Mastering the Chart of Accounts – Part 1: Income and Expense

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A well-structured chart of accounts is the foundation of good bookkeeping. The idea is to set up categories for bookkeeping information to keep track of expenses and income in a way that makes it easy to access that data for reporting and analysis. The trick is to make sure that categories are correctly set up at the outset and that data entry categorization is consistent and correct.

We work closely with our clientsto make sure that data is categorized correctly. This is more challenging than might be expected, especially when you have to consider how accounting software is configures and to stay in compliance with GAAP standards. For example label the account “postage and delivery” rather than “stamps” in order for accounting professionals to read your reports properly.

Understanding the types and hierarchy of the line items in your chart of accounts will make it easier to maintain clean books, and use your accounting software properly. The chart of accounts categories fall under a few basic groups: income and expense, assets, liabilities and equity accounts. We will offer suggestions as to how to structure the chart of accounts for each group in two separate blog entries. The first topic of discussion is Income and Expense that are represented on your Profit and Loss statement.

Income and Expense is the life’s blood of any business, and keeping close track of cash flowing in and out of the company is how to keep the operation running smoothly. Here is how we approach income and expense when mapping out the chart of accounts:

· Income accounts – Create different income accounts for each type of income you need to track separately. If you are tracking the same type of income from different locations, then use “classes” instead of multiple income accounts. For example, if the company owns multiple properties the result is multiple sources of rental income. Create a “rent” income account, but use classes to track individual properties and to generate the P&L report by class in order to show rental revenue for each property. If there is ancillary income from the properties, such as laundry machines, then create a new income account called “Laundry,” to separate that revenue from rent. Again use the classes to differentiate laundry revenue from each location.

· Cost of Goods Sold (COGS) – Use accounts for COGS items, such as inventory required to make a product for sale or payroll costs for employees offering services to be sold. Include any accounts that are directly related, such as merchant fees. Be sure to allocate COGS properly. For example, payroll for an employee dedicated to production is a COGS payroll expense, whereas payroll for an operational employee such as a receptionist should be categorized as an overhead expense account.

· Expense accounts – Organize expenses in accordance with GAAP standards, but make sure the categories work for the business’s reporting needs as well. Group expenses into sub-accounts to create structure and to provide more or less detail in collapsed or expanded reports. For example, you can group expenses under broad categories such as Employee Benefits, with sub-accounts for health insurance, 401K matching, continuing education, etc. Name accounts using best practices, e.g. “continuing education,” not “college classes.”

· Avoid creating too many accounts – Many of the items that need to be tracked and reviewed can be reported using means other than categorization on the chart of accounts. For example, create one category for Telephone expenses that encompasses office phones and cell phones. Use the vendor field properly and sort by vendor to determine specific expenses for individual telephone categories such as “AT&T Mobile” and “AT&T.”

In the next blog entry, we will review balance sheets items such as assets, liabilities and equity accounts and how to set them up properly in your Chart of Accounts. Click here to Read Part 2 of Mastering the Chart of Accounts