Get Your Chart of Accounts Right

A detailed guide about setting your chart of accounts correctly

Accounting is all about preserving balance on both sides of the accounting equation. In simple terms, it is to retain a balance between what you own and what you owe. While it may not sound challenging, however when one attempts at balancing both sides without any experience, things turn out to be notably complicated than expected. Qualified Accountants pursue years of theoretical and practical training to be able to do just that with pinpoint accuracy. If you want to save yourself the trouble of wasted time and effort try looking for an Accountant in London.

Building an effective double-entry accounting system requires an operative chart of accounts, which will ensure long term accuracy and a strong foundation upon which your accounting data can be built.

The details of Chart of accounts:

The chart of accounts comprises the list of key account categories and codes that are relevant to the finances of your business. There are four general sections relating to a chart of accounts that you should know about:

1. Assets Account
2. Liabilities Account
3. Income Account
4. Expenses Account

Remember that each line item is an account itself within each category. A line item can be referred to as the unit of information in a document, financial record or financial statement and is a budget element that is identified separately.

This article aims to provide you with the basic knowledge of the 4 primary categories before you start working on getting your charts of accounts setup correctly.

Assets Account

You should know that an asset is anything that retains value and can also be considered as a resource that can help businesses generate cash flows in the future, for instance, your property is an asset through which you can earn additional rental income. Other examples of assets include buildings, equipment, inventory, and other valuables.

You should seek the assistance of an accountant, as managing your asset accounts can become very tricky. This may be because you have to track multiple things together, for instance, the money you paid to buy an asset (buildings, equipment) along with factoring in depreciation of that particular asset over time.

There are two primary types of assets generally, current and non-current assets. Current assets are generally more liquid as compared to non-current assets and are expected to be consumed within a timeframe of a year. Your current assets include cash, marketable securities, accounts receivable and inventory. On the other hand, non-current assets help provide productivity to a business for more than a year. The line items recorded in this category include tangible fixed assets ( e.g buildings, furniture, equipment, and vehicle), intangible fixed assets (e.g copyrights, trademarks and patents) and goodwill.

With the assistance of a chart of account, you can organize a number of accounts into line items so that you can get a better track of multiple items together. Your Chart of Accounts is a map that confirms how various transactions get mapped in your accounting system.

Liabilities Account

Your liabilities include everything that you owe, be it individuals, banks or other businesses. Your bank loans, personal loans, mortgages, payroll taxes, income taxes payable, bills, etc, all add up to your liabilities account.

Whilst you are entering the amount of loan you have taken into your company’s chart of accounts, you must remember that you should add the principal amount you owe and ignore the interest owed. If you are making monthly payments, you must keep in mind that before entering the payment in your company’s general ledger, you have to divide the payment after subtracting the amount you owe and interest paid, which will be added into the expense account

Income Account

The Income account comprises the amount of income generated through various sources. Many business owners do not pay much attention to the income account and usually work out their income account by dividing it into two general categories ‘sales’ and ‘service’. However, there are sources through which income generation is simple and quick, other sources do not promise such an easy mechanism of income generation and require more time, effort and costs.

You should first identify the most profitable income sources and sort them by their income type. Once you figure out the most profitable areas of your business, you will definitely get a better hold over your business’s cash flow in the future.

Assume for a while that you are an owner of a vehicle workshop that provides body parts and kits, repairing services and cleaning services. The best way to work your income account will be by creating a line of items such as ‘income from cleaning services’ and ‘income from repairing services’, and then comparing the level of profits earned by each line item and the cost incurred in providing those services, to get a holistic view of the financial health of your business

Remember that it’s very important to include everything that is adding up to revenues whilst working out your company’s income account.

Expense Accounts

The Expense account comprises of the expenses incurred whilst managing the operations and finances of your business, in other words, the money you have spent to run your business activities. For instance, when you spend cash on fuel for running your business vehicle, your cash will move from your cash account to your repair & maintenance line item in your expense account.

An expense account helps you get a better track of the cash flowing out of the business or cash that you no longer have.

Like income accounts, breaking your expenses into different line accounts is always a good idea. Breaking down your expenses, managing and tracking them can get very frustrating, so it’s advisable to seek the expertise of an accountant or an accounting firm to help you save time for other primary responsibilities.

Tips

If you are running a startup and struggling to organize your business’s chart of accounts, you should remember that simplicity is key. When setting line items, you should avoid assigning complicated titles to your line items for transactional purposes. Instead, choose simple titles like ‘’bank fees’’ or ‘’repair & maintenance’’ for your line items, so that it is understandable for your management team and your accountants as well.

You can also utilize the sub-accounting feature of your accounting software to meet the need of creating new line items over time. Without creating sub-accounts, the new line items have the potential to clutter your chart of accounts and make it very confusing to track.

For instance, you are paying rent for a building or machinery, to track the cash flowing out, you might add a rent expense account and further divide it into subcategories such as building rent and equipment expense. You might want to track expenses incurred for maintenance and repair as well, so for this purpose, you can break down your repair and maintenance account into repair expenses and fuel expenses(to maintain your machinery) separately, so that you can easily navigate any discrepancy resulting in the imbalance of your business books.

Hire an accountant to manage your chart of accounts:

Your chart of account reflects your business’s past performance and helps projects future financial conditions. With time, you will take steps to expand your business, and as the scale of your business increases, so will the need for accurate and reliable financial reporting. If you are able to set up an effective chart of account, you can ensure error-free and reliable accounting practices for your business and can also help make well-informed business decisions in the future.

With growth, comes numerous complications, so it’s advisable to hire a business accountant, tax accountant or a chartered accountant to help you track your business’s finances, save time and money.

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