Transactions, Chart of Accounts, & The Kiss Method
What are Accounting Transactions?
Every business goes through the process of completing financial and non-financial transactions on a daily, monthly, quarterly and annual basis. This process is quite simply “HOW” the owners and employees go about selling their goods/services to customers, purchasing supplies from vendors, dealing with investors and creditors, and so on.
Most of the time, it is easy to understand a transaction because there is an exchange of CASH in some way or another. For example, the office manager needs to buy a new office printer, so she goes online and purchases one with the Business Credit Card. The exchange of cash for a business expense is an accounting financial transaction.
How to Classify the Transactions and What does it mean to Record?
These daily, monthly, quarterly and annual transactions need to be classified. This is a seemingly complicated word that just means to tag the transaction to the appropriate account type so that it filters to the correct financial statement.
Once the transaction is classified it is “Recorded” in the accounting ledgers to organize all the company’s transactions by account type within the “Chart of Accounts”.
What is the Chart of Accounts?
How does the Chart of Accounts impact the Financial Statements?
A Chart of Accounts is a list of all the types of accounts specifically created for the company. These accounts fit into (7) very specific types and are then filtered into (2) main financial statements – the Income Statement (aka Profit & Loss) and the Balance Sheet (aka Statement of Financial Position).
These (7) accounts are Revenue, Expenses, Gains, Losses, Assets, Liabilities, and Equity. The Income Statement has all Revenues, Expenses, Gains, and Losses transactions reflected in it. The Balance Sheet has all Assets, Liabilities and Equity transactions reflected in it.
The company then creates more detailed account names/categories that fit the company type, industry standards, and financial reporting requirements. For example, “Office Supplies” is a type of “Expense” account that is linked directly to the “Income Statement”. Another example is “Note Payable – XXX Bank”, which represents a “Liability” (debt obligation) account that is due in over (1) year and is represented on the Balance Sheet.
This brings us to the most important point about transactions: Each transaction ALWAYS impacts at least two accounts in the company’s Chart of Accounts. Think about the above example of purchasing a new printer. This transaction impacts two accounts: The Credit Card account (a Balance Sheet – Current Liability account) and the Office Supplies account (an Income Statement – Expense account).
FOLLOW THE KISS METHOD – “KEEP IT SIMPLE STUPID”.
Once a good Chart of Accounts is completed, it should not change often. It is not meant to be a lengthy list to include the minutia details between two very similar transactions, or various ways of naming one type of transaction when it is slightly different from another.
Unless a financial or tax reporting regulation (rule) forces your hand to create a brand new account, your first attempt should review the existing accounts and try to fit each transaction into the mold first.
Unfortunately, too many owners and newbie accountant’s think that if the Chart of Accounts includes more detailed accounts, then the Financial Statements have a greater degree of accuracy to them. This is, in fact, the opposite. The Financial Statements are a tool to aid in business decisions based on the historical transactions and current financial position.
Think of the saying, “couldn’t see the forest for the trees” (author unknown), which means that you cannot see the big picture because of the denseness of the details. If the Chart of Accounts, and by the direct relationship the Financial Statements, is overwhelmingly detailed and lengthy, the owners and decision makers of the company might miss out.
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