Building A Master Chart of Accounts (Part 2)
The Profit & Loss Statement
Often referred to as a statement of financial performance, the profit and loss statement (P&L) is a structured very differently to how the balance sheet accounts are organised and grouped for reporting purposes.
Classifications normally seen in a balance sheet like Current and Non-Current don’t exist in the P&L statement but it’s still very important to have a properly formatted set of P&L accounts broken up into meaningful segments.
Again using MYOB’s Account Right system, we can see below there are 5 system header groups for the Profit and Loss Statement. These are as follows:
- Income – All income accounts start with a “4-xxxx”
- Cost of Sales – All cost of sale accounts start with a “5-xxxx”
- Expense – All expense accounts start with a “6-xxxx”
- Expense Other – All other expense accounts start with a “8-xxxx”
- Income Other – All other income accounts start with a “9-xxxx”
Essentially, the type of income and expense groups shown in the profit and loss is largely driven by the type of business you operate and whether you provide customers goods, services or both.
However, in saying that there are still a few standard types of income and costs that most businesses will generate or incur respectively.
Here is an example of some possible grouping scenarios for the profit and loss statement.
The Income & Other Income Accounts
Revenue is vital to all businesses so a well-planned account structure will really improve the type and level of income insights you can obtain about your business and how easily this is achievable on a regular basis.
Unlike the balance sheet which has a 4 level header structure, the MYOB Account Right Profit and Loss has only 3 levels to structure your accounts.
I normally suggest to clients to use the income section for the businesses main income operating activities and the other income section for all other types of income like dividends, interest received, insurance refunds and those types of income not central to business operations.
Here is an example for the income section used in the sample chart of accounts (COA) below.
In the above example I have broken up the sales of goods using accounts starting with 4-1xxx, sales of services start with 4-2xxx and sales of time starting with 4-5xxx.
The level 3 accounts in the above example are used for the detailed transactional accounts and it provides you with the functionality to create multiple income accounts to segregate differing income types.
Again, it’s extremely useful to have an account structure that segregates your income and provides an instant ability to report on different activities or products that generate income. A CFO and business owner then can easily obtain a picture of what’s going on with revenue generation.
Income is a key driver in any business so if you structure your accounts correctly, it can really allow your business to understand how your cash inflows are generated and enable decision-makers to easily make judgements about expenditure and profitability.
Cost of Sales Accounts
The cost of sales account ranges represent the direct costs associated with a businesses main income activities.
Common direct costs can include expenditure like direct labour, direct materials or expenditure which can be directly attributed to the income generation process.
Often different types of businesses and industries will include various direct costs so it’s important when constructing this section of accounts that you clearly understand what the key cost drivers for the businesses are and how they are incurred to produce income.
Following our income example above here is an example cost of sales structure.
In this example business, it’s main activities involve the sales of goods and naturally, the purchase of goods is a direct cost which can be attributed to each good sold.
Some employee costs can also be linked to the main income activities so these costs have also been included in the cost of sales section under its own header section.
The cost of sales section in the chart of accounts is particularly important as it’s a component in working out businesses gross profit which is an excellent indicator for the general profitability for any business.
There is also a lot of information that can be derived from the gross profit margin and most industries and the Australian Taxation Office often use this measure to benchmark and compare the reasonableness of this calculation.
Expenses and Other Expenses
I normally see a lot of problems with the layout of the expenditure accounts in accounting systems and over the years I have evolved my own set up for expenditure account ranges.
A lot of expenses are common to most businesses and they can be easily grouped into useful and meaningful categories.
Here are some example groupings you could consider if you’re looking to streamline the organisation of your expenditure accounts.
As you can see above, the expense account ranges are grouped into segments that provide a super easy way for the reader to understand how the business has incurred costs for each relevant category.
Grouping like costs together is a very useful approach which I always discuss with my clients when building a master chart of accounts.
Use this methodology, also enables you to build budgets, cash flow and forecast information a lot easier and I will be releasing a post about how to approach these tasks in the near future.
Let me know if you have any chart of accounts tips by leaving a comment below.
Image courtesy of Richard John via creative commons license, some rights reserved