Chart of Accounts

A chart of accounts is a list of all the accounts a company set up in order to group like transactions together. For example when a company pays their phone bill they would debit their phone expense account and credit their cash asset account. To learn more about debits and credits click here.

How to set up a simple chart of accounts

Each account is made up of three parts: type of account, number, and name.

TYPE OF ACCOUNT – the different types of accounts are current assets, long-term assets, current liabilities, long-tem liabilities, owners’ equity, revenue, and expense accounts.

NUMBER – or account code, can have as many digits as the company wishes to designate. Small companies generally have fewer digits in their accounting code then larger companies. It is best to group similar account types together by having all like accounts start with the same digit.

Balance Sheet Accounts
1XXXX - Current Assets
2XXXX - Long-term Assets
3XXXX - Current Liabilities
4XXXX - Long-term Liabilities
5XXXX - Owners Equity
Income Statement Accounts
6XXXX - Revenue
7XXXX - Expenses

NAME - for accurate book keeping purposes the name has to have a descriptive element to it. Both the name and the number of each account are, for the most part, arbitrary and companies are free to name accounts as they see fit.

Example:
71285 – Travel

Where:
Number = 71285
Name = Travel
Type of Account = Expense Account


The chart of accounts is very important because it is the foundation of the information system. A company can set up as many accounts as they wish. If there are only a small number of accounts then the information generated will be very general. Too many accounts is also a problem because it can lead to coding errors and having to combine multiple accounts in order to get useful information. An optimal number of accounts will give the end user the ability to get very specific information on the transactions of a company with a relative level of ease.



Example of a Simple Chart of Accounts

11000 – Cash
12000 – Short-term Bonds
13000 – Inventory
21001 – Trucks
22001 – Cars
31001 – Accounts Payable
41234 – Lease – Capital Equipment
41340 – Lease – Building
51000 – Shareholders Capital
52000 – Dividends
60000 – Revenue
61000 – Other Revenue
71000 – Cost of Goods Sold (COGS)
72100 – General Operational Expenses
72101 – Direct Labor
72102 – General Labor – Operations
73101 – Direct Materials
73102 – General Materials – Operations
74101 – Direct Overhead
74102 – General Overhead – Operations
75001 – SG&A Salaries
76001 – General Marketing
76002 – Meals and Entertainment
76003 – Travel – Air
76004 – Travel – Hotel
77005 – Phone – Land
77006 – Phone – Cell phones
78007 – Computers – hardware
78008 – Computers – Software
78020 – Office Supplies
78030 – SG&A Utilities
78040 – Building Rent

Why Cash Flow Can Be Tricky

Cash flow can be tricky because you would think to increase cash flow in the short term all you do is reduce all of your expenses. Although reducing all your expenses, as long as it doesn't impact your level of quality, is a good idea it will not exactly solve the problem. The problem could be you are not producing enough units of product and if that is the case you will need to increase your variable expenses and not reduce them.

Revenue
Less Variable Expenses
Gross Margin
Less Fixed Expenses
Business income

In order to increase cash flow you will have to sell more units of product. For example if Bob sells cupcakes he will have to buy more flour mix in order to make more cupcakes. Flour mix is a variable expense. The flour mix expense will increase as the amount of cupcake sales increase, making it a linear relationship.

Bob has fixed expenses too. For example he rents the building his bakery is in. No matter how many units of cupcakes he sells the building lease will stay the same.

In order to increase cash flow Bob can try to eliminate the waste in some variable and fixed expenses. For example maybe the building Bob rents is too big for his level of operation, if Bob finds a new smaller building he would save his company a lot of money. Another example is maybe some flour mix goes bad if it is left out too long. To reduce the waste Bob can make only the amount of cupcakes he needs for morning sales and then bake more for the afternoon sales.

Accounting Entry - Job Costing Example

There are many different types of job costing methods. Two very popular methods are: variable costing and absorption costing. How they differ is absorption costing considers fixed overhead a product cost and variable costing does not.

Both costing methods have the same accounting entries except for the overhead entries

To Learn About Debits and Credits Click Here

Variable Costing Method - Accounting Entries

Revenue Accounting Entry

Dr Revenue 10,000
Cr Accounts Payable 10,000

Product Cost Entries

Before Conversion into Products
Direct Materials
Dr Inventory - Raw Materials 100
Cr Accounts Payable 100

Direct Labour
Dr General Labor Hours 200
Cr Accounts Payable 200

Direct Overhead
Dr Variable Overhead 300
Cr Accounts Payable 300

Start Conversion into Product Entries
Direct Materials
Dr Inventory - WIP - Materials 10
Cr Inventory - Raw Materials 10

Direct Labor
Dr Inventory - WIP - Labor 20
Cr General Labor Hours 20

Direct Overhead
Dr Inventory - WIP - Variable Overhead 30
Cr Variable Overhead 30

Finish Conversion into Product Entries
Dr Finished Goods Inventory 60
Cr Inventory WIP - Materials 10
Cr Inventory WIP - Labor 20
Cr Inventory WIP - Variable Overhead 30

Sell The Product Entry
Dr Cost of Goods Sold (COGS) 60
Cr Finished Goods Inventory 60

Period Cost Entries

Dr Fixed Overhead 400
Cr Accounts Payable 400

Dr Selling and Administration Costs 1000
Cr Accounts Payable 1000


Absorption Costing Method - Accounting Entries

Revenue Accounting Entry

Dr Revenue 10,000
Cr Accounts Payable 10,000

Product Cost Entries

Before Conversion into Products
Direct Materials
Dr Inventory - Raw Materials 100
Cr Accounts Payable 100

Direct Labour
Dr General Labor Hours 200
Cr Accounts Payable 200

Direct Overhead
Dr Variable Overhead 300
Cr Accounts Payable 300
Dr Fixed Overhead 400
Cr Accounts Payable 400

Start Conversion into Product Entries
Direct Materials
Dr Inventory - WIP - Materials 10
Cr Inventory - Raw Materials 10

Direct Labor
Dr Inventory - WIP - Labor 20
Cr General Labor Hours 20

Direct Overhead
Dr Inventory - WIP - Variable Overhead 30
Cr Variable Overhead 30
Dr Inventory - WIP - Fixed Overhead 40
Cr Fixed Overhead 40

Finish Conversion into Product Entries
Dr Finished Goods Inventory 100
Cr Inventory WIP - Materials 10
Cr Inventory WIP - Labor 20
Cr Inventory WIP - Variable Overhead 30
Cr Inventory WIP - Fixed Overhead 40

Sell The Product Entry
Dr Cost of Goods Sold (COGS) 100
Cr Finished Goods Inventory 100

Period Cost Entries
Dr Selling and Administration Costs 1000
Cr Accounts Payable 1000

Debit / Credit - How They Work in an Accounting Entry

Accounting is a two entry system which means when you move a balance out of one account you have to move it into another. Debits and Credits denote a plus / minus relationship in accounting entries.

Each type of account in accounting has a 'natural balance' of either a debit or credit

For Example:

Income Statement
Revenue (Cr)
Expense (Dr)
Net Income (Cr / Dr)

Balance Sheet
Asset (Dr)
Liabilities (Cr)
Owners' Equity (Cr)

The positive or negative balance left in the account determines what debit or credit position the account will have.

Therefore:
A positive value in an asset account = the account is in its natural debit position
A negative value in an asset account = the account is in an unnatural credit position

Positive Cash Value = Asset Account is in a Debit Position
Negative Cash Value = Asset Account is in a Credit Position

A positive value in a liability account = the account is in its natural credit position
A negative value in a libility account = the account is in an unnatural debit position

Positive Accounts Payable = Liability Account is in a Credit Position
Negative Accounts Payable = Liability Account is in a Debit Position

Sample Accounting entry - Moving Balances In and Out of Accounts

Bob gets his company's $100 monthly phone bill

Dr Phone Expense 100
Cr Accounts Payable 100

Bob pays the bill

Dr Accounts Payable 100
Cr Cash Asset 100

Ending Account Balances

Phone Expense = 100______________Expense Account = + Value = Debit Position
Accounts Payable = 100-100 = 0______Liability Account = No Value = Credit Position
Cash Asset = -100________________ Asset Account = - Value = Credit Position

Explanation
Bob added the $100 balance to one account and subtracted it from another. The expense and liability accounts' ending balances were left in their natural positive positions, so their natural debit and credit positions did not change.
The ending cash (asset account) balance was negative and as a result its natural debit position changed to an unnatural credit position

See How To Job Cost