Chart of Accounts – How to Create

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Congratulations, you have started your own business.  You have purchased or rented property for your business.  You have furnished the space with everything you need to run your particular business.  You have hired employees to work for you.  Now you are ready to set up your accounting system.

One of the first things you will need is a chart of accounts.  A chart of accounts will allow you to organize your transactions into categories. When you record transactions, you will post them to an account and then you can print various reports using some or all the these accounts.

Depending on your industry there are some accounts you will need and others you don’t need.  For example, if you are in construction, you will need a WIP (work in process) account,  if you are a retailer, you will need an inventory and COGS (cost of goods sold).  A not-for-profit business will need restricted and un-restricted funds account, a law firm will need a retainer account to record deposits from clients.  These are just a few examples of the different accounts a business may need.

Depending on your accounting software, you may be able to choose your industry when setting up your chart of accounts.  If this is the case, choose your industry or the one closest to it.  Go through the accounts and delete the accounts you know you will never use.  Edit some of the other accounts, giving them names that make sense for your company.

If you have to set your chart of accounts up manually, it’s easy.  The first group of accounts are your Balance Sheet accounts.  All your asset accounts will be listed first.  List your current assets first, other current assets next, and finally other assets.  Next are your liabilities, listing your current liabilities first, then your short-term liabilities, and finally long-term liabilities.  Next on your list are your equity accounts.  Depending on your entity depends on the name of these accounts.  You will have at least two, your retained earnings (the accumulative sum of your net income (loss)) and your net income (the current year’s sum of your net income (loss)).  You may have other equity accounts such as a draw(s) account, treasury stock, etc.

The next group of accounts are the Income Statement accounts.  List your revenue accounts first, followed by COGS accounts and then the expense accounts.  If your software allows, you can assign numbers to your accounts with numbers starting with a #1 your asset accounts, starting with a #2 your liabilities, #3 your equities, #4 your revenues, #5 COGS, and #6 your expenses.

Some accounting programs will also let you use segmented account numbers, you can define how many segments your company needs, how many digits each segment is, etc.  This would be good for tracking revenues and expenses for departments, locations, etc.

I personally like to use sub-accounts when I set up a new chart of accounts.  The two accounts I use these on the most are the payroll liabilities and payroll expense accounts.  With the payroll liabilities account, the main account is called payroll liabilities and then each of the sub-accounts are named whatever the withholdings are, i.e. FICA & Fed W/H Payable, State W/H Payable, etc.

Don’t forget, when setting up your chart of accounts, to set up any contra-accounts you may need, for example, if you have a fixed asset account, you will also need an accumulated depreciation account.  But, don’t go crazy on creating your chart of accounts.  Only set up the accounts you know you need, you can always add more later.

 

 

 

Reimbursable Business Expenses

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What exactly is a reimbursable expense?  It can be an expense a company incurs when performing work for a client, such as postage, mileage, meals.  It can also be an expense when an employee purchases either goods or services for the employer.  Or it can be when a company bills out material and labor costs on a cost plus basis.

There are two types of reimbursable plans, accountable and non-accountable.  With an accountable plan, the employee or company saves all receipts and is reimbursed for the expenses.  Anything without a receipt becomes taxable either to the employee or company.  For example, an employee may go out of town on a business trip.  The cost of the gas, or airfare is reimbursable, along with meals and other incidentals related to the trip.

An advance would not be taxable to the employee until after all receipts were turned in and reconciled with any cash returned.  If the receipts do not match up with the amount of the advance, then the difference owed the company becomes wages to the employee subject to federal, medicare, social security and futa tax.

An advance should be posted to an Expense Advance account on the Balance Sheet.  After the receipts are turned in, then the Expense Advance account is credited and the proper expense accounts are debited.  Other types of reimbursements would be cell phone usage, if for the benefit of the company, meals, mileage, tolls, and parking.

A non-accountable plan is just like it sounds.  There is no accounting for the expense.  Instead, the company will give an employee an allowance for the benefit.  This allowance is a taxable fringe benefit to the employee.  These fringe benefits are taxable for federal, social security, medicare and futa tax.

A company that incurs expenses on behalf of their client will bill their clients for those expenses.  Some companies, like lawyers, accountants, and doctors will not bill separately for postage, copies, travel, etc., but rather include the cost in their fees.  Other companies will bill their clients for the exact amount of the expense.  In this case the expense will be credited for the amount of the reimbursement.

Contractors, builders, and other service type companies may offer their clients a “cost plus” contract.  The reimbursable expenses will have an additional cost added to it.  This additional cost is income for the company.

There really is no right or wrong way to record a reimbursable expense.  It just depends on how the company wants to view the financial statement.  All of the reimbursement can be credited against the expense or credited to an income account.  You could also split the account if you use the “cost plus” method and record the actual expense reimbursement to the expense and the amount above the reimbursement to an income account.

However you plan to record your reimbursable expenses, remember to record your meals in an account by itself because it is treated differently on your tax return.

 

 

 

Can You Read Your Balance Sheet?

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This is an easy question, isn’t it? Maybe not. You know the formula, Assets = Liabilities + Owner’s Equity.  As long as it is in balance then everything is okay, right? Maybe not. It is important as a business owner you understand what the figures on your balance sheet are telling you.

ASSETS
Assets are the first section on the balance sheet. Your current assets are listed first. Current assets are cash or cash equivalents that can be expected to be converted to cash within a year. Your bank accounts are listed first and the normal balance will be a debit. If any of your bank accounts show a credit balance, that account is overdrawn as of the date of the balance sheet.

Accounts receivable will be the next current assets on your balance sheet.  This account will have a debit balance.  You will want to keep track of how many times your accounts receivable have been collected during an accounting period.  This is called an Accounts Receivable Turnover Ratio.  The better the ratio, the better you are using your assets.

The next group of current assets will depend on your type of business.  They may be customer deposits, prepaid expenses, inventory, employee advances, etc.  They should all have a debit balance and you can convert them into cash within a year.

The last group of assets will be your fixed assets.  These cannot be converted to cash within a year.  They will consist of your property, furniture and fixtures, equipment, automobiles, etc.  These accounts will have a debit balance.  There will be an accumulated depreciation account associated with these accounts that will have a credit balance.

If you have paid any security deposits it may listed under Other Assets on the Balance Sheet.

LIABILITIES

Your liabilities are what you owe to other companies.  A current liability will be paid off within a year.  Your current liabilities will be accounts payable, and all your credit card accounts.  These accounts should have a credit balance.  If an account has a debit balance you may want to investigate the reason.  For example, a credit card account may show a debit balance which would indicate that you have a credit due to you from them.

If you have employees, your other current liabilities will be payroll liabilities.  Depending on the number of employees and the benefits you offer your employees, you may have several liabilities, or you may have just the payroll tax liabilities.  Whatever liabilities you have, they should have a credit balance.  If a liability has a debit balance, then you have probably over paid and are due a refund.

Your long term liabilities are the debts that will not be paid off within a year.  They will be your mortgage payment, loan payments, vehicle payments,etc.  These liabilities will also have a credit balance.

EQUITY

This is the last section of your balance sheet and it shows how much  money has been invested in your company.  Depending on the type of entity, you may have an Owner’s Equity account, Capital Stock, or Treasury Stock account.  Your retained earnings account shows what your company has earned since the beginning of it’s operation.  Your retained earnings should be a credit if your company has been making money.  If your company has not been making money it will be a debit balance.  Dividends paid to shareholders, and draws to owners and partners will have a credit balance. 

In summary, your balance sheet is a snap shot of your company’s financial position at a single point in time.  The purpose is to give the users an idea of the company’s financial position along with what it owns and owes. It is very important that you understand how to analyze and read this document.