Every business needs a system to classify expenses.
The system for classifying expenses is known as the chart of accounts. The chart of accounts is a system that numbers the account names that describe the nature of the expenditure. The same chart of accounts is used to also number the income accounts, as well as assets, liabilities and net worth accounts. The chart of accounts serves:
- The need to know how much is being spent by expense type.
- The need to capture totals by type of expense for the tax return.
- The need to provide the bank with financial statements.
- The need for historical numbers to help in preparing budgets.
- The need to compare actual results against a budget.
- The need to compare this year’s results against last year’s results.
- The need to know costs when calculating breakeven.
- The need to determine whether you can afford a new hire.
- The need to manage cash flow.
- The need to determine where you can cut costs.
- The need to compare results against industry results.
- The need to track key performance indicators (KPIs).
- And others.
There is no set numbering system that every business employs. And, unfortunately, accounting software programs do not provide good default systems. Each business should have the flexibility to build their own numbering systems. Most systems use a three-digit or four-digit number. The vast majority of small businesses can get by with three-digit numbers. The four-digit number adds a zero to the three-digit number.
There are many accounts that make up the total dollars in each of the above basic categories. Building a chart of accounts is a science—not an art. “Chunks” of numbers should be allocated to each basic category as follows:
| Category | 3-Digit | 4-Digit |
|---|---|---|
| Assets | 100-199 | 1000-1999 |
| Liabilities | 200-299 | 2000-2999 |
| Net Worth | 300-399 | 3000-3999 |
| Sales Revenue | 400-499 | 4000-4999 |
| Direct Costs | 500-599 | 5000-5999 |
| Operating Expenses | 600-799 | 6000-7999 |
| Other Income/Expenses | 800-899 | 8000-8999 |
| Income Tax Expense | 900-999 | 9000-9999 |
Other Income/Expenses are accounts that capture items outside your normal operations of selling goods or services. Examples include interest income, dividend income, interest expense, gain (loss) on disposal of assets. You are not in the business of earning interest and dividends, nor borrowing money, nor selling assets. That is why these items are classified below operating expenses as other income/expenses.
The reason for differentiating Direct Costs and Operating Expenses is to provide a break-out for determining Gross Profit as opposed to Operating Profit. This distinction is often needed to calculate breakeven sales. It is also a further “chunking” exercise.
Direct Costs may be defined as costs directly associated with the cost to manufacture, warehouse, distribute, deliver, or to consult, for a “line of business”. Direct Costs exclude selling, general and administrative expenses. Sales Revenue minus Direct Costs equals Gross Profit. A line of business may be represented as a product line, a service line, a consulting line, etc.
Operating Profit may be defined as Gross Profit minus total Operating Expenses, including advertising, marketing, selling, research and development, information technology, general and administrative expenses.
The attached expanded Income Statement illustrates “chunking” in action and “sorts out expenses”. It can be used as a Chart of Accounts for any business, including manufacturing, distribution and services. Not all accounts will be used if your business is in distribution or services. The 3-digit coding can accommodate two product lines; if you have more than two, use 4-digit coding which considerably expands the coding universe. Please note that service lines may be substituted for product lines. Also, if you prefer not to use the “Direct Costs” coding, simply use “Operating Expenses”. And within operating expenses, if you prefer, just use one salaries account to capture all salaries.
The coding (numbering) is there for you to use as you wish, or that which will accommodate your reporting needs. Remember, it is all in the coding. When you receive a vendor invoice or pay an expense item, the document that you pay must be coded with the system you are using. For example, if you allocate rent between Direct Cost (Plant 80%) and Operating Expense (Office 20%), 80% will be charged to Account # 570 and 20% to Account # 660.
Chart of Accounts
(Income Statement Format)
| Account # | Category | Amount |
|---|---|---|
Labor and Benefits |
||
| 530 | Direct Labor—product line 1 | xxx,xxx |
| 531 | Direct Labor—product line 2 | xxx,xxx |
| 535 | Indirect Labor—product line 1 | xxx,xxx |
| 536 | Indirect Labor—product line 2 | xxx,xxx |
| 540 | Overtime Labor—product line 1 | xxx,xxx |
| 541 | Overtime Labor—product line 2 | xxx,xxx |
| 545 | Payroll Taxes—product line 1 | xxx,xxx |
| 546 | Payroll Taxes—product line 2 | xxx,xxx |
| 550 | Employee Benefits—product line 1 | xxx,xxx |
| 551 | Employee Benefits—product line 2 | xxx,xxx |
Receiving |
||
| 555 | Receiving Expenses—product line 1 | xxx,xxx |
| 556 | Receiving Expenses—product line 2 | xxx,xxx |
Shipping |
||
| 565 | Shipping Expenses—product line 1 | xxx,xxx |
| 566 | Shipping Expenses—product line 2 | xxx,xxx |
Facilities |
||
| 570 | Facilities Rent | xxx,xxx |
| 571 | Facilities Utilities | xxx,xxx |
| 572 | Facilities Insurance | xxx,xxx |
| 573 | Facilities Property Taxes | xxx,xxx |
| 574 | Facilities Security | xxx,xxx |
| 575 | Facilities Maintenance & Repairs | xxx,xxx |
| 576 | Facilities Janitorial | xxx,xxx |
| 577 | Facilities Supplies | xxx,xxx |
| 578 | Facilities Landscaping | xxx,xxx |
| 579 | Facilities Snow Removal | xxx,xxx |
Overhead |
||
| 580 | Tools & Operating Supplies | xxx,xxx |
| 581 | Equipment Rental | xxx,xxx |
| 582 | Equipment Operating Leases | xxx,xxx |
| 583 | Equipment Maintenance & Repairs | xxx,xxx |
| 584 | Workers’ Compensation Insurance | xxx,xxx |
| 585 | Liability Insurance | xxx,xxx |
| 586 | Telephone | xxx,xxx |
| 587 | Travel | xxx,xxx |
| 588 | Other Overhead | xxx,xxx |
Depreciation |
||
| 595 | Depreciation Expense—product line 1 | xxx,xxx |
| 596 | Depreciation Expense—product line 2 | xxx,xxx |
| 597 | Amortization Intangibles—product line 1 | xxx,xxx |
| 598 | Amortization Intangibles—product line 2 | xxx,xxx |
| subtotal | Total Direct Cost | $ xxx,xxx |
Gross Profit |
||
| subtotal | Gross Profit—product line 1 | $ xxx,xxx |
| subtotal | Gross Profit—product line 2 | xxx,xxx |
Operating Expenses |
||
| Marketing | ||
| 600 | Advertising | $ xxx,xxx |
| 601 | Promotion | xxx,xxx |
| 602 | Marketing Trade Shows | xxx,xxx |
| 603 | Marketing Conventions | xxx,xxx |
| 604 | Marketing Expenses | xxx,xxx |
| 605 | Marketing Print Materials | xxx,xxx |
| 606 | Marketing Salaries | xxx,xxx |
| 607 | Marketing Payroll Taxes | xxx,xxx |
| 608 | Marketing Employee Benefits | xxx,xxx |
| 609 | Marketing Travel | xxx,xxx |
| 610 | Marketing Meals & Entertainment | xxx,xxx |
| Selling | ||
| 611 | Sales Trade Shows | xxx,xxx |
| 612 | Sales Conventions | xxx,xxx |
| 613 | Sales Expenses | xxx,xxx |
| 614 | Sales Print Materials | xxx,xxx |
| 615 | Sales Salaries | xxx,xxx |
| 616 | Sales Commissions | xxx,xxx |
| 617 | Sales Payroll Taxes | xxx,xxx |
| 618 | Sales Employee Benefits | xxx,xxx |
| 619 | Sales Travel | xxx,xxx |
| 620 | Sales Meals & Entertainment | xxx,xxx |
| Research & Development | ||
| 625 | R & D Expenses | xxx,xxx |
| 626 | R & D Salaries | xxx,xxx |
| 627 | R & D Payroll Taxes | xxx,xxx |
| 628 | R & D Employee Benefits | xxx,xxx |
| Information Technology | ||
| 630 | IT Expenses | xxx,xxx |
| 631 | IT Salaries | xxx,xxx |
| 632 | IT Payroll Taxes | xxx,xxx |
| 633 | IT Employee Benefits | xxx,xxx |
| Training | ||
| 640 | Training Expenses | xxx,xxx |
| 641 | Training Travel | xxx,xxx |
| 642 | Training Meals | xxx,xxx |
| Web Site | ||
| 650 | Web Site Expenses | xxx,xxx |
| Office Facilities | ||
| 660 | Office Rent | xxx,xxx |
| 661 | Office Utilities | xxx,xxx |
| 662 | Office Insurance | xxx,xxx |
| 663 | Office Property Taxes | xxx,xxx |
| 664 | Office Security | xxx,xxx |
| 665 | Office Maintenance & Repairs | xxx,xxx |
| 666 | Office Janitorial | xxx,xxx |
| 667 | Office Operating Supplies | xxx,xxx |
| 668 | Office Scaping (Décor) | xxx,xxx |
| General & Administrative Payroll & Benefits | ||
| 670 | G & A Salaries | xxx,xxx |
| 671 | Officer Salaries | xxx,xxx |
| 672 | Bonuses | xxx,xxx |
| 673 | Employer FICA Taxes | xxx,xxx |
| 674 | Federal Unemployment Taxes | xxx,xxx |
| 675 | State Unemployment Taxes | xxx,xxx |
| 676 | Workers’ Compensation Insurance | xxx,xxx |
| 677 | Group Insurance | xxx,xxx |
| 678 | Pension Expense | xxx,xxx |
| 679 | Profit Sharing | xxx,xxx |
| Other G & A Expenses | ||
| 680 | Accounting & Auditing Fees | xxx,xxx |
| 681 | Auto and Truck Expenses | xxx,xxx |
| 682 | Bad Debt Expense (small balance write-off) | xxx,xxx |
| 683 | Bank Charges | xxx,xxx |
| 684 | Business Meals | xxx,xxx |
| 685 | Business Taxes (other than income & sales) | xxx,xxx |
| 686 | Cash Over and Short | xxx,xxx |
| 687 | Charitable Contributions | xxx,xxx |
| 688 | Computer Expenses | xxx,xxx |
| 689 | Dues & Subscriptions | xxx,xxx |
| 690 | Entertainment Expenses | xxx,xxx |
| 691 | Equipment Maintenance & Repairs | xxx,xxx |
| 692 | Equipment Operating Leases | xxx,xxx |
| 693 | Equipment Rental | xxx,xxx |
| 694 | Gifts (business) | xxx,xxx |
| 695 | Insurance Expense (general) | xxx,xxx |
| 696 | Kitchen Expenses | xxx,xxx |
| 697 | Legal Fees | xxx,xxx |
| 698 | Licenses & Fees | xxx,xxx |
| 699 | Messenger & Delivery Expenses | xxx,xxx |
| 700 | Miscellaneous Expenses | xxx,xxx |
| 701 | Office Supplies | xxx,xxx |
| 702 | Penalties and Fines | xxx,xxx |
| 703 | Postage | xxx,xxx |
| 704 | Printing Expenses | xxx,xxx |
| 705 | Professional Consulting Fees | xxx,xxx |
| 706 | Sales Tax Expense | xxx,xxx |
| 707 | Telephone—office | xxx,xxx |
| 708 | Telephone—mobile | xxx,xxx |
| 709 | Travel Expenses | xxx,xxx |
| Office Depreciation | ||
| 720 | Depreciation—office items | xxx,xxx |
| 725 | Amortization Intangibles | xxx,xxx |
| subtotal | Total Operating Expenses | $ xxx,xxx |
Operating Income |
||
| Subtotal | Operating Income | $ xxx,xxx |
Other Income/Expense |
||
| 800 | Interest Income | xxx,xxx |
| 801 | Dividend Income | xxx,xxx |
| 805 | Other Non-Operating Income | xxx,xxx |
| 810 | Interest Expense | xxx,xxx |
| 815 | Other Non-Operating Expense | xxx,xxx |
| 850 | Gain on Disposal of Assets | xxx,xxx |
| 855 | (Loss) on Disposal of Assets | xxx,xxx |
| subtotal | Total Other Income (Expense) | $ xxx,xxx |
Income Before Income Tax |
||
| Subtotal | Income Before Income Tax | $ xxx,xxx |
Provision for Income Tax |
||
| 900 | Federal Income Tax Provision | $ xxx,xxx |
| 910 | State Income Tax Provision | xxx,xxx |
| subtotal | Total Income Tax Provisions | $ xxx,xxx |
Net Income |
||
| Subtotal | Net Income | $ xxx,xxx |
Sign Up for our email newsletter, “Cover Your Assets”
