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A Chart of Accounts for a Merchandising Business: Explained

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Brief on a Chart of Accounts for a Merchandising Business

For a merchandising business, the inventory categories can be extensive. Therefore, maintaining a chart of accounts for a merchandising business is crucial. It is an essential tool to enable the management to analyze the costs and profitability and make the required adjustments. However, there is no strict structure or template for the chart of accounts, and it depends on the requirements and size of the business. Therefore, preparing a chart of accounts for your merchandising business can seem daunting.

But there is nothing to worry about, as you are only a few minutes away from being an expert at accounting for merchandising business. This complete guide will explore what a chart of accounts is and its essence in a merchandising company. We will sail through the concept of accounting for merchandising operations and learn how to develop a chart of accounts for your business.

Getting Started with Chart of Accounts

The chart of accounts, in simple terms, is a list of different accounts that the business includes in the ledger for recording transactions. Therefore, a chart of accounts can be the accountant’s or bookkeeper’s guide when they want to record a transaction in the journal. When the management wants to go through the income and expenses, the chart of accounts breaks it into simple categories.

Therefore, when you want to assess the cash flow and profitability of the company or look for a journal entry for reference, you know if you will find it in assets, revenue, liabilities, or expenditures, for example. Thus, a chart of accounts for a merchandising business is an index of the accounts.

Accounting for Merchandising Businesses

Merchandising businesses are the most common type of businesses in the market. These companies or small businesses buy the products from wholesalers or manufacturers and distribute them to direct consumers or other businesses.

A merchandising business sells out to a massive number of consumers, making reporting and keeping track of transactions challenging. It is then coupled with the wide variety of items available in the stock. Therefore, a chart of accounts for a merchandising business is crucial from the beginning. A chart of accounts, in conclusion, offers a multi-level benefit for accounting for merchandising operations.

Why Does Your Business Need a Chart of Accounts?

Let us see the precise reasons why a chart of accounts for a merchandising business is the most crucial.

1. Indexes Accounts

A chart of accounts in a merchandise company lists all the accounts in an index. Moreover, it defines where an account is placed. The chart can assign numerical figures to each account, where the first digit can be used to identify the type of account.

For example, for accounts numbered 12, 1 can stand for the assets, and the second digit 2 would denote the type of asset. Generally, when an accountant or bookkeeper sees account number 12, they would know it corresponds to an asset account.

2. Records Transactions

For a merchandising business, the transactions are diverse and huge in numbers. A chart of accounts provides an easy way to record a transaction in the journal. Therefore, when a certified accounting specialist needs to enter a specific entry in the book, they know which account to place it at.

The chart of accounts for a merchandising business will guide the accountant or the bookkeeper to find the concerned account and note the entry.

3. Provides Insights

A merchandising business relies on the profit generated from reselling the goods procured in large quantities. Therefore, the margin is of great essence here, where the only profits are generated through the margins and not providing services. The management, therefore, needs in-depth insights into the expenses and incomes to understand the profitability of the business.

This allows the management to monitor the operations and adjust the company plans. A chart of accounts neatly separates the different categories of income and expenses and provides powerful insights.

Key Aspects of a Chart of Accounts (COA)

Before you make a chart of accounts, you need to have a knowledge of the essential aspects of it.

A chart of accounts for a merchandising business is an organized list of all the business transactions. Therefore, making a chart of accounts starts with creating a system for accounting for merchandising operations. This is important for laying down the categories for recording transaction entries, which give way to different accounts.

1. Categories

Defining business transaction categories is essential to determining accounts in an accounting system. The general financial reporting standards advise two broad categories of accounts: balance sheet accounts and income statement accounts. This includes accounts like assets, liabilities, equity, revenue, and expense accounts, etc.

The number of categories depends on the business size, the physical area it is located in, etc.

2. Numbering System

The chart of accounts or indexes generally appoints a number to every account. When they do so, they follow a numbering system that helps the accountants or bookkeepers recognize the type of accounts. For example, let’s say the asset accounts are numbered like 1AX. Therefore, whenever the accountant sees the account 1AX, they would know it is an asset account.

Example of Numbering system

3. Structure

There is no fixed structure or template for a chart of accounts for a business. The complexity of the chart of accounts of a merchandising business or any business, in general, depends on the complexity of the business itself. Every business creates its chart of accounts depending on its requirements and the business structure.

A Quick Look at the Income Statement of a Merchandising Company

In the list below, you can see the different equations a merchandising business uses regularly.

  • Net Sales = Sales revenue – Sales discounts – Sales returns and allowances.
  • Gross margin = Net sales – Cost of goods sold.
  • Total Operating Expenses = Selling expenses + Administrative expenses.
  • Income from operations = Gross margin – Operating (selling and administrative) expenses.
  • Total other revenues (expenses) = Other Revenues – Other Expenses
  • Net income = Income from operations + Other revenues – Other expenses.

Adhering to these co-relations mentioned above is of utmost importance to enhance a company’s profitability. For example, when you notice a high gross margin in sales, you can immediately predict the profitability of a business. On the contrary, when sales commission and shipping costs take a high jump, this significantly reduces the actual profit, as only a fraction of the gross margin is saved.

How To Create a Chart of Accounts for a Merchandising Business?

The chart of accounts for a merchandising business can be as sophisticated as the business itself. A multinational business tax service with tens of hundreds of divisions may require several thousand accounts, but a retail outlet requires a few hundred. Therefore, when creating a chart of accounts for a merchandising business, it all begins with laying down the base for accounting for merchandising companies. Here are the core steps for creating a chart of accounts for a merchandising company.

1. Segregate the Accounts

This is the most fundamental role of a chart of accounts – to separate the income, expenditures, revenues, liabilities, and assets. The accounts should be laid out so the reader can immediately get a sound idea of the company’s financial health. A nicely laid out chart of accounts does not only fill the informational need of the management.

The chart of accounts (COA) has another purpose: to help with taxation and financial reporting. A well-designed chart of accounts makes tax reporting easier and helps the business comply with federal and state regulations. Therefore, lay out the broad categories and segregate the accounts carefully. Ensure that you consider the general and accepted principles for accounting and financial standards of boards.

2. Select the Identifiers

A chart of accounts uses identifiers like a number system or codes to help the viewer recognize the account instantly. Generally, the companies assign numerical values to the accounts. You can choose a numerical system for easy identification.

For example, you can label asset accounts like 101, 102, and so on, and liabilities from 201 and onwards. Moreover, you can subcategorize the assets and assign importance to the second digit to separate the type of assets. For example, the current assets could be 110 to 119, etc. Structuring in this way helps in many instances, like when the departments separately prepare the reports.

3. Plan For the Future

The chart of accounts should remain the same for quite a long time if you want to use it to analyze the company’s growth over the years. Therefore, when you lay down the chart of accounts, you need to have a general overview of the company size in the near future. This should be done to ensure that the COA can accommodate the expanding business without needing to change it.

A Sample Chart of Accounts for a Merchandising Business

A COA has great importance in the accounting of merchandising companies. A sample chart of accounts will give you a head start in preparing the COA for your business. Take a look at a sample COA below.

Sample of Chart of Account

Final Words

So that was all about preparing a chart of accounts for a merchandising company. We hope that with the help of this guide, you can take your accounting for merchandising business to the next level. If you feel stuck or require an expert’s take on making a COA well-tailored to your business, we can help.

Don’t hesitate to call us now at 1800 580-5375, and let us help to add to your business growth.

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