A chart of accounts provides a complete listing of every type of account, including account codes and numbers for assets, liabilities and so on.
It provides a logical structure to make it easy to record information and to add or remove accounts.
Nobody will have accounts memorised, so you need the accounts laid in front of you, like a map of the financial parts of your business.
It should make it easy to understand what transactions are being recorded in each of your accounts.
If you’re running a small business, remember to keep things simple, such as setting simple titles to your account codes.
If you create an effective chart of accounts, it’ll allow you to follow proper accounting standards, create effective financial statements, and make better business decisions in the future.
How using a chart of accounts can help
A chart of accounts can benefit your business in a number of ways:
Understand your revenue
If you’re running a business, you need the insight to understand what you are earning.
A chart of accounts can tell you about your financial situation in various ways, such as cash flow and income trends.
Get a handle on your debts
A chart of accounts can give you a clear understanding of how much money you owe in the short and long term.
It will help you calculate how much of your income you can put in, paying back your debts in the form of repayment plans.
Spend in the right way
A chart of accounts can give you valuable information on how and what you are spending your hard-earned money on.
You’ll understand where you need to cut costs where necessary.
Provide data insight and reporting
Through an accurate chart of accounts, you can create incredibly valuable financial reports that can help you understand the financial situation of your business, as well as make plans for the short and long term.
Pay your employees and simplify tax
To stay on the right side of HMRC and handle your payroll finances properly, you need to get your chart of accounts properly organised and accurate.
Setting up a chart of accounts
If you’re starting a business, a chart of accounts will be a first step in establishing your accounting system.
What makes up your chart of accounts depends on the type of business you have – for example, if you’re a manufacturer, you’ll have an inventory account.
But if you are in services, you won’t.
Accounting software often includes sample charts of accounts for different types of business. It’s expected that you’ll modify these sample charts of accounts depending on your needs.
In accounting, there are a few categories to consider for a chart of accounts.
- Assets: This is an account category used to keep track of what the business owns.
- Liabilities: This is where debt obligations are tracked – what’s owed or what could be owed in the future.
- Equity: This depends on the type of business set up, but a simple calculation for equity is assets minus debts.
- Revenues: With an income chart of accounts, sales revenue is money earned from goods and services. This could include service, product and repair revenues.
- Expenses: The cost of doing business. This could include costs such as rent, supplies and utilities.
When setting up the chart of accounts, think about what will be needed in the future.
You may not have employees now, but might in the future, which means you could already be planning and thinking about payroll.
Be aware that charts of accounts can be amended to suit the business but for most companies, the standard one supplied in accounting software will fit well.
How to set up chart of accounts in payroll
When it comes to a payroll chart of accounts, the accounts needed to set up for tracking payroll will be in the form of an expense or liability account.
- Payroll expenses: An expense is a cost that occurs through doing business, such as gross wages, tax and health insurance. An expense account allows you to track the payroll expenses incurred.
- Payroll liabilities: Liabilities are money owed but not yet paid, such as payroll taxes and employee health insurance, which will be paid to the business that provides health insurance benefits for the business.
What else do you need to know about payroll liabilities?
Payroll liabilities become payroll expenses. Your business will accrue the liabilities as your employees work. As an employee accrues hours and wages, their associated taxes and benefits are added.
Most businesses pay in arrears. Time accrues for a certain time period (such as a week or month) and then employees are paid.
Before they have worked and before money has been paid to an employee, it’s a payroll liability. After it has been paid, it becomes a payroll expense.
Amounts owed to employees for work for the work they’ve performed are recorded separately from accounts payable.
You use expense accounts such as wages or salary expense to record an employee’s gross earnings, and a liability account such as wages payable to record your net pay obligation to employees.
What chart of accounts should small businesses use?
Here are examples of the accounts on a payroll chart of accounts:
- Gross salary: Of course, payroll is about paying employees. This is the amount of money paid to an employee every pay period, before deductions are made.
- Payroll tax expense: This is a holding account used to track the balance of an employee’s contribution to payroll taxes, which could include National Insurance payments and pay as you earn (PAYE).
Typical liability accounts on a payroll chart of accounts
- Payroll tax payable: If, like most businesses, you use accrual-based accounting, this holding account recognises that payroll tax expenses are a liability in your accounting, a payment that you are obliged to make.
- Accrued holiday pay: If employees are given time off with pay, you need to keep track of the amount of time they have earned from each pay period. Accrued holiday pay is money owed to the employee.
As your business grows, you may need to create several charts of accounts.
For example, as your company grows and forms departments (production, marketing, HR and so on), your organisation can serve as an outline for accounting chart of accounts.
Each department will likely be accountable for its own expenses, such as salaries, supplies and phone. Understanding the basics of charts of accounts will help you to track everything in the right way.
The ultimate guide to payroll compliance
Facing the challenge of keeping up with payroll compliance? Read this guide for essential tips to make sure your business complies with the relevant payroll legislation.
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