The Anti-DIY Chart of Accounts: How to Build it Right

Welcome to Accountants LawPod, where accounting professionals and law firms converge, hosted by Lynda Artesani, Sarah Prevost, and Stephen Libhart.

Hello everybody. Hi Lynda and Sarah, how are you? Good, how are you? Good, good. We're recording in the afternoon, which is unusual for us, so—

I know.

You know, our after lunch—

Are you on? You'll know why.

Exactly, exactly.

East Coast time.

Everybody have a good weekend?

Yes, it was fast. I feel like every weekend is fast.

Did you have a good dog father weekend?

I did. Hector went with me camping in the Airstream, and yeah, yeah, we had a good time. So, and summer solstice is here. It's officially summer.

Oh, I didn't even know.

This weekend. Yeah, yeah, it was— it's here. But, um, let's dig into what we're going to talk about today, and that's the anti-DIY chart of accounts. And how to build it right. But I want to preface by saying that we might be telling some real-life stories of our experiences with attorneys and law firm accountants and things about how the chart of accounts can sometimes get messy because it's not set up a certain way or what have you. So just kind of wanted to put that little disclaimer out there. Don't take any of this personally, folks, because we've seen and heard a whole bunch of what we're going to talk about today. So yeah, let's dive in. Why, why Why don't we want to use the default QuickBooks chart of accounts? That's the biggest software ever.

I just fixed one this weekend and it really wasn't the default QuickBooks one, but the default QuickBooks one is for a contractor.

Well, just put that out there.

It's the contractor. It's got job supplies on it. It's got things on it that are not necessary. There's most of the things that are on there we don't use for law firms. So And it has that— first of all, it has licenses and businesses licenses, and the word license is not spelled right. That's one of my things that bothers me about QuickBooks default chart of accounts.

That's—

Every time I see it, I'm like, oh, you know, I gotta fix it because it's misspelled. But also, one of the things we do do when we do a chart of accounts is we try to separate the operating accounts from the IOLTA accounts. So if they've got multiple, we try to keep them separate. It just helps when you're doing the reconciliations of the IOLTA accounts. To put them in a little grouping and sub-liability and sub-asset them down. And that way it's easier to track when you're trying to reconcile the trust account. It keeps it away from all the operating accounts, especially if the firm's bigger. They might have multiple, they might have a payroll one, they might have savings, maybe a CD. You want to keep them all kind of bucketed in the type that they are. That makes it easier.

Well, and bless QuickBooks, they, you know, they have to appeal to all kinds of different businesses. And, um, you know, so you can't plug and play with the law firm QuickBooks setting it up.

Yeah. Well, you know, there was a thing back in the desktop days. If you remember, you picture industry and they had a bucketed list.

They did. You're right.

Way back in the day.

There's also the evolution of if you, depending on when you started your QuickBooks Online firm file, there's the evolution of how they bucketed certain things. So, I'll use the simplest example. There was dues and subscriptions, and then there were software dues separate from subscription dues, and then it was dues and office supplies and software. And I'm like, well, that's— it's just the evolution of software. And at that stage, and oftentimes, to your point, Lynda, the chart of accounts is more tailored to that contractor, but there are certain pieces of it that land in the say the expense side that are more home office focused, and that's just presuming everyone's a home office.

Yeah, in QuickBooks, they kind of put it down in the other expenses with the home office bucketed section, but that can get mislabeled if it's, you know, if you don't know where you're putting it as you're entering the transactions. If you're sticking it down there and it's not the home office, you really want to look at your tax return. I think that's a great place to kind of look and say, okay, where did all this I've got a chart of accounts now existing and I've got a tax return. And how is the tax person moving stuff over? Because if you can align those 2, it's going to make your life a lot easier when you get your tax return. You're going to know exactly what— because they kind of bucket things together. They put things in little bundles and we kind of have to figure out where they— how they put them together. And some things have changed, like the entertainment expense is gone. That's been gone for a while, but it's Not deductible. You can use your funds from your business for it, but it's not deductible. So I usually rename the account not deductible so they know it. Meals has changed this year. That's, that's a different— now staff meals has changed. So it's some of the things you want to, you know, it's 50%. So you want to put 50% on, just remember it. So when you do your taxes—

That's great advice.

It's the amount at the end of the day in your profit and loss is different than the amount that the tax person has, that's why, because some of those expenses that you took the whole amount for have now been reduced by 50%.

The other one that's a, a big misnomer on is your furniture and fixtures and those types of things, because QuickBooks puts only the asset side on, but there are accommodations. So as you said, um, Lynda, they— you can reverse engineer it to your tax return, but there are some key pieces that might be important to you that as long as you understand where the information goes, I think that's important. But that's not how you want to set up your chart of accounts necessarily, because you have areas that are key metrics that you want to pay attention to. Your entity type, your service industry also—

That's the big one.

What your structure is on your chart of accounts. And to go back to what you had said earlier, Steve, is we're never really mocking anybody, but what we tend to find in files in client files is this misunderstanding or unfortunate circumstances where they, for their own mindset, they will list every vendor name or list every attorney name and kind of do this income thing or this like expense thing. And bear in mind, when you're producing a document like that, the purpose has to be twofold or threefold. It's a tax return, it's to run your business, and it's also for what people are going to see. And We never would want your employee names listed on the return or listed on the financial statement for someone else's eyes to see.

And we've seen that happen.

We've seen it happen. Yeah. What are some things you see, Steve? What are areas that you've—

Oh gosh, the— just the way they name some of the accounts. You know, sometimes you can't tell if it's a personal business, personal expense that should go into their equity against their equity, or if it's a business expense. Yeah, you know, that's a big one. Uh, you mentioned the employee names. Um, what about trust account?

Oh yeah, estimated taxes. How about estimated taxes? That's one that we see.

Yeah, yeah, yeah.

Yeah. And they— then you have to put it underneath the distribution side depending on their entity type, right?

I think a lot of people get confused by that when they take money out of their— doesn't even have to be a law firm, just take it out of their business to pay the estimated taxes. Well, you're taking money from the business entity and paying it for your personal tax estimate. So that's equity that you're taking out of your company, whether it's a law firm or anything else.

Which is a distribution, and now it's taxable.

Correct. And now it's taxed. I know people get so hung up on that.

Oh, they do get upset, and you can't blame them. It's just what Sarah was saying about the furnitures and fixtures. So that's a default account on the chart of accounts, and if it's— if you spent less than $2,500 It's expensed in the year. So you put it down in office expense or whatever, you know, furniture less than $2,500. And people don't know that because that's not what they do for a living. And then they're looking at it and they're putting it up in the asset. And if the tax person doesn't catch that, then, you know, you have another issue because it shouldn't be up in the asset. It was less than the $2,500. You don't want to put that over—

Well, and have you seen some, some tax preparers and CPAs use a different number than $2,500? Yeah, some of them say I want you to use $2,000 or $500, and I've never understood what they're thinking.

I can tell you from my own experience of working with directly with a few of them, is there, there are, yes, you can put them in the $2,500 or less, but there might be something behind it that we don't have knowledge on that deems it a fixed asset versus a direct expense. And so To Lynda's point and your question, Steve, is having it clearly called out and putting those little— like, I do a list on the profit and loss that will say, you know, fixtures, furniture, fixtures, what is something, something kind of other than, and then I'll label it less than $2,500. I only do that for my own sanity, for one, but also, you know, I'll use an example. You can go to Best Buy. I'll just use Best Buy.

Mm-hmm.

And you can buy a lot of stuff. Well, okay, sure, you've spent $4,000, but is any one of those items $2,500 or more or $2,500 or less?

Or what happens when—

tricky.

I'm sorry about what happens. Because again, we see all these wacky things sometimes.

Yeah.

What happens when you go out and buy a computer, it's $2,600, but 3 weeks later you go buy a mouse and a mouse pad and a this and a that? Where does that go, Sarah? Where do you, where do you put that?

It depends on, on the individual. So it— and then here, here it goes. Lynda and I probably will probably give you 2 different answers because sometimes people like to see it with their office equipment line item. That's just— sometimes people just want that in office supplies. It just depends, right? And right, that's where the questions start to come up. And you know what, you're running a business. You're not meant to have this sort of internal dialogue on how to figure all this out. This is stuff that we have to— mind you, we're not doing taxes, but again, we're all 3 business owners. But we also have to think of these things because we have the same rules that apply to us as we're running our companies. And I believe wholeheartedly, as you're dialoguing with a client and figuring out, oh, that's how you think about that.

Mm-hmm.

That makes sense. Marketing is one area that Lynda goes in and chops it up very cleanly. But then, you know, she'll find, okay, wait, you're using this app, this tool, but like, you have to draw some lines of where you're gonna put things.

And ask questions.

And, and that's your— And then you have clients too that like, they maybe they decided to buy a building and they took the money out of their business to buy the building, but the building's actually owned by a separate company. So now how do you, where do you put that? We've actually had this happen a few times. Where do you, where do you put that? Because the building's now owned by an LLC, money came out of the operating of the law firm, but the law firm doesn't own it but is paying rent to the building. So now you've got this crisscross applesauce kind of situation going on, and you need to have that documented properly because if it's not documented properly, now you're in a whole nother world of hurt because the tax person is going to say, well, what is this? You know, and we've had this happen twice this year already where somebody bought a building and we don't know, we just see this giant amount of money leave the bank.

All of a sudden, sure.

You know, and that's what brings the questions. And it can even be some of the technicalities on the— if you're trying to do a DIY, like I said, get started with your tax return and then get some sort of— that's the bones, but then you want to— what are you tracking? Do you want to track how much you're spending on advertising? And the thing is, a lot of times people that aren't accountants or bookkeepers will go in and they'll, like Sarah said, they're going to make a name. Okay, I spent money on Facebook ads, I got Google ads, and those are all subcategories under the marketing. But you don't need to do that. They can all go into the marketing category. If you want to see how much you spent on Google ads, go into the Google ads vendor and see what you spent. You can get all that detail there. You don't need to make the detail on the profit and loss because it gets unruly, right?

Oh, I like that. Yeah.

So I think too, when you're looking at the chart of accounts, you know, you get to factor in also— actually, Sarah, we've got a blog post coming out on this in August. I'm kind of ahead of myself. We— I just wrote this article basically on this. It's going to be coming out. Are you using class tracking? Are you using, you know, location tracking? Not specific to the chart of accounts, but it's part of the transaction entering that you're doing. So you kind of have to mind map this out. For your— think of your end result. What is your end result? Is your end result to do a tax return? Then that's where you want to have it be. And then you also— is your end result also how's your business doing? Where am I spending? Where am I? You know, where— what am I doing? Metrics. Then you need to have that in mind as well as you're starting to mind map out your chart of accounts.

And that's good advice. Very good advice, because some of them are very driven by the KPIs of employee, chopping it up by employee, by class, by collections or time, billing or what have you. I mean, there's a lot of different things that go into the formula. So, but to your point, listing out all the different apps and what you spend on them, they should all be bucketed into 1 or 2 areas there.

Yeah, software.

Behind the scenes, you can go do your research on how much you spent on them and What type of return you think you have, because those vendors are going to provide that to you. Google Ads, you can see what the performance is on that. What, you know, that shouldn't be a separate bucket on the books generally.

And then depending on what you're looking for, yeah, um, maybe we just did this, you move your, your cost of sales, right? You start to track cost of sales separately than the expenses because you want to know what it's costing you to do the work. So for them, be they paralegals or admins or whatever, you might want to move that up into its own little dedicated section.

She just read my mind.

Oh no, I love it.

That's something—

that's a big thing that we do. Because if you— for every dollar earned, what is the production behind it that's directly related to it? Otherwise you wouldn't have had that production, right? It wouldn't be that cost. So, so there's that question. And how do you lay that out? What makes sense? You know, it's all dependent on what you mentioned, Steve, is your metrics and how you're going to see that. But also it does have bearing on what a tax person will do. And then there are things that— I'm not saying this right or wrong, but there are things that may not show up on the return, and there might be reasons why. And sometimes that's a conversation to have, or to Linda's point of the entertainment, or Steve, like, I think of things like people putting stuff in the wrong places. Advanced client cost is a big one.

That's a big one.

We always have that merry-go-round conversation.

Yeah.

Or when you lose a case, what happens to those costs that aren't recouped? There's a whole slew of them.

Sometimes we can go into a file and you can tell that this firm's been around a long time by the naming of some of the accounts that are in there, like Steve mentioned in the beginning. Like sometimes if you see the word personnel, that is an old dated word and you don't usually see that on the chart of accounts, right? Oh, what's the other one that we see sometimes that it's like, oh wow.

We know it too when we see it.

Every time we see it, we know exactly what coaching program they're using. Oh God.

Yeah. Shoot, it'll come to me.

But it's funny. It's just what you see. And a lot of times it could be an evolution of bookkeepers that have added to it. So it's not a bad idea to go in and do a little housekeeping checkup of your chart of accounts. This is a great time of the year to do it. Take a look at what you're using, what you're not using, make them inactive if you're not using them. Old bank accounts, old credit cards that are closed, get them off the list. Obviously with a law firm, you might have old client matters that you want to clean up and they're done and they're zero. You want to get them off the books. Now's a great time to do that.

Cost receivables is a great one on that. And also the trust accounts.

Yes.

Let's talk about drilling down on those.

Yes, because it's a good housekeeping tip, because otherwise the list gets unmanageable.

And if there's zero inactive when they're done, when a case has been completed, and because it will— it's scary because it will say either deleted or inactive on a report when you're looking at historical on a trust. You know, you're looking up your trust and you're like, oh my God, it's not gone forever, friends. And we're only talking about You know, QuickBooks ledgers, we've got Xero ledgers that work in a similar fashion. It just, uh, I, I lost my train of thought because there's something I was thinking about too. When you're looking—

You can make sub-ledgers in Xero because I've watched Sarah make them. Yeah, it's a different way of doing it, but she has a way of doing it so it's not one flat line of it. Because we see that too sometimes, we get charts of accounts on client files and we're like, oh, this is so hard to visually interpret because it's One flat line. So we usually export it out. We have a preferred list. We put that in, and we kind of do a blended tab and show the client these. This is the blended, and then we go—

Great way to do it.

Yeah, and then we do it with the client, and then they accept the changes or not.

I know my question. Have you had it where you're both sitting with a client? And, and I've, I've heard this. I, I could fairly say, Lynda, I've heard this too, but they don't know where to look. It's so long.

So big.

You know, they're, they're profitably— they don't understand what they're looking at anymore. And so, Steve, I don't know what your experience has been because I know we talk about running this way lengthwise. But for those listeners, I always talk about the accordion when we're running accordion style because we've got tracking maybe locations or attorneys or originatings or whatever the case is when you're running the accordion style. And if you're not housekeeping, to your point, sometimes people just don't know where to look.

Well, and you know what trap that, that people fall into with that one is attorney compensation versus officers' compensation. Right there is a great example of that, you know, taking money out of the firm for, you know, maybe paying for your family's health insurance that's not covered under the law firm plan, but you You pay for it out of the law firm. Well, what is that? Is that a payroll item or is that a distribution item? And a lot of people get mixed up on that because one ends up on the balance sheet usually under equity and the other one ends up as an expense on P&L, on the P&L, you know. All the payroll expenses, the expenses to actually run the payroll and all of that, you know, where do those go?

And those can get crazy too depending on what payroll company you have.

Correct.

Sometimes the payroll company puts some crazy things on your chart of accounts like, Where'd that come from? And the person's like, I didn't put that in there.

A penny.

Right? Yeah.

Pennies drop in all the time.

Oh no, I have a new one that's a whole bank account, a new asset. And we're like, what is that?

Sometimes QuickBooks Payroll creates a separate bank account on its own because it named differently or changed names, or you changed the name in the chart of accounts, and now it says, oh, it's gone, I'll make a new one. And it makes a mess. It makes a giant mess. So you have to be aware that those things can happen. And then also they made their own little account too. That clearing account to get rid of the crossover things.

Yeah.

Yeah. I've not seen that to go to zero. So I mean, those are kind of their own things. You can't— and I've discovered from doing the cleanup this weekend that if any account, if the person's using QuickBooks Payroll and any account is married to the payroll, you cannot edit it. You cannot change it. You cannot make it a subaccount. You can't make it a parent account. It is stuck.

On the payroll side.

Oh no, on the chart of accounts side too. You can't edit it. So I have one, just one account that has no number and I've numbered, I like to number the chart of accounts and this one payroll account, I cannot change it. I'd have to disengage it from the payroll, change it, reconnect it to the payroll settings.

So you can journal in and out of it?

You can journal, but you can't edit the chart of accounts to make it—

I'll be darned.

Okay. Like look right. And that's something that's kind of new because there's a lot of new features in the chart of accounts in QuickBooks. I'm speaking about QuickBooks. There's a lot of new things where you can lock the parent account. Love that. But there's some new things that when you look into what it can and cannot do, I did try a couple of things in there this weekend and I just ended up doing it manually the long way because that was the way it worked the best. So sometimes you have to do that. I think I was like, I'm not going to mess with this because it wouldn't, it wouldn't work. Like my little tricks weren't working. What it said it could do, didn't do it. I tried it, made it subaccounts out of something. It didn't work. And I'm like, okay, well, I'll just do it the old way of going into each one and making it subs to make it look better.

You know, I mean, it's funny too, Lynda, because we have like previous accounting professionals have done work in the file. And so you have to move stuff from one to the other. And there's certain tools we get to do certain things. But sometimes when we're getting a new file, we're trying not to change the historical data, not, not for any reason other than just retain it the way it was and then show like the journal entries We're moving it to this new thing, but a lot of times you, you can't close it out because it's restricted, um, in, in both ledgers. You know, that happens not just in those types of accounting ledgers, other types of accounting ledgers. So a lot of times you'll see ZZZ, or you, you have to put some sort of—

Get it down off those lists.

Get it down or out. But there, you know, sometimes there's bank connection issues that happen, and banks will— this 90% of the time, the issue that we often find is not because the user doesn't know what they're doing. You're moving fast, you're connecting the bank, and lo and behold, you somehow have made a new account. Now you've got a whole new problem and you've got to figure out how to unwind that again. I mean, these go back to like fundamentals of things that we do every day and know how to fix. We're not practicing law to understand how to do that, so There is a DIY moment, but if you're a growing firm, that's probably not the best use of your time. The question comes, what's the best use of your time? And at some point you can't straddle all things. And we, we as business owners have the same conversation internally. We know what this feels like. So yeah, it's a lot.

We have to hire out too. I mean, depending on the work, right? We have to hire As to finish it.

So that's a lot.

Goodness gracious.

My head hurts. Okay.

Well, it's the first thing we clean up when we get a cleanup job. That's the first place we get up to get it fixed because it's usually a little unruly and it's just to make it better for the client in the end of the day.

Well, and it's a great way to learn about how they're operating because you'll have the discussions with them. You know, I'm going to remove this account. I'm in emergencies or whatever. And you learn just by talking to them about these changes. What they do, for sure.

Oh wow.

Well, I hope that helped everybody.

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Well, that was a great episode, you guys. I hope to help people out there and have a great afternoon. Great rest of your day.

Thank you. Thank you.

Bye-bye.