The chart of accounts structure used by legacy ERP systems present problems to the modern business. Modern ERP systems are leveraging new technology to drive flexibility and agility in reporting and transaction processing.
Older ERP systems use a chart of accounts structure
that is flawed
In the past, ERP systems used segments to store information in the account code for the Chart of Accounts. For example, the first segment is the actual account code reflecting the ‘natural account’ such as deferred income. The second segment is the department code, the third segment is the market sector and so on.
A natural account is used to group revenues and expenses by their types such as revenue, salaries, rent, and other expense types. Depending on the complexity of the business, the average company typically requires 250 – 350 natural accounts in the chart of accounts to fully categorise revenues, expenses, assets and liabilities. However, in addition to the natural account, a business may also need to report by one or more organisational units.
- Department: sales
- Market or territory: South Africa
- Product: sporting goods
- Product sub-category: sport shoes
Because these segment-based accounting systems use 3 or 4 segments in the account structure, this leads to thousands of accounts in the chart of accounts, while limiting the number of reporting and analysis segments to 2 or 3 (the first segment is the natural account code). When a new account code is created, it is linked to each account-code combination that may require this code.
If a new department is created and attached to 40 natural accounts and it also must be linked to 10 divisions and 20 products, this will result in the creation of 8,000 new account combinations!
It is easy to see why such a system often results in the creation of thousands of accounts in the chart of accounts.
What kind of problems does this ‘old school’ chart of accounts structure create?
It creates complexity and introduces errors
Legacy chart of account structures and complexity increase the learning curve for new accounting staff and complicate accounting processes. Capturing invoices becomes complicated and error-prone.
As a result, many companies try to minimise the number of new account codes they create to avoid complications and errors. But this reduces the usefulness of the structure and achieves the exact opposite of the original objective.
It makes financial and management reporting more challenging
Financial reports need to be maintained as new accounts are added. It may take a long time at month-end to update the various financial reports so that they balance.
Then there’s also the significant effort in creating management reports with this complex account structure which leads to reporting delays, the potential for errors, and the costs of reporting specialists or tools.
The Dimensional Accounting Approach
Multi-dimensional ERP systems use relational databases effectively to overcome the hard-coded segment structure. This enables them to make use of multi-dimensional arrays of information -think of them as Rubik’s Cubes – which in turn enable the use of dimensions and tags.
The modern approach is to create separate fields to store information that extend account codes, and these are called “dimensions”. A dimension is a piece of information about your business that you want to store and reference. It could be a department, a market sector, a cost centre, a product code and practically anything else that matters in managing your business performance.
With dimensional accounting, we only require the natural account to be initially coded. If a new department code is added, just one code or ‘tag’ is added to the department dimension and no other sub-account codes are required. If an expense is entered into the system, it is posted to a natural account, and the department code is added as it is entered.
These new accounting systems are called “multi-dimensional”, and they facilitate complex reporting structures with a simple chart of accounts.
How does Dimensional Accounting solve the problems of legacy chart of account structures?
It reduces complexity and errors
Minimising the chart of accounts down to a few hundred, or less, natural accounts simplifies it enormously and makes it much easier to work with. New staff can learn the chart of accounts numbering system in less time and allocating invoices to the right account is also easier resulting in fewer errors.
Reporting becomes simpler and more efficient
Thanks to more effective use of relational database technology, these new dimensional accounting capable ERP systems are even more powerful in their reporting and analysis capabilities than the old segment-based ERP systems.
Most organisations have a reporting structure, typically on organisational lines such as departments or divisions. They may also want to report by product line, geographic area or by industry segment. These reporting needs can be met by setting up dimensions for each requirement. Dimensions can be grouped to reflect the organisational structure without affecting the underlying transactions.