A suitable chart of accounts

Accounting for management

Finding the accounting model that's right for your company

ACCOUNTING SOFTWARE has become so sophisticated and inexpensive that practically any shop can afford to automate. Common software options for small businesses include such software as Quick Books and Peachtree.

Although getting started with these programs is often as easy as turning the computer on, the reports built into them are not adapted to a service shop's needs. Moreover, the shop may lack the internal accounting expertise necessary to design the system. This situation can easily lead to frustration.

A chart of accounts is the heart of an accounting system. It is in the design of the chart that the kind of information, its organization, and level of detail are determined.

With a poorly designed chart, financial reports will give information little better than measuring the cash left in the proverbial shoe box at the end of the day. Total inflow and outflow provide little useful management information.

The remainder of this article provides an example chart of accounts for a service shop and gives some accounting basics by which to get appropriate records started.

Chart of accounts

A sample chart of accounts for a service shop appears in the box on the facing page. The chart of accounts used is essential to good accounting. The chart defines the categories tracked for financial reporting. Good financial reports can give insight into the source of profits and the means for managing costs.

Accounting is based on double-- entry bookkeeping, meaning an equal amount of debits and credits. To illustrate, when a deposit is made into a bank account, cash increases with a debit, whereas accounts receivable are credited or reduced to reflect the collection.

Similarly, when a check is written, cash decreases with a credit, and an asset, cost, or expense is debited or increased, depending on what was purchased.

The chart of accounts is organized as follows:

* Assets. These are what the company owns. They appear on the company's balance sheet as debits.

* Liabilities. These are what the company owes to others. They appear on the company's balance sheet as credits.

* Equity. This includes capital paid in to the company by owners plus retained earnings, which represents cumulative income, expense, and dividends that have occurred since the entity's inception. They appear on the company's balance sheet as credits, unless cumulative losses have occurred that turn retained earnings into an accumulated deficit, which is a debit.

* Sales. Sales are the company's revenue recognized. They are generally the first items to appear on a company's income statement. They are credits.

* Costs and expenses. These are the deductions from sales in determining net income on the income statement. They are debits.

Note that assets, liabilities, and owners' equity are balance sheet categories. The balance sheet provides the company's financial position at a point in time. Assets must equal liabilities plus equity. The revenue, cost, and expense categories, on the other hand, are income statement categories. The income statement explains the change in a company's financial position over a specified period of time.

Reporting features

Certain sophisticated features have been built into the chart of accounts to accommodate improved accounting. Sales categories include type of repair and distribution.

Cost of sales can be reported along the same lines as long as either job costing or perpetual records costing by sale is maintained. Although it requires additional accounting effort, the information obtained is usually well worth it. The relative profitability of types of business can be known explicitly.

Assuming that cost of sales per system is maintained, cost of sales actual is a separate accounting. It consists of actual costs of sale in terms of materials, labor, and overhead. These then are applied to inventory based on actual or assumed costs.

The difference between the expense debits and application credits is the cost variance. If the variance remains positive or a debit, it indicates that the cost system is under-applying costs. The practical implication of this is that orders are under-costed and profits by order are overstated.

Another feature included in the chart is the potential to use suffixes to designate departments within the cost of sales - actual classification. Breaking down direct labor and manufacturing overhead department supports creating separate departmental reports for managers responsible and developing costing rates by department. Thus, the winding department manager will be able to view and manage the costs of that department.

Certain categories of expenses, payroll fringe, and occupancy in particular, are accumulated as if separate departments through 900-series accounts. The idea is to accumulate them separately and then allocate them to other departments through a credit to the "account allocated to other departments."

The basis for allocating payroll fringe would be salaries and wages up to the FICA or social security tax base, which is $84,900 for 2002. This approach eliminates the effect of highly compensated executives. For occupancy costs, on the other hand, an appropriate basis for allocation is square footage.