Chart of Accounts 101

JOB APPLICANTS to IT service companies hold a range of certifications, such as MCSE, CCNP, and PMP. Hiring managers yearn for another Microsoft Certified Solutions Expert, Cisco Certified Network Professional, or Project Management Professional. Rarely, if ever, does a resume include CPA, or Certified Public Accountant. But accounting is the framework for your company's success, and the chart of accounts (COA) is the foundation for all accounting.

A well-constructed chart of accounts is a baseline requirement for collecting useful and actionable financial metrics, but few small businesspeople without a background in accounting know much about designing one.

You may wonder why you need to understand the basic principles to building an effective COA when you can just turn to QuickBooks and other accounting vendors that offer a predefined chart of accounts, including vertical options. The list of all asset, liability, equity, revenue, and expense accounts are included in the general ledger. The first three are balance sheet accounts while the last two are income statement accounts. The devil is in the details, though.

"The problem comes when life gets more complicated," says Ken Boyd, who was an accountant until becoming a business writer and author of four Dummies books, including Cost Accounting for Dummies and CPA Exam for Dummies. He also wrote articles for QuickBooks for several years. "Your chart of accounts is the backbone for all the accounting that happens afterwards, moving all your transactions to a trial balance, and then to your final balance."

"This conversation is as old as the accounting profession," says Rayanne Buchianico, owner of ABC Solutions, an accounting firm specializing in MSPs across North America from its Clearwater, Fla., office. "Running meaningful financial reports depends a great deal on the account listing. Financial reports are only as informative as the COA allows."

Your banker loves a good COA supporting your balance sheet too, says Chuck Langenhop, senior director at CFO Advisory Services in the Dallas area, and Certified Management Accountant. "The right level of detail is critical for bank and credit card reconciliations, debt management, and bank loan compliance." In addition, with proper subaccount design, such as different categories for expenses by location and department, "responsibility accounting can be implemented," he says, meaning each department manager can be held accountable for meeting budgets.

Getting the Details Right

The guidelines for your COA follow a general framework with plenty of customization options. The trick is including enough accounts with enough detail to provide accurate financial statements, without adding confusing or redundant listings.

Jennifer Johnson, associate professor of instruction in accounting in the Naveen Jindal School of Management at The University of Texas at Dallas, teaches students to "choose a numbering scheme that allows for growth, such as a four- or six-digit number." The standard convention is to use the first number to identify the type of account, such as "1" for all asset accounts, "2" for liabilities, and so on. "Every account description should be easy to understand, so make sure abbreviations don't become cryptic."