Key insights
- A well designed chart of accounts is the foundation for clear financial reporting, efficient processes, and better business decision making.
- When creating a chart of accounts, too much detail can slow accounting teams and obscure insights, while a balanced structure improves both efficiency and clarity.
- Aligning your chart of accounts with your business model and financial and tax reporting needs helps your l data tell a meaningful, actionable story.
Get more value from your chart of accounts.
The finance and accounting functions are as dynamic as ever. There are several emerging and innovative applications for general ledger automation, real-time management reporting, and data mining for financial analysis — and that means business and operations teams are receiving better information more efficiently.
However, even advanced software can underperform without a well-designed chart of accounts (COA). Before you can consider investing in the newest accounting or reporting software, start by looking at your chart of accounts design.
What is a chart of accounts?
At its core, a standard chart of accounts lists accounts that comprise the financial records of the general ledger. The COA structure is often overlooked and taken for granted, and yet somehow, it’s just as easily over-relied on and expected to contain all financial answers.
To find middle ground, invest the time, energy, and skill to create a solid chart of accounts design. This leads to structured reporting and processes that can help you make better business decisions.
Why is the chart of accounts structure important?
The chart of accounts forms the basic structure outlining your organization's financial story. It serves as the foundation for designing your reporting package.
A properly structured COA facilitates the efficient transfer of data to financial statements and tax returns (or informational returns if you’re a nonprofit). A poorly designed COA can create confusion and require manual adjustments during financial reporting.
Given the advancements in technology, there is plenty of opportunity to leverage data analysis tools rather than relying on manual manipulation.
The chart of accounts is a vital tool for your fiscal management, providing that baseline structure that you need for effective accounting and reporting.
So, then why does your chart of account structure matter? So, your chart of account structure matters so that you can provide that clear financial reporting to your users, and it also helps to reduce errors and confusion and also enhances your operational efficiency.
So, having a well-structured chart of account ensures that you have transparent and consistent financial reporting across all periods, and also it helps so that you can have data that's being classified correctly across all the periods.
So, structure also matters to make sure that we're producing financial statements that can be relied upon for analytics.
Chart of accounts design factors to consider
Balance detail with efficiency in your chart of accounts
The prospect of gaining detailed information is enticing. Unfortunately, in a general ledger, a continuous drive for detail can reduce accounting efficiency to a crawl.
Simplistic chart of accounts example: You wouldn’t order black pens and then create a pens — or even a black pens — account, as opposed to an office supplies account. In most cases, the extra detail in the COA doesn’t bring additional value.
Instead of burdening your accounting system with unnecessary detail, design your COA to operate at the intersection where decision making meets efficiency. If you don’t need the specific amount or category quickly on a routine, monthly basis, combine it with another account.
The most common mistake we see with chart of accounts is excessive account creation. One example I have is from back in my audit days: I had a client that had over 5,000 GL accounts. Every year, they created hundreds of new GL accounts. And one year, we were importing the trial balance into our audit software and it actually crashed our audit software because there were too many accounts. When there's too many accounts, it can lead to improper variance analysis.
So, for example, if you're doing that year-over-year flux analysis — comparing how your revenues or expenses look from year to year, or even if you're looking at budget to actual comparisons — if you have too many new GL accounts in the current year, they weren't in the budget, they weren't in the prior year activity, and so it's really hard to compare that apples to apples.
In addition, when there are so many GL accounts, it's also going to cause confusion within the team that is assigning account codes to transactions. There's too many to choose from.
You don't need to have a different account for every restaurant that you buy food from. You don't need to have pens, pencils, paper, all recorded to their own accounts.
Instead, you want to think of it as more of buckets or categories that you're classifying each of these transactions into. More meals, travel expenses, office supplies, that sort of thing.
When you have too many accounts, it decreases efficiencies.
Another good chart of accounts example: Utilities. Most companies need to know their monthly utilities spending, but few need the same visibility to the office gas or water bill. If you periodically find utility variances when compared with budget or historical actuals, the finance or accounting team can analyze the utilities components to determine the outlier and driver of the variance.
If you need a deeper level of granularity, consider investing in an accounting system allowing you to track items via another dimension (cost centers, divisions, locations) vs. the chart of accounts.
Be consistent with chart of accounts structure across internal departments
For companies with subsidiaries or different locations, COA consistency can increase accounting efficiency among individual units. It can also enhance management reporting across the entire company.
Without consistency, one subsidiary with an overly complex COA may spend more time accounting for the same items another subsidiary performs in less time. COA differences across the company also lead to inconsistencies in accounting policy. As a result, the CEO or board may not realize a category or profit and loss line item may contain differences across each subsidiary.
Companies acquiring different businesses may do so over time and in unrelated industries, which often results in separate, unrelated COAs for each company.
Adopt a standard chart of accounts slightly customized for the business unit to create an efficient company-wide accounting function. This standardization can help ease the transition of future acquisitions so they’re measured accurately and consistently.
Connect the COA to your business model
As transactions are recorded, verify the COA is directly related to your business model. You may find you’re separately tracking divisions, locations, or even cost centers within the accounting system.
While your income statement may be complete overall, determining product or location profitability can still be an extremely manual process, increasing the risk of inconsistent or inaccurate analysis and overburdening accounting and finance teams.
For nonprofits that must report expenses by function — such as program versus supporting activities — this structure is especially important because it can reduce the need for extensive manual work in the general ledger and Excel.
Whether you use QuickBooks, Sage, SAP, or another financial accounting software, take advantage of grouping conventions. This allows you to properly segregate activities within a specific product category, program, event, location, or even reporting geography (e.g., sales and marketing, general and administrative, etc.). These practices can allow teams to focus on reporting and analysis, not manual manipulation and consolidation.
Build a finance function that runs smoothly today — and scales confidently for what’s next. View our Finance the Fuels Growth webinar series.
Understand the role of your general ledger
The chart of accounts is the foundation for building effective financial reporting systems. Yet many small businesses attempt to extract insightful analysis by only comparing general ledger accounts. They believe having an account for every potential expense or revenue item diminishes the need for analysis since they have visibility to all accounts.
While that premise may sound reasonable in theory, it’s less than optimal in practice.
The first problem is it significantly dilutes your transactions to where the monthly landscaping bill has the same prominence in the COA as sales commissions. Second, when evaluating overall operating expenses and postulating why sales and marketing expenses are higher than budget, you may find considerable variances, most of which are insignificant in isolation.
When there are several accounts serving the same function, staff may become confused about which account to accurately enter data. As a result, the accountants or bookkeepers spend considerable time recording transactions, and analysts must almost work backward to get variances to a point where key drivers can be discovered.
Other recommended financial analysis tactics
Instead of relying solely on the chart of accounts to conduct variance analysis, establish an analysis process aligning with the accounting period close. Rather than reviewing individual accounts and investigating $100 differences alongside $100,000 variances, empower the finance or accounting team to present financial statements supported by commentary and analysis focused on key performance indicators.
Adding charts and graphs to the financial package can also help tell the broader financial story more clearly and effectively. Your financial data should go beyond mere figures, telling the narrative those numbers represent.
Get support to modernize your chart of accounts
Established businesses, nonprofits, and startup companies alike benefit from a well-designed chart of accounts. Although the process for building or redesigning the COA can be time consuming for both the financial and operations teams, the payoff is efficiency and the foundation needed to transform the accounting and analysis function.
A consulting CFO or consulting controller can work directly with you to understand your company and your business model. Creating a chart of accounts that modernizes your accounting function helps position your organization to drive growth.
How CLA can help with chart of account design
CLA supports the entire accounting and finance infrastructure. Our professionals leverage their experience and industry benchmarks to create or update a chart of accounts tailored to your business’s needs, applying industry practices, and providing seamless data transfer for tax returns.