentation (Assets, Liabilities , Equity, Revenues, Expenses)  – This has several advantages.
  • First, there is a natural order that is built into the financial statement model which gives guidelines to reference for future decisions (i.e. “we’ll put this investment account first because it is our most liquid”).
  • Second, this approach should simplify the preparation or rollup into financial statements. This is particularly true if this is done manually.  
  • Finally, this approach is fairly common, so if at some point your organization chooses to merge or report with another organization, consolidated reporting should be simplified.
• Follow a standard /simple numbering scheme
  • This starts by actually assigning numbers. In some accounting software it can be tempting to just use text descriptions. This can complicate reporting.
  • This goes hand in hand with the point above (Assets = 1XXXX , Liabilities = 2XXXX etc.).
  • It is also wise to avoid alphanumeric systems as these can complicate reporting.
• Design around management reporting – The primary purpose of reporting will be for management decisions. Think about what information would allow management to make good decisions. It might be helpful to brainstorm a list.  For each item on the list review how you will sort/query your new Chart of Accounts. If there are gaps or inefficiencies, consider if there are ways you could change the Chart of Accounts to improve this reporting.
• Think multidimensional – Management reporting needs are often best served by data views beyond just Account classification. Some common examples are: Department, Location, Region, Function, or Project. This can be challenging on some basic accounting systems. (For example in Quickbooks you can add one dimension using the Class field, but you are limited there). But used wisely dimensions can significantly improve reporting.  
• Plan for the future – Design your Chart of Accounts so it can grow to meet your future needs. Here are some things to consider:
  • Leave numbering gaps for future needs (ie. Salaries 5100, Benefits 5200, Training 5300). This way, if later on you find you need to differentiate between hourly and exempt wages you can add a “Hourly Wages 5110” account without complicating rollup structures.
  • Make sure each dimension is large enough for future needs. For example, your company may only have 15 departments, so you might think two digits would be all you will ever need in a “department” field. However if you expand, or frequently close old departments and open new ones, you may quickly have over 100 cumulative historical department codes. By starting with a three digit “department” field you could avoid reusing department numbers, thus maintaining historical reporting accuracy.
  •  Finally if using more than one dimension, it may be wise to create a blank dimension for future use. This could default to zeros. If in the future you find yourself needing an additional dimension, you won’t need to redesign your Chart of Accounts.
• Keep a separate posting account for each sub ledger – It can be tempting to roll two sub ledgers into one account (i.e. to Accounts Payable systems in two separate locations feeding into on Accounts Payable account). However, if you keep separate accounts it can make reconciling between the GL and sub ledgers much easier.
• Standardize chart of accounts across any subsidiaries or partner companies – this is not always an option, but if you can, do it. It will make consolidated reporting much easier.  
• Implement a clear process for making changes to the chart of accounts – once the new chart of accounts is in place make sure you have a process with appropriate approval for making changes to accounts, departments, or other dimensions.  This will ensure only needed changes are made, and that any changes conform to the guidelines used in creating the Chart of Accounts as a whole.

Do Not:

• Track detail for detail’s sake – if there is not a purpose for the detail, use a broader category. It is easy to fall in this trap. For example, I’ve seen separate accounts for “office supplies” and “cleaning supplies”. Unless there is a known reporting need it is best to keep accounts more general. The additional detail creates added coding work with each transaction.
• Mix dimensions – It is often tempting to use one dimension for a purpose for which it is not designed. For example, a company may start creating separate salary expense accounts for each department (Sales salaries expense, finance salaries expense, etc.). This expands the size of the GL, clouds transaction coding, and make reporting more difficult. Instead, make sure dimensions are well defined and used exclusively for these purposes.
• Assume your non-finance employees think in multiple dimensions – While many dimensions make reporting easy, proper coding of transactions often requires understanding by non finance employees. It is often difficult to gain business acceptance of multiple dimensions.  The greater the number of dimensions and the more abstract the definition, the greater this challenge becomes. Most employees can understand Account, Cost Center, and Location; but Class, Function, Purpose, etc. can cause confusion.
• Start from scratch –If you are creating a new chart of accounts don’t build from the ground up. Reach out to colleagues for examples and look online. There are many sources out there to get you started, but be sure to review guidelines above and customize as appropriate.

Links

http://www.wikicfo.com/Wiki/Problems%20in%20Chart%20of%20Accounts%20Design.ashx – problems in COA design

http://bookkeeping-resources.blogspot.com/2007/06/designing-your-chart-of-accounts.html – basic intro and simple sample COA.