Top mistakes to avoid when using a Chart of Accounts
A chart of accounts is a simple method for tracking income and expenses. It provides a clear and structured framework for monitoring a business's financial transactions. By breaking down your earnings and spending into categories, a chart of accounts makes it easier to track the financial health of your business. This post discusses the importance of having a chart of accounts and the top mistakes to avoid when using one.
A chart of accounts lists all the financial accounts that a business uses to record its transactions. These accounts are grouped into categories such as assets, liabilities, equity, income, and expenses. Having a chart of accounts allows small business owners to see the overall financial picture of their business at a glance and can help them identify areas where they may need to cut costs or increase revenue.
One of the most significant advantages of using a chart of accounts is that it makes it easy to comply with tax and regulatory requirements. Small business owners can quickly provide the information needed to file taxes and meet other compliance requirements by tracking all their business finances in one place. In addition, a chart of accounts can also help small business owners make better financial decisions by making it easy to compare activity across accounts and past financial years.
When deciding on the accounts to include in a chart of accounts, it is essential to consider the specific needs of your business. For example, if you run a restaurant, you'll likely have different accounts from an online retailer. It is also important to consider the maturity or stage of your business operations. For example, in the early days, before you hire any staff, you wouldn't need a wages account. However, as the business grows and you hire a team, you'll want to track wages, payroll tax and any super you pay.
Some common income accounts that may be included in a chart of accounts for a small business are:
- Sales: Tracks all the money received by the business from its customers.
- Interest received: Records any interest earned from bank accounts.
- Grants: Used to log any money received from government grants.
Similarly, there are some common expenses accounts that most small businesses use:
- Advertising: Any expenses related to advertising, including social media.
- Insurance: Insurance costs, including public and professional liability.
- Entertainment: Money spent on food or taking clients out.
- Rent: Record the amount of spend on renting a work office.
- Depreciation: Tracks the gradual decrease in the value of assets, such as work vehicles.
- Wages: Tracks the wages and salaries of employees.
- Superannuation: Records superannuation contributions made by the business.
- Tax: Used to calculate the income tax paid by the business to the ATO.
When using a chart of accounts, it's important to note that how detailed and segregated you go is entirely up to you. At a minimum, you'll want enough detail to know the difference between each label and what tax treatments apply. Beyond that, it's down to personal choice. An excellent example of how you could split up your accounts would be wages. Some small businesses may track wages and payroll tax under one account. Others may prefer to split the two into a separate chart of accounts. Going even further, some may choose to split the accounts by location, e.g. Wages (VIC) and Wages (NSW).
Once your accounts have been defined, assigning income and expenses to the appropriate account is vital. This is done through bookkeeping, which involves recording financial transactions against the relevant accounts. For example, when a business receives payment from a customer, the income is recorded in the sales or revenue account. Similarly, when the company pays for a product or service, the expense is recorded in the appropriate account, such as insurance or advertising.
When it comes to using a chart of accounts, one of the key benefits of using Thriday is that your accounts are automatically generated as you spend or earn money. By using artificial intelligence and its proprietary bookkeeping function, when you make a transaction on your Thriday transaction account or Debit card, it's automatically assigned to a chart of accounts. As a result, you can accurately track your spending and compare year-on-year reports without having to do any calculations yourself. If you want to save time on bookkeeping, sign up for a free trial today.
Now that you know how to create and use a chart of accounts, you should avoid some common pitfalls. Here is a list of the top mistakes to avoid when setting up your chart of accounts:
Mistake 1. Not updating your chart of accounts regularly
Many business owners take a 'set and forget' approach to their chart of accounts. After the initial list of accounts is created, many take the lazy approach of sticking to the same list no matter how much the business evolves. This not only becomes unwieldy over time, but you can often find yourself plugging square blocks into round holes. As your operations change, you will need to add new accounts or discontinue old ones. For example, if a business starts selling a new product line, a new account for that product line should be added to the chart of accounts so you can track this new income stream against your historical revenue lines.
Mistake 2. Not adjusting accounts for regulatory or industry changes
Businesses are subject to various regulations and compliance requirements, which may change over time. If a new law is introduced that affects the business, a new account may need to be added to the chart of accounts to comply with the new requirement. Likewise, changes to the industry in which a business operates may also affect the chart of accounts. For example, a new accounting standard may be introduced that affects how a particular transaction is recorded. The instant asset write-off or changes in superannuation payments would be the most recent examples for most small businesses in Australia.
Mistake 3. Missing accounts due to business growth
As your business grows, you may need to add new accounts to the chart of accounts to track additional financial information. For example, a business that expands to include multiple locations may need to add new accounts for each location. If you start hiring contractors, you should track that separately from your employee wages. If you purchase a property, that should be tracked as an asset, and the corresponding depreciation should be recorded.
Mistake 4. Confusing or complex account names
Using overly complex or confusing account names and codes can make a chart of accounts cumbersome and hard to use. Not having clear labels can make it difficult for users to understand each account's purpose, which may lead to errors in data entry or reporting. For example, if you have an account called income, and another account called sales, what transactions are placed into each one? If another person was to help you update your budget, how would they know which one to use? Whilst the labels could seem like a minor issue, they can cause significant problems, and you might find yourself miscalculating taxes that need to be applied.
Mistake 5. Lack of access control
Because a chart of accounts records your financial transactions, it's crucial that only selected trusted stakeholders have access to the data and also to change the chart of accounts. Not having proper access controls and restrictions can lead to data integrity issues and financial statement errors. If someone does not understand the accounts or the definitions you have, they could easily change it or assign the wrong transactions to the wrong accounts. This could lead to significant confusion, poor business decisions, and the incorrect application of tax rules. To avoid this, minimise access to your chart of accounts, and provide clear training to those who can update it.
Chart of Accounts FAQs
What is a Chart of Accounts?
A Chart of Accounts is a list of all the accounts a business uses to record financial transactions. It is a framework that classifies and organises financial transactions into categories, allowing the business to track its finances better.
Why is a Chart of Accounts important for my business?
A Chart of Accounts is important for a business because it provides a structure for organising financial transactions and helps the business to make more informed decisions. It lets you track income and expenses, prepare financial statements, and make tax filing easier.
How do I set up a Chart of Accounts?
To set up a Chart of Accounts, you must first identify the different types of financial transactions your business has, such as income, expenses, assets, and liabilities. You can then create a list of accounts under each category and assign account numbers for easy reference. Consider using accounting software like Thriday to automate this process.
What are some best practices for using a Chart of Accounts?
Some best practices for using a Chart of Accounts include keeping the Chart of Accounts simple and easy to understand, using consistent account names and numbers across all financial documents, reviewing and updating the Chart of Accounts regularly, and ensuring that all transactions are recorded accurately and promptly. It is also important to ensure that your Chart of Accounts complies with any relevant accounting standards or regulations.
A chart of accounts is a popular tool that groups business transactions against a list of accounts so that a business can easily track its financial performance. It is important to have a well-organised chart with clear labels, updated regularly, and with tight access controls. This is the best way to ensure that financial information is accurate and complete so that you can comply with ATO requirements. Now that you know how to use a chart of accounts, you'll be able to make strong financial decisions to ensure your small business is a success.