Chart of Accounts
Chart of accounts is a list of ledger account names and numbers arranged in the order in which they customarily appear in the financial statements. The chart serves as a useful source for locating a given account within the ledger. Whether your business is a services business, a manufacturing business, a retail business, a wholesale distributorship, or combination of any of these, you will be able to easily adapt this simplified system to work with your particular situation. A key to designing the most useful recordkeeping system for our particular needs is to examine your type of business in depth. After a close examination of the particular needs and operations of your type of business, you will need to set up an array of specific accounts to handle your financial records.
A chart of accounts will list all of the various categories of financial transactions which you will need to track. There will be an account for each general type of expense which you want to keep track of. You will also have separate accounts for each type of income your business will receive. Accounts will also be set up for your business assets and liabilities. Setting up an account for each of these categories consists of the simple task of deciding which items you will need to categorize, selecting a name of the account and assigning a number for the account.
Before you can set up your accounts, you need to understand the reason for setting up these separate accounts. It is possible, although definitely not recommended, to run a business and merely keep track of your income and expenses without any itemization at all. However, you would be unable to analyze how the business is performing beyond a simple check to see if you have any money left after paying the expenses. You would also be unable to properly fill in the necessary information for business income tax returns.
A major reason for setting up separate accounts for many business expense and income transactions is to separate and itemize the amounts spent in each category so that this information is available at tax time. This insures that a business is taking all of its allowable business deductions. The main reason, however, to set up individual accounts is to allow the business owner to have a clear view of the financial health of the business. With separate accounts for each type of transaction, a business owner can analyze the proportional costs and revenues of each aspect of the business. Is advertising costing more than labor expenses? Is the income derived from sales items worth the discounts of the sale? Only by using the figures obtained from separate itemized accounts can these questions be answered.
You will select various income accounts, expense accounts, asset accounts and liability accounts. For each account, you will also assign it a number. For ease of use, you should assign a particular number value to all accounts of one type. For example, all income accounts may be assigned numbers 10-29. Sales income may be account number 11; service income may be assigned account number 12, interest income may be account number 13. Similarly, expenses may be assigned numbers 30-79. Balance sheet accounts for assets and liabilities may be numbers 80-99. Be sure to leave enough numbers for future expansion of your list of accounts. There will normally be far more expense accounts than any other type of account.
If you have income or expenses from many sources, you may wish to use three-digit numbers to identify each separate category. For example, if your business consists of renting out residential houses and you have 10 properties, you may wish to set up a separate income and expense account for each property. You may wish to assign accounts numbers 110-119 to income from all properties. Thus for example, you could then assign rental income from property number 1 to account number 111, rental income from property number 2 to account number 12, rental income from property number 3 to account 113 and so on. Similarly, expenses can be broken down into separate accounts for individual properties. Advertising expenses might all be account numbers 510-519, thus advertising expenses for property number 1 might then be assigned number 511, advertising expenses for property number 2 would be assigned account number 512 etc.
How your individual chart of accounts will be organized will be specific to your particular business. If you have a simple business with all income coming from one source, you will probably desire a two-digit number from, perhaps, 10-29 assigned to that income account. On the other hand a more complex business with many sources of income and many different types of expenses may wish to use a system of three-digit numbers. Take some time to analyze your specific business to decide how you wish to set up your accounts. Ask yourself what type of information will you want to extract from your financial records. Do you need more details of your income sources? Then you should set up several income accounts for each type and possibly even each source of your income. Would you like more specific information on your expenses? Then you should most likely wish to set up clear and detailed expense accounts for each type of expense that you must pay.
Be aware that you may wish to alter your chart of accounts as your business grows. You may find that you have set up too many accounts and unnecessarily complicated your recordkeeping tasks. You may wish to set up more accounts once you see how your balance sheets and profit and loss statements look. You may change, add, or delete accounts at any time. Remember, however, that any transactions that have been recorded in an account must be transferred to any new account or accounts that take the place of the old account.
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