Setting up a chart of accounts that actually helps you run the business

The chart of accounts is the list of categories every transaction in your business is sorted into. Most owners never look at it. They accept whatever the accounting software set up by default, add an account here and there when something does not fit, and a few years later end up with a list that is too vague in some places, cluttered in others, and unable to answer basic questions about the business. A well-designed chart of accounts costs little to set up and pays off in every report you run.

What the chart of accounts does

Every transaction, whether a sale, a supplier bill, a wage payment or a loan repayment, is coded to an account. Your profit and loss and balance sheet are simply those accounts added up. So the chart of accounts decides:

• what your reports can and cannot tell you
• how easily your accountant can prepare year-end accounts and tax work
• how reliably GST is applied
• how consistently different people code the same kind of transaction

If an account does not exist, you cannot report on it. If too many accounts exist, people code inconsistently and the reports become noise.

The standard structure

Charts of accounts follow the same five broad groups:

1. Assets — what the business owns or is owed, such as bank accounts, receivables, stock and equipment
2. Liabilities — what it owes, such as supplier payables, GST, PAYG withholding, super, loans
3. Equity — the owners' stake, including capital contributed, retained earnings and, for sole traders and partnerships, drawings
4. Income — revenue from sales and other sources
5. Expenses — the costs of running the business, often split between direct costs (cost of sales) and overheads

Assets, liabilities and equity form the balance sheet. Income and expenses form the profit and loss. Most software numbers accounts by group, which keeps the list in a logical order.

Principles of a chart that helps

Design it around decisions

Start by asking what you need to know each month. If you run three service lines, you probably want to see revenue and direct costs for each. If you sell both products and services, you want their margins separately. Build the income and cost of sales sections to answer those questions.

Separate direct costs from overheads

Costs that rise and fall with sales, such as materials, subcontractors, freight on goods sold or merchant fees on each sale, belong in cost of sales. Costs you incur regardless of sales, such as rent, insurance, software and administration wages, are overheads. This split gives you gross profit and gross margin, which is often the single most useful number for a business owner.

Be specific enough, but no more

An account called "General expenses" that holds 20% of your costs is a problem. So is a chart with forty separate expense accounts, half of which are used twice a year. A reasonable test is: would you make a different decision if you could see this number on its own? If yes, give it an account. If no, group it.

As an example, a small professional services firm might find these overhead accounts enough: rent, utilities, insurance, software and subscriptions, telephone and internet, motor vehicle, travel, professional fees, advertising and marketing, staff training, office supplies, bank fees, and depreciation. That is far more useful than either one catch-all line or fifty narrow ones.

Use tracking categories for the other dimension

Do not create a separate revenue account for every location, branch or project. Most accounting software lets you tag transactions with a second dimension, called tracking categories, classes, departments or jobs depending on the product. Keep the accounts for what the transaction is, and use tracking for where or for whom. You can then report revenue by location without tripling the size of your chart.

Keep tax treatment clean

Each account in Australian accounting software usually carries a default GST code. Group transactions so the default is right most of the time. For example, keep GST-free sales (such as exports or certain food and health supplies) in a separate income account from taxable sales, and keep items with no GST, such as wages, super, bank interest and many government charges, away from accounts that default to GST on purchases. It reduces errors on your BAS. Our GST guide explains the different categories.

Similarly, some expenses are treated differently for income tax, such as entertainment, fines and penalties, or private use of assets. Giving these their own accounts makes life easier for your accountant at year end.

Set up the balance sheet properly

Owners often focus on the profit and loss and neglect the balance sheet side of the chart. Make sure you have:

• a separate account for each bank account, credit card, loan and payment platform
• clearing accounts for wages, super and payment processors, which should return to zero
• separate GST, PAYG withholding and superannuation liability accounts
• a loan account for each director, shareholder or related entity, so these are never mixed with ordinary expenses
• fixed asset accounts by type, with matching accumulated depreciation accounts

Clear balance sheet accounts make reconciliations straightforward, which is the backbone of a reliable month-end close.

Cleaning up an existing chart

If your current chart has grown untidy, you do not need to start again.

1. Run a report of every account and its balance or year-to-date activity.
2. Archive or hide accounts that have not been used in the last year or two.
3. Merge accounts that are effectively duplicates, such as "Phone" and "Mobile phone".
4. Split any catch-all account that holds a large share of costs.
5. Check the default GST code on each account.
6. Write a short coding guide for anyone entering transactions, listing the common items and where they go.

Make structural changes at the start of a financial year where possible, so comparisons within a year stay consistent. Talk to your accountant before merging or deleting accounts that carry balances, as historical reports and year-end workpapers may rely on them.

Common pitfalls

• Using the software's default list unchanged. It is a starting point, not a design.
• Coding owner payments to expenses. Private spending and drawings belong in equity or a loan account, not in the profit and loss.
• Creating accounts for one-off events. Use a description or tracking category instead.
• Letting everyone add accounts. Limit who can change the chart, and keep it under review.

A good chart of accounts is short enough to code consistently and detailed enough to answer the questions you actually ask about your business.

How we can help

If your reports are not telling you what you need to know, the chart of accounts is often the place to start. We can review your existing setup or design one around how your business works. Find out more about our accounting services or contact us.

This article is general information only and does not take into account your circumstances. Speak to a qualified adviser before acting on it.