Cleaning Up Your Chart of Accounts Before Year End
As the year comes to a close, it’s even more important to make sure your accounting is in order, and that you’re ready to hand off your financials to your CPA. To save some back and forth between you and your CPA, it’s important to review your financial statements to ensure your chart of accounts are in order. In this post, we’ll examine in detail some of the steps for cleaning up your chart of accounts before year end. We’ll break it down into four of the most common corrections I frequently make to clients’ chart of accounts.
Having Too Many Accounts
Oftentimes I’ve opened up a client’s Quickbooks or Xero file to discover multiple accounts for the same types of transactions, which could easily be consolidated for the ease of reviewing financial statements. For example, I will see accounts named “Office Supplies” and “Office Expenses”– both of which are for the same types of transactions. These are easily correctable, and should make your financial statements clearer and more concise. This will also help you easily evaluate your spend at the end of each year, and make for more accurate budgets and forecasts.
Not Having Enough Accounts
On the flip side of having too many accounts, there is also some concern when there aren’t enough accounts in your chart of accounts to adequately explain the different transactions taking place in your business. For example, if you don’t have separate (or at least one master and some sub or child accounts) for Meals & Entertainment, you could be missing out on some tax deductions. This is because some meals are 100% tax deductible, but most are only 50% deductible. If you don’t separate out these different transactions, your tax accountant could miss this deduction.
Naming Your Chart of Accounts Incorrectly
Your chart of accounts is used as a means to explain the types of transactions your business is engaging in. If you don’t adequately name your chart of accounts with conventional naming, you could confuse or mislead investors and other stakeholders. As a recent example, I worked with a company that had a chart on their P&L called “Investment Income.” This, to a seasoned investor or user of financial statements, could be misleading. This would imply that you generated income from an investment of some sort, rather than receiving cash for an investment into your business. As such, having clear naming conventions is critical for your startup or small business.
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Incorrect Account Categories
The final issue to consider when cleaning up your chart of accounts before year end is also perhaps the most important. Making sure that your accounts are mapped to the appropriate category type is crucial, because that is what dictates how it impacts your financial reporting. As an example, “Payroll Expenses” is an income statement account that reduces your overall net income, whereas “Owners Distributions” or “Owners Draws” are balance sheet accounts, which decrease your total equity. Incorrectly setting up your accounts to the wrong category can cause some headache at year end, and should be avoided at all costs.
Your chart of accounts within your accounting software is the framework by which you drive your financial reporting. Setting this up incorrectly is akin to building a home on an uneven foundation, and can lead to unforeseen issues down the road. Make sure you consult with a CPA prior to setting up your bookkeeping system, or ask your CPA to review your chart of accounts before year end. He or she will be a great corrective resource for cleaning up your chart of accounts before year end.