Chart of Accounts - Problems
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The document discusses common errors in designing a chart of accounts, particularly in QuickBooks, which is often used by small companies. It highlights issues such as the use of alphabetical instead of numerical account coding, excessive account numbers, insufficient detail in financial reporting, and the importance of honoring GAAP for management purposes. The text also provides suggestions for effective account segmentation, numbering, and handling of accrual accounting.
Chart of Accounts - Problems
- 1. Cliff’s Chart of Accounts Design SOME COMMON ERRORS - - - - - - - AND - - - - - - - - SOME SUGGESTIONS Cliff Beacham CPA, MBA
- 2. Error#1: No Account Numbers Alpha coded keys sort alphabetically For small companies (and most companies start small) QuickBooks is the most common accounting software suitable for beginners and claiming for non-accountants. This means sorting is in alphabetical order and does not enable logical order Unfortunately, the Chart of Accounts is encouraged as an alpha coding system instead of number based system Account numbering takes knowledge (of theory and practice), experience (having done it before + familiarity with the industry) and will not be as straightforward/simple as you first think
- 3. Error#2: Too Many Accounts “If you don’t know what to do with it, open a new account” Often the number of GL accounts grows over time . When faced with an accounting entry that is not specifically described by an existing general ledger account, many times, the user just sets up a new account Data may not be entered by anyone trained in accounting
- 4. Error#3: Too Much Detail Many times I see Companies with hundreds (even thousands) of Sales Accounts when they should be performing the analysis in a Sales Module. The GL should be orientated to Financial Statement presentation not detailed management” Analysis Paralysis There should be a good reason for a GL account 1.Item is significant at the level one below the FS 2.Item is hard to control and requires ‘only’ items relevant to the item
- 5. Error#4: Too Little Detail in Revenue and COS Aim to provide information On the other hand there is considerable detail in Selling General and Administrative expenses ‘Sales’ is probably not adequate to describe Most accountants manage profitability by controlling costs, however, more value can be created by managing “above the line” or gross margin
- 6. Error#5: Align definition of Revenue with COS ‘COS’ by same segment It is not uncommon to see revenue sorted by product or category and the Cost of Goods Sold being tracked under different segments. ‘Sales’ by segment You should define and sort revenue and Cost of Sales by the same methodology so the reader can understand gross profit by category.
- 7. Error#6: Use a combination of Logical and Sequential numbering in GL 1 Assets 2 Liabilities 3 Equity 4 Revenue 5 Costs 6 & 7 Overheads & Expenses 8 Allocations 9 Interest and Tax There is a Generally Accepted Standard for the first number in a series of Natural Accounts
- 8. Error#6: Logical numbering in GL Balance Sheet: 1000 Current Assets 1500 Fixed Assets = 2000 Current Liabilities 2500 Long-term Liabilities + 3000 Equity Example:
- 9. Error#6: Logical numbering in GL Income Statement: 4000 Revenue 5000 COS = Gross Profit 6000 Overhead expenses 7000 Allocation accounts 8000 Finance costs 9000 Other Income & Exp = Net Profit Example:
- 10. Error#7: Abbreviations and Acronyms In some instances acronyms are used to title accounts making it difficult for a reader of the financial statements to decipher the accounts. There is no reason why not - except that it should not be confusing
- 11. Error #8: Too little detail – need for separate accounts EG: Bank accounts always have their own GL account It can aid control if an item is separated in the GL
- 12. Error #9: Follow the Business Model Use allocation accounts to assign amounts to direct costs (cost centers) from indirect costs EG Rent to departments
- 13. Error #10: Do NOT Follow US GAAP GAAP is for presentation that is a reporting function The COA needs to be for the purpose of management
- 14. Error #11: Segment the GL into Divisions Use segmentation to reflect information that is useful for decisions
- 15. Error #12: Segments do not have to follow ‘logical’ coding Can have a segment that is sequential Example: 1234-9999 The second segment makes no pretense at using logical coding Default is 1234-0000 = no sub-accounts to the 1234 group The segment just starts at 1 and increases This adds to flexibility and does not detract from ease of reporting
- 16. Error #13: Use one Standard COA across all group companies This is not always an easy exercise but it can be simplified
- 17. Error #14: ‘Other’ can be the default account Use a 0 for the default when there is no further breakdown/analysis in the GL Example: 1200 Auto expenses 1200 Auto Expense Default 1201 Gas 1202 Auto Licenses 1203 Auto Insurance
- 18. One Last Thing: The accrual system A COA must be designed to handle accrual accounting The cash flow method does NOT reflect true Profit/(Loss)
- 19. IS YOUR LIFE NOW CHANGED? The End
- 20. Questions?
- 21. CliffB
Editor's Notes
- #2: Be afraid – be very afraid Be scared but go on – you will be glad you did This presentation will open your eyes to possibilities While I have read many books – probably all the major ones – on Excel I have never come across the material that is in this presentation. For example: Please note: There is one special characteristic about XL and other Office Apps that sets it apart from a program that you write. This is that things are not always what they might seem on the face of it. Functions in XL return results that are not expected but are predictable. By this I mean that XL often tests the data and returns a 0 or a 1 – alternately maybe a True or False. At first you might think that this is not a good thing – hold on – it is predictable so it can be used to extend the functionality of the functions that use it. This presentation is probably based on the notion of zero’s and One’s and the concept that when we are interrogating data we can be looking at the value or we can be looking at some other property – like whether it exists (instead of what value it holds). So 0 & 1 can mean True or False. There is also the concept of error handling to be dealt with.
- #3: For small companies (and most companies start small) QuickBooks is the most common accounting software, suitable for beginners and claiming for non-accountants. Unfortunately, the Chart of Accounts is encouraged as an alpha coding system instead of number based system. This means sorting is in alphabetical order and does not enable logical order. Account numbering takes knowledge (of theory and practice), experience (having done it before + familiarity with the industry) and will not be as straightforward/simple as you first think.
- #4: A controversial issue is the Prepaids and Accruals which usually require some reconciliation between a GL control and a Spreadsheet subledger. It is possible to argue either way – the separate GL account approach aids control but there are limits to this and a subledger may be needed. A good technique is to set up Prepaids in AR as a separate class that uses a separate GL account and Accruals as part of AP (as a class of AP). An advantage of separate GL accounts for a prepaid is that the Controller can see at a glance at the TBal how much of the PPD is left.
- #5: Many times I see Companies with hundreds (even thousands) of Sales Accounts when they should be performing the analysis in a Sales Module. The GL should be orientated to Financial Statement presentation not detailed management. There should be a good reason for a GL account Item is significant at the level one below the FS Item is hard to control and requires ‘only’ items relevant to the item
- #7: It is not uncommon to see revenue sorted by product or category and the Cost of Goods Sold being tracked under different segments.
- #8: You do not have to accept this standard chart but it is in common use this standard framework. To assign a meaning to a digit is called logical coding. A common example is a vehicle VIN number – but you know how long they can be so it cannot be a completely logical code. At some stage a sequential number has to be used. Example: Cash in California Bank 10-1020-00 This might mean that the first segment ‘10 means California. The second segment is the Natural Account with the 1 designating Cash and the 2 meaning Wells Fargo. Usually a digit is added after the 2 so that you have the opportunity to add accounts in the future. Gaps in sequences are left for future allocations as well The 3rd segment can be assigned to something else or it may just be a filler to enable future expansion See separate discussion about designing a GL number system
- #9: Some companies use the 0 series for non-financial information – just to have a place in the GL to store statistics. Numbers that start with a 0 can cause problems so most companies start at 1000
- #10: Of course we can discuss details and modifications to this basis framework – but you get the idea
- #12: Reconciliations are a way of life in the accounting dept but the control of certain items can be aided by the way they are accounted for in the GL AR Classes should be separated Example: Retail Trade Accounts receivable Wholesale customers Employee receivables Contra accounts should not be netted EG Provision for Bad Debts should have its own GL account
- #13: Of course – do this with intelligence and do not go mad over every little detail
- #14: Of course – do this with intelligence and do not go mad over every little detail
- #15: Of course – do this with intelligence and do not go mad over every little detail
- #16: Of course – do this with intelligence and do not go mad over every little detail
- #17: Segments in GL account numbers can aid the process Example: 10-20-30-4567-890 Company-Division-Dept-NaturalAccount-Project/Location This seems like a long number but because it divided into segments it is fairly easy to implement and entered through a 10keypad is fast since input masks do not require the – separator and each segment is a different list. While it may be too long for a small company, it is a good way to deal with complexity
- #18: Segments in GL account numbers can aid the process Example: 10-20-30-4567-890 Company-Division-Dept-NaturalAccount-Project/Location This seems like a long number but because it divided into segments it is fairly easy to implement and entered through a 10keypad is fast since input masks do not require the – separator and each segment is a different list. While it may be too long for a small company, it is a good way to deal with complexity
- #19: I have heard many accountants who say ‘Cash Flow is King’ and other such sayings that seem to be trendy or catchy This is not true – although Cash Flow is a crucial in the short term it does not give a true reflection of PoL – people who say this have not gone to University or business school. All I can say is Call me if you have questions on this!