The Art of Accounts

Overview

Setting up the general ledger chart of accounts is one of those things people don’t really give a lot of thought to.  They usually accept the defaults or something similar to what they’ve used before and move on.  Changes to the chart tend to be pretty reactive rather than proactive and intentional.  What if more people thought about how this important consideration affects all kinds of downstream processes, especially reporting and research?  They’d find one of those rare opportunities where accountants can be creative!

In this post, I’ll share three key approaches that can help you creatively structure the chart of accounts to streamline key parts of the accounting cycle: recording, researching, reconciling, and reporting – 1) subaccounts, 2) contra accounts, and 3) statistical accounts.  With these approaches, I’ve been able to automate the compilation of reporting packages, including the entire GAAP financial statements (even the cash flow statement)!

Use subaccounts

Most accounting systems support the ability to configure accounts into segments such as entity, main account, cost center, project, etc.  One often overlooked segment is the subaccount.  Subaccounts allow you to break down an account type further with a natural parent-child or roll-up relationship where needed, but without cluttering up the high-level chart of accounts.  The natural roll-up is an important distinction because inconsistent account roll-ups are a huge source of frustration for many finance and accounting teams and people they collaborate with, such as auditors.  The idea is that in most reporting, subaccounts are grouped together into total amounts but for deeper research the subaccounts are all listed separately.

Benefits

There are three main benefits to using subaccounts:

1. They help keep balance between too much and too little detail in the chart of accounts.
2. They offer a controlled way to naturally roll-up accounts in a consistent and seamless way.
3. They aid in research by giving you a way to isolate activity into separate related accounts.

Example 1: Utilities expenses

Companies often lump several types of expenses (i.e. electricity, natural gas, water, sewer, garbage collection, etc.) into one “utilities expense” account.  While it’s easy, you might miss concerning trends.  What if a water leak slowly got worse but that was masked by the balances in other expenses?  Subaccounts allow you to easily see both the total and individual expense type trends.  I often build reports that collapse the subaccounts into the subtotals.

Example 2: Discounts – controllable vs. uncontrollable

In some industries, it’s really common to offer discounts in the form of coupons, promotional codes, special sales, or from a more negative context, comped products/services due to a negative customer experience.  It’s important to distinguish what is controllable and what isn’t to assess performance.  Comped products would generally be considered controllable, but accepting a coupon would not.  What if that was all lumped into one “discounts” account?  It would be tough to identify improvement opportunities and execute on them.  Subaccounts allow you to easily segregate controllable and uncontrollable expenses all throughout different account types in this way.

Example 3: Actual expenses vs. accrued expenses

One of the fun (?) parts of accounting is following the accrual basis – matching up revenues and expenses in the period they were incurred, not necessarily paid.  Accruals are often tricky for many reasons (it’s an accrual world, isn’t it?!?).  Whether you accrue and reverse or accrue and hold (I usually prefer the former), mixing the actual A/P-fed expenses and accrual journal entries in the same expense accounts often makes research tough.  What if you used subaccounts for those accrual journal entries?  The standard income statement still looks the same but you can also build a report that separates the accruals to see what’s missing and how accurate those accruals are.  I’ve even seen separate subaccounts for the accrual and the accrual reversal! 

Use contra accounts

Contra accounts are also widely supported by most accounting systems.  They are used to offset or net down account balances for a variety of reasons.  Like subaccounts, they are often grouped together displayed in standard reports.  There are several common examples where contra accounts are used, but there is often room for many more.

Benefits

There are three main benefits to using contra accounts:

1. They keep the account(s) they are offsetting clean, simplifying reconciliations.
2. They add control to the process, ensuring transactions/balances are correct.
3. They simplify disclosures and other supplemental reporting requirements.

Example 1: Allowance for doubtful accounts

This is a very common example.  Based on the allowance calculation policy, an adjustment is made to an account that offsets accounts receivable.  It is usually recommended not to directly adjust accounts that flow from a subledger (like A/R, A/P, or fixed assets) as it makes it difficult to reconcile between them.  You’d also have a tougher time disclosing your allowance balance and activity in the financial statement footnotes if it’s not stated in a separate account.  You could use other contra accounts for recording reclass adjustments, such as customers with credit balances to liability accounts.

Example 2: Prepaid expense amortization

This one is less common but I recommend it.  Recording amortization entries in contra accounts has a couple of subtle benefits.  First, it keeps the account extremely clean – it’s easy to see when things are in the gross account (or the contra) that don’t belong.  Second, it makes it easier to see the gross spend or amount left to amortize.  You can clear out fully amortized items each period or each year – I recommend at the beginning of the next period/year.  This is the way fixed assets and the offsetting accumulated depreciation are recorded, but without the ease of a subledger to do most of it for you.

Example 3: Prepaid expense installments

This one gets really creative.  When prepaid expenses are paid via installment, they aren’t really prepaid, at least not fully.  To complicate things, the payment stream often isn’t equal over the term (if it were, you’d just expense it!).  Because of this, I’ve seen a lot of errors here, such as where each payment is separately coded as a prepaid and amortized for the remaining life (clearly not right – it under expenses the earlier months).  Try using a contra account for the payments, booking three types of entries (also used in this Excel example file):

1. When the agreement is signed, record the full value to a gross prepaid account, and an offsetting amount to a contra account.  There’s a net $0 prepaid amount until something is actually paid, but you can set up amortization schedules off of the gross amount.
2. When payments are actually made, record them to the contra account.  Now there’s a net prepaid amount, but it doesn’t affect the gross prepaid amount, which is the basis of amortization.
3. Record amortization like you normally would, but off of the total amount of the contract, divided over the contract term.

Statistical accounts

Statistical accounts (often also called stat accounts) are a vastly underutilized feature that most accounting systems have.  These are accounts that sit outside of the balance sheet and income statement accounts, and are used to track non-financial data or financial data in different ways than standard account types.  It’s certainly not a concept taught much in standard accounting courses!

Non-financial data (such as customer traffic) is often just as important as the corresponding financial data (such as sales), and tracking it consistently, accurately, and auditably is important.  After all, non-financial metrics are often prevalent in publicly reported financial reports. Most companies that track important data like this have it stored in spreadsheets, where access is loosely controlled and files can easily become lost or corrupted.  Entries to statistical accounts are booked very much like any other journal entry, so it’s easy to record other important information.  The potential uses of statistical accounts are only limited by your imagination!

Benefits

There are three main benefits to using statistical accounts: 

1. They give you a standardized, controlled, and documented way to record important data.
2. They simplify internal and external reporting processes.
3. They give important data points actionable attention.

Example 1: Customer traffic counts

Customer traffic counts were one of the first types of statistical accounts I was exposed to in the restaurant industry.  They greatly help explain trends in sales levels, along with the indirectly calculated sales per traffic unit (check average). Knowing traffic trends helps plan inventory purchases and staffing levels, among other things.  Recording them in the general ledger statistical accounts lets you memorialize them and easily build useful reports.  Other similar metrics often recorded in statistical accounts related to sales included weather-affected closings, location counts, guest satisfaction scores, and sales by revenue area/category.  See the screenshot below – the red box contains traffic counts and check averages, powered by statistical accounts.

Example 2: Labor metrics

Labor costs are often among the highest expenses that companies have, and ensuring certain productivity standards are maintained is a great use of statistical accounts.  I’ve seen categorized labor hours and employee headcount tracked in statistical accounts, which makes it easy to build trend reports and calculate related ratios like labor hours per traffic unit and employee count per location.

Example 3: Off-balance sheet amounts

Another type of statistical account I was exposed to was off-balance sheet loan balances.  Because of the way some state laws worked, certain loans were made by third-parties, and our company guaranteed them.  The loan balances were not recorded in our general ledger, but we still had to track them in order to calculate fees.  Statistical accounts allowed us to record and report on them just like the loans for other states that were in standard loan accounts.

Example report leveraging statistical accounts for traffic and check average calculations

Summary

By using subaccounts, contra accounts, and statistical accounts, hopefully you’ve found several ways to simplify recording, researching, reconciling, and reporting key data in your accounting processes.  As with most concepts in accounting, documentation is key.  Defining a purpose for any accounts used in your entire chart of accounts will ensure they are used correctly and consistently.  With any changes to your chart of account, make sure to communicate with any stakeholders to ensure everyone is aligned and to save painful hours reconciling reports.

Do you have any stories of leveraging a creative chart of accounts that made life easier for you and your team?  Share your thoughts in the comments below!