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A chart of accounts (COA), representing a unique set of codes to record all an entity’s transactions consistently, is a well-recognised, fundamental accounting need. Whether it concerns a complex organisation with numerous divisions, or an individual applying basic cash accounting, it is essential to be able to collate financial information that is relevant, both for internal management and external parties.
This article considers some questions that management should take into account when implementing a standard COA, such as:
- Why update a chart of accounts? An organisation may need to adopt a new COA if its industry or country adopts a new set of specific accounting standards. Furthermore, as organizations evolve, it is vital that the COA keeps pace and stays relevant to management.
- What are the options when implementing a chart of accounts? Implementing a new COA can improve an existing system, or involve a completely new development. Management should take care to incorporate all useful accounts from older systems.
- What are the practical consideration when designing a chart of accounts? Management must consider user needs, detailed design specifications, logistics, cost/benefit analysis, and legal requirements.
Introduction
A chart of accounts (COA) is essentially a set of codes for the consistent classification of financial information. This allows for the systematic production of decision-useful accounting information for management, such as budgeting, monitoring, and management reporting. Similarly, a standard COA helps to ensure comparability in external financial reporting.
The COA facilitates the recording of all transactions, which are filtered into a unique account code, based on certain criteria. While this criteria is influenced both by internal management needs as well as regulatory requirements, many common types of codes would always be expected, such as revenue, expenses, assets, liabilities, and equity.
Why Update a Chart of Accounts?
A standard COA represents an integral part of an overall financial information system. A COA takes inputs from source accounting documents and journal entries, and allocates that information to a prescribed set of accounts, ultimately producing financial reports, which in turn enable users of that information to track the performance of the business, in a format that best suits their needs.
External Decisions
COAs can change for a number of reasons, including an industry-wide move to standardize accounting terminology. An example of this was the development of a standard COA for not-for-profit organizations (NPOs) in Queensland, Australia. In 2002, Queensland University of Technology (QUT) and Queensland Treasury commenced a project to develop a standard COA for small NPOs that received government funding. The project was commissioned because, at the time, Australia did not provide specific national accounting standards for NPOs. As a result, there was tremendous inconsistency in accounting categories and terms required by government departments in their funding relationships with such organizations. Research from QUT indicated that these inconsistencies created a heavy compliance burden on NPOs when acquitting grants, with many additional costs being incurred in the reporting process . Thus, through an extensive consultation process, a standard COA was launched in Queensland in 2006 . The success of the COA, both for NPOs and the funders, through reducing simplification of the reporting process, increasing understanding, and consistency of accounting practices, led to other Australian jurisdictions subsequently commencing similar projects.
A significant number of companies around the world have recently implemented International Financial Reporting Standards (IFRS). For many of those companies, the IFRS implementation was mandated in national legislation. The transition to IFRS involves significant practical and logistical challenges, especially in upgrading and adapting IT systems across the organization. A recent report by KPMG indicated that, “IT costs are generally over 50 per cent of the cost of IFRS conversion”, and that changes to the chart of accounts are inevitable.
Other key regulatory requirements, which can have an impact on the COA, revolve around taxation. For larger companies with overseas subsidiaries that will be using the same general ledger system, it is important to consider country-specific requirements when completing the COA, while providing as much consistency as possible.
Organizational Decisions
More commonly, businesses are likely to go through restructuring, make a strategic decision to implement a new IT system, or simply acknowledge that the current COA is not fulfilling the information needs of the business. Whatever the reasons are for change, management needs to assess both the new business requirements, as well as any that were not being met previously.
Similarly when considering the implementation of new reporting systems, it is essential to ensure that the individual components of the financial system, such as invoicing, stock management, and disbursements, are providing the appropriate support to the wider business objectives. This is often why ERM packages are so useful, as they allow information from a common source to be shared across previously disparate departments of the business.
Options When Implementing a Chart of Accounts
Essentially, an organization is faced with three choices.
- Keep the COA from the legacy system in place;
- Supplement the existing COA with some additional ones;
- Overhaul the COA and implement the new, changed structures.
From a practical point of view, moving away from the existing chart of accounts also has the significant advantage of offloading redundant codes and accounts which unnecessarily congest it.
In practice, especially when a comprehensive system such as an ERP package is being implemented, the organization faces limited choices. The chances are management will have to consider a whole-scale overhaul of the current system. Thus, it is also essential to ensure that, while this is an opportunity to cleanse the current COA, it is also vital to ensure that the new COA reflects the realities of the business. All-round general ledger systems are, by their nature, more sophisticated, linking various sets of data. Designing an appropriate chart of accounts is a complex process.
Practical Considerations When Designing a New Chart of Accounts
As previously described, the COA is only one element in the information system (manual and automated) which aids management decision-making. The COA is, however, a key part, bringing together financial information held within the general ledger, and filtering it into a format that can be used by managers.
The general considerations for implementing a new COA are, unsurprisingly, akin to those that would be assessed when making any significant system changes. Considerations include an assessment of user needs, a detailed design, potential impact assessment and testing, and simulations prior to final running. By thoroughly considering these basic procedures, it should be possible to complete a relatively risk-free, “big bang” approach to the adoption of the new COA. However, in the case of an overall system change, management may decide to run both systems for a period of time in order to ensure that all data is being captured. While costly and time-consuming, the old COA is then still available for cross-reference.
User Needs
Again, reiterating the main reason for having a standard COA, the initial phase of implementation must begin with a thorough analysis of the organization’s information requirements. Thus management will need to consider the existing outputs resulting from their present COA, and ensure that all potential stakeholders, within and outside the finance department, are involved in the process.
Understanding the current condition should ensure that relevant COAs are included in the new version, and that shortcomings are remedied. A simulation of the revised COA can then be produced, allowing the stakeholders to preview the resulting information. The main aim of this phase is not to determine what the final reports may look like, but to confirm that the required information is being generated.
Logistical Consideration
Business analysts tend to want as much information as possible, and then decide which information they really need at any given time. This desire, coupled with the wide range of internal and external stakeholders, may make it tempting to include excessive fields in a COA. However, it is generally the case that by widening the net of accounts, the likelihood of error, as well as underutilized codes, will be greater too. Thus, it is also vital to strike the right balance between the user’s often-exhaustive demands, and the limitations of an efficient data-capture system.
Typically management may be interested in analyzing performance based on:
- individual product basis and product class;
- separate cost centers;
- geographical segments;
- legal entities.
However, it is the needs of the business that should ultimately dictate the scope of data requirements.
It is also possible that the difficulty and cost of generating some information might ultimately mean that it is not worthwhile. The tendency is that future preparers of information may find it too difficult to provide the inputs regularly, and, therefore, these accounts would again become vacant. Thus, it is imperative to conduct a careful analysis of the process for data capture. While much reporting information can easily be extracted from basic input data from invoices, etc, the consistent splitting of costs and revenues by appropriate cost and activity centers is more challenging.
In order to maintain a consistent application of the COA, it is also important that a thorough guide is in place, outlining how information should be captured and recorded. Again, a regular review of these guidelines should be conducted.
Manual or Electronic Conversion?
In practice, the choice of manual or electronic conversion will be dictated by the type of system being implemented. If a totally new package is introduced, then the standard COA is already inbuilt, and only the process of identifying and/or adding new accounts is required, as discussed above. If the organization is simply implementing a new standard COA only, then the organization is faced with either a manual or an electronic change. Usually, electronic downloading into the accounting software is straightforward—the relevant file is downloaded from the data file into the existing accounting package, which then essentially overlays the existing COA.
A manual conversion requires a thorough comparison between the new standard COA and the existing COA. The process of identifying relevant accounts is, again, critical, although by virtue of the fact that this is not automated, it can be lengthier. A constant review of output reports, such as trial balances, is required.
If the company’s financial statements are audited, it is important to consider any requests from auditors, regardless of whether the process is manual or electronic. It is, therefore, important to document any changes to the COA, with an appropriate audit trail in place.
Balancing Cost-Centre Demands and Legal Entity Requirements
Many large organizations have a number of subsidiaries that are legal entities in their own right. While management may make business decisions on quite different aspects, the financial reporting process demands that a COA is able to meet all external reporting requirements, such as statutory and tax reporting. The COA must be set up so that a full trial balance for that individual entity can be obtained.
This can lead to possible conflicts and difficulty, especially where corporate cost centers are managed across a number of reporting entities. It may be that, at a cost-center level, additional detail is required on income-statement accounts, but limited detail is required for balance-sheet classifications—there is no compromise on statutory requirements.
Management should carefully consider how best to set up an accounting company, or a cost center for COA purposes. Typically, when businesses have their own general ledger systems or are legal reporting entities, a separate accounting company approach is the optimal solution. A cost-center approach is more appropriate when an organization is reviewed on the basis of divisional performance, which is supervised by individual mangers themselves.
While a standard COA should be comprehensive enough to allow for all divisional requirements, it should not compromise the compliance requirements of statutory reporting, either for the local entity, or the group as a whole.
Conclusion
Changing a COA involves a thorough understanding and analysis of the existing business requirements. However, it is equally important to realize that most businesses constantly evolve, and management information needs may also change. It is, therefore, essential that the implementation process includes a clear vision for future years, and makes the most of available technologies such as eXtensible Business Reporting Language (XBRL), for example. XBRL can benefit the dissemination of financial information from various sources, including various charts of account.
Finally, it is important to be mindful that there is no ideal standard COA. What fits the needs of one organization, and indeed one manager within an organization, may be considerably different for another. What is vital is that a thorough investigation of the needs of the organization as a whole is conducted.
Making It Happen
A correctly structured COA should support the financial and management reporting process, enabling the organization to evaluate its performance in a manner that uses information systems efficiently. Ultimately, a good understanding of the business and its future direction ensures that an optimum COA is developed. It is essential that managers are involved throughout the implementation process. At the centre of the considerations should be:
- Appraising the current system, including the relevance of outputs and accessibility of information, by bringing together managers from relevant departments.
- Understanding the current and potential information needs of the organization and focusing on the overall business strategy and processes, while taking into account external reporting and regulatory requirements.
- Designing and assessing the potential impact of the new COA against those user needs, and adopting an appropriate strategy to move from the old chart.
- Balancing the benefits of numerous financial information demands with the finite resources, both time and costs, required to capture that information, and ensure its accuracy.
- Putting in place a robust framework for operating the COA, including guidance on use (for future employees), regular review of outputs, and methodology for inputs.
Source: QFinance Author:Aziz Tayyebi
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