Audit + Accounting: Summing It All Up

CPAs Calculating the Latest in Audit + Accounting News

Developing a Chart of Accounts

Often, I receive a request from new businesses for a sample chart of accounts.  While each chart of accounts is customized to that business, there are a few best practices that I communicate to my clients. When creating a new chart of accounts, you want to keep it simple and easy to use but also allow room for future growth. First, I recommend following this guide when developing an initial chart of accounts, which allows for quick identification of what type of account each is:

  • 1 Series: Asset Accounts
  • 2 Series: Liability Accounts
  • 3 Series: Equity Accounts
  • 4 Series: Revenue Accounts
  • 5 Series: Cost of Sales Accounts
  • 6 Series: Operating Expense Accounts (sometimes I see operating expenses further broken out between 6 and 7 Series, though not necessary)
  • 7, 8, or 9 Series:  Other Income and Expense Accounts (which includes interest income and interest expense)

Usually, I see companies start with four or five digit general ledger account numbers.  The number of digits you use is up to you, however, having more than three allows for greater flexibility when you need to add new accounts. You may also want to create separation within each general ledger account series for the different types of accounts that would show up on financial statements (for example, 1,000 for cash accounts; 1,100 for accounts receivable; 1,200 for inventory; 1,600 for property, plant and equipment; and 1,900 for deposits and other assets). This would allow for easier grouping of similar accounts as a single line item on financial statements. In addition, many accounting software programs also provide account groupings and account classes that can be used in order to develop a set of customized financial statements within the software.

Another thing to consider is when you have sister companies or parent and subsidiary relationships. I highly recommend using a similar chart of accounts format for each of the companies. For example, don’t use 1,100 for cash on one entity and 1,100 for accounts receivable on another. Should there be a need to provide consolidated or combined financial statements in the future; having similar account structures makes it easy to prepare these financial statements as each account number will be mapped up the same.

Finally, as companies grow and become larger, companies will further break out their expenses between cost centers. At that point, you will see a sub-string added for the various cost centers (marketing, human resources, sales department, executive, etc.).   Accordingly, each operating expense account will be expanded to provide for the cost center extension. For example, meals and entertainment costs could be established as such:

  • 6650-010 Meals & Entertainment: Executive
  • 6650-020 Meals & Entertainment: Human Resources
  • 6650-030 Meals & Entertainment: Sales Department

This also can be done on the revenue side if there are different revenue centers for the company. These are often added on to get better visibility to the operating performance of each cost or revenue center. Furthermore, this assists with creating budgets for each center and, ultimately, monitoring performance in relation to the budget.

There is no exact way to establish a chart of account for each business. However, thinking it through on the front end will provide a good foundation for growth of your general ledger to compliment the growth of your business.

Jonathan Poppel, CPA