Designing a new COA, in accordance with Generally Accepted Accounting Principles (GAAP), for a new company or changing an existing COA is easy to accomplish if you understand the basic fundamentals.
There are 3 fundamental rules that need to be followed when designing a new chart of accounts.
Keep it Simple
Allow for Flexibility
Develop a Logical Numbering Sequence
When designing the COA, you will need to look at it in 2 parts. The 1st part is the Balance Sheet and the 2nd part is the Income Statement. Depending on whether your company is on Cash or Accrual basis will assist in guiding the type of accounts that will be required.
For the purpose of this blog, we have defined the following structure:
- Account Category
- Summary Account Roll-up
- Account
Account Category
The Balance Sheet includes account categories, such as; Cash, Accounts Receivable, Inventory, Current Assets, Fixed Assets, Long-Term Assets, Accounts Payable, Short-Term Liabilities, Long-Term Liabilities, and Equity.
The Income Statement includes account categories, such as; Revenue, Cost of Goods Sold (COGS), Operating Expenses, Other Income, Other Expenses, Interest, Depreciation, Amortization and Taxes.
Summary Account Roll-up
Summary Account Roll-up totals up a group of like accounts, for example:
“Travel” would be the Summary Account Roll-up account. The total of the following related accounts Air, Train, Taxi, Hotel, etc. would equal the Summary “Travel” Roll-up account.
Account
Account is the base element where the transaction is recorded. Note that within the Equity account category: accounts such as; Retained Earnings and Net Income are accounting system generated.
Keep it Simple
Once the account categories have been determined, define the accounts in each account category. Once the accounts have been decided upon, group similar accounts together within each category to form a summary account roll-up (Some accounting systems allow for additional roll-ups).
For example:
6XXX Operating Expenses (Account Category)
6000 Salaries & Wages (Summary Account Roll-up)
6010 Executive Staff (Account)
6020 Administrative Staff (Account)
6030 Bonuses (Account)
6100 Payroll Taxes (Account)
6200 Benefits (Summary Account Roll-up)
6210 Health Insurance (Account)
6220 401K Match (Account)
6230 Paid Time off (Account)
Grouping similar accounts will allow you to quantify each group for easier understanding of the company’s financial position.
Note: In Quickbooks, do not leave the accounts in alphabetical order.
Allow for Flexibility
Each accounting system allows the user, including Quickbooks, to establish a unique COA structure. Make sure that when defining the segments of the COA that you have thoroughly thought out the reporting output. In addition, define each account number with enough room to add a new account if needed.
Develop a Logical Numbering Sequence
A good standard numbering sequence that could be used is:
Balance Sheet (“X” wild card number)
1XXX Assets
1000 Cash
1200 Accounts Receivable
1300 Inventory
1400 Current Assets
1500 Fixed Assets
1900 Long-term Assets
2XXX Liabilities
2000 Accounts Payable
2400 Short-term Liabilities
2900 Long-term Liabilities
3XXX Equity
3000 Equity
3999 Retained Earnings (Accounting System Generated – Established at Setup)
Income Statement (“X” wild card number)
4XXX Revenue
5XXX COGS
6XXX Operating Expenses
6000 Salaries & Wages
6010 Executive Staff
6020 Administrative Staff
6030 Bonuses
6100 Payroll Taxes
6200 Benefits
6210 Health Insurance
6220 401K Match
6230 Paid Time off
70XX Other Income
75XX Other Expenses
8000 Interest
8100 Depreciation
8200 Amortization
9XXX Taxes
Net Income (Accounting System Generated)