Whether you use a manual set of books or computerised accounting software for maintaining your accounts, the chart of accounts has an important role to play.

The chart of accounts is like the foundation stone of your accounting system as it determines where your accounting transactions are allocated and forms the basis of your financial reports.  It is these financial reports that you rely on to make decisions relating to your organisation.

With a well set up chart of accounts the analysis of the financial reports is made easier and allows better decisions to be made but done poorly it can result in confusing information that makes effective decision making difficult to achieve.

Typical mistakes

One of the main mistakes made with a chart of accounts is that you try to have too many accounts in the belief that more detail is good.  For example, you may have different accounts for photocopy paper, pens, pencils and staples when you only need to have one account for stationery.

Another mistake that can happen is that you may in fact have an account for stationery but when you purchase notebooks you are not sure if that should be allocated to the stationery or a different account.  As a result, you may set up a new account for notebooks.

If this was to occur on a regular basis then you would have far too many accounts, making the finance reports very detailed and hard to understand.  To address this issue you can have a description of the type of transactions that can be allocated to that account.

You also need to be careful that you don’t have too few accounts that contain too much information.  For example, using the stationery example from above you may end up including not only stationery supplies but also computer supplies, magazines and books.  Therefore, if you were just trying to determine how much you spent on actual stationery it would be hard to ascertain.

The next post provides some tips on how to set up a chart of accounts.