Friday, February 1, 2008

Chart of Accounts an Organization Structure

By Sean Anderson

The chart of accounts should have a simple and logical organizational structure. More so than that last sentence. I personally prefer to use five digit numbers for primary accounts and 3 digit numbers for sub accounts.

There are many concerns to address when coming up with a chart of accounts. Short and long terms considerations have to be taken into perspective. Many accountants would disagree with me whole-heartedly but this is the one time in accounting that you should avoid being conservative. I like to create a chart of accounts that can weather the storm of business to come. Dream about where you want your business to be, take into scope international possibilities and make your accounting structure flexible so you can quickly adapt to business events.

When developing a chart of accounts consider the business type, industry, business function, standard industry practices, the needs of managers, the possibility of inter-company transactions and the flexibility of your structure.

The number structure should look something like the following
00000 - Short-term assets
10000 - Long-term assets/Intangible Assets
19000 - Depreciation and Amortization
20000 - Current Liabilities
30000 - Liabilities
(I like to have short-term notes and long terms notes correspond to a similar the digit extension 25860 - Short Term Note Payable 35860 - Long Term Note Payable and even the A/R and A/P are on different sides of the accounting equation I line them up as well. It is a part of a better logical structure and assist in memorization of accounts).
40000 - Equity
50000 - Income
60000 - Operating Expenses
70000 - Administrative Expenses
80000 - Taxes/Interest/Extroadinary Income(Expense)

If you really want to spend time developing a chart of accounts you can try to best align closely related income and expenses. Keeping in mind that if payroll expense for plant workers is 60100 that 70100 should be salary expense for sales and administrative employees.

Now to specifically address some of the considerations above. Will start with business type. This is important for obvious reasons. Business revolving around service are obviously going to differ from those revolving around products and retail. For example a manufacturing has to keep track of inventory traveling from cost center as it develops from raw materials and purchased parts to WIP (works in process) to a Finished Good. While a retailer may only need to keep track of inventory and a service potentially may not even need an inventory account.

The industry from within a company operates is also important to consider. This is predominantly due to GAAP you want to be sure to setup a chart of account that will allow the business to remain conducive to the industries standard accounting practices.

Other concerns include the needs of managers. For instance managers typically like a smooth trend of expenses. I personally, don't think this is highly important but you may have the need to setup up several accruals that operate from a budgeted number or you may want to setup a permanent accrual to eliminate the need to perform that operation monthly. It is really only necessary to true this account up at the end of the year if payment amounts are based on an estimate.

Inter-company transactions are also highly important especially when dealing with foreign businesses. The foreign factor involves minimizing tax liabilities while still managing cash. After all you don't want to get all your cash tied up in one country. This is all done through transfer pricing, which I am not yet qualified to address.

Finally, leave yourself some breathing room. Make sure you are always able to add necessary accounts in a logical manner. Business evolves you chart of accounts should evolve with the business. Well this should help with the development of your chart of accounts.

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