Most new QuickBooks users are at least partly overwhelmed by the number of the choices they face for how to set up QuickBooks. Everyone wants to "do it right the first time", and for some there's a lot of hand-wringing involved--worry that they will set up QuickBooks in a way they'll regret later. 

My advice: Relax! QuickBooks is very flexible, so almost any way you've set up the program's Chart of Accounts and other lists can be changed later. In fact, restructuring QuickBooks' lists (adding, merging, and deleting list items) could even be called easy. That's important because almost every QuickBooks user will feel the need to make changes later, after using the program for long enough to fully grasp its possibilities--regardless of how hard they tried to get everything set up "just right" in the beginning.

Still, it helps to have a general understanding of QuickBooks lists as you're getting started, to prevent wasting the time and effort involved in making extensive changes later. This is especially true for the Chart of Accounts and Classes lists. New QuickBooks users often confuse the purpose of these two lists, and mistakenly include sub accounts in their Chart of Accounts that would be best handled by setting up Classes.

This article describes the purpose and recommended uses of these two important QuickBooks lists, to help you have a clear understanding of the best ways to use them for getting food financial and management information from your QuickBooks accounting records.

Contents

In QuickBooks, an "account" normally refers to an item in the Chart of Accounts list--an asset, liability, equity, income, or expense account. 

By convention and necessity, the purpose of accounts is mostly to categorize transaction records in a way that makes it easy to get financial and tax information from them. In fact, most financial reports are just summaries of account balances or account activity. For example, a Profit and Loss Report like the simple one at right simply displays income and expense account totals for a specific period of time; one month in this case.

OK, so what is this "Chart of Accounts" thing? The term "chart of accounts" has no deep, mystical significance. It's just the traditional term for the list of all financial accounts for a business.

Account:  Not the Same as "Customer Account"!

"Customer account" refers to the collection of charge and payment transactions (Invoices and Receive Payment entries) for one of a business' customers. Unfortunately, the phrase "customer account" is often shortened to "account" in conversations about customer accounts, so sometimes you have to ask to be sure which was meant. In QuickBooks jargon though, "account" normally refers to an entry in the Chart of Accounts list.

About customer accounts in QuickBooks:  QuickBooks doesn't maintain a separate Chart of Accounts entry for each customer account. Rather, it keeps all customer account records within a single account of the Chart of Accounts--by default, the one named Accounts Receivable. To show details for any customer account (charges, payments, and the customer's current balance) QuickBooks simply searches in Accounts Receivable for the transactions of that specific customer.

The classes feature of QuickBooks is more difficult to describe than to use. Every transaction must have an account assigned to it, but optionally you may also assign a class if you want. So think of the Classes list as like having a second chart of accounts which you can apply to transactions to group them into categories different from those provided by the Chart of Accounts.

Accounts mostly organize transactions into financial categories--income, expenses, payables, receivables, etc.--but classes let you organize transactions into any categories you want. You have full control over what those categories are. The Classes list is empty when you first create a QuickBooks company file, so you can set up any classes you want in it. Most often you'll used classes for grouping transactions into management information categories as opposed to the financial accounting categories provided by the Chart of Accounts. 

You can even use classes for "ad hoc" kinds of things. Suppose a storm has damaged some buildings and you need to keep track of all the repair bills, so that later when repairs are completed you can submit a total bill to your insurance agent. If you set up a Storm Damage class and apply it to each of the repair transactions you enter in QuickBooks, later you'll be able to get a report for the Storm Damage class that (1) shows the dollar total for storm damage repairs, and (2) lists each of the bills you paid for storm-related repairs.

But again, classes are most often used for getting management information from your accounting records. Why? Because classes can represent specific areas or subunits of your business rather than just financial and tax categories. So they let you get separate reports about the profitability of those subunits of your business. Here are some examples of how classes may be used for management information:

• A farmer may use classes to represent the different crops and types of livestock he raises, so he can determine which areas of his business are making a profit.
   
• An apartment manager might set up a class for each apartment building, and maybe even subclasses representing the apartments in each building. By tagging rent revenue and maintenance expense transactions with the appropriate classes, she'll have better information about which buildings or apartments are "problem areas".  Knowing that a particular building has had high repair costs over a period of time may help with decisions about whether to continue operating the building or to sell it.
   
• A manufacturer of running shoes might set up different classes for each step in the manufacturing process, to better understand labor and materials costs for each step.  Or he might set up a class for each model of shoe produced, to know what each shoe model costs to produce.
   
• A trucking/transportation company could set up a different class to represent each truck in his fleet, allowing him to keep track of revenue, down time, repair costs, and fuel expenses for each each truck.  

All of this relates to a branch of accounting known as managerial accounting, which is all about keeping and analyzing records in a way that provides useful management information. Using classes doesn't constitute a full managerial accounting system, but it can go a long way toward improving the information you have about your business without a lot of effort. 

Can't find your Classes list? Click on Lists in QuickBooks' main menu, and if you don't see a Class list item in the submenu, then the classes feature isn't enabled. To turn it on: Click on Edit > Preferences in the main menu, to open the Preferences window. Click on the Accounting icon in the left pane of the Preferences window. Select the Company Preferences tab in the right pane. Check mark the Use class tracking item on the Company Preferences tab. Click OK to close the Preferences window.  After completing these steps, a Class column will appear in many of QuickBooks' form windows. In some cases such as for invoices, you may have to customize the form's template to have the Class column appear.

Classes for Management Information:  An Example

Here's an example of how classes might be used for better management information in a trucking company. Even if you are not interested in the trucking business, please read on. This is a simple example that should give you basic ideas about how to use classes in any kind of business.

Suppose you have several trucks or maybe a fleet of trucks, and you'd like to know how costs for repairs, fuel, and so on compare among the trucks in your fleet. The basics of gathering repair expenses involves assigning a Repairs account when you enter transactions in QuickBooks:

This is fine for tax records, but of course it won't associate this repair expense with a specific truck. For that, you need to set up a class for each truck and apply those classes to your QuickBooks transaction entries for repairs, fuel, etc. Here is a simple Classes list for a "fleet" of three trucks:

And here is the same QuickBooks transaction as above, but with a truck class assigned to the repair expense, to associate it with a specific truck:

 

"Why should I use classes here? Couldn't I just set up a subaccount below Repairs for each truck? That would let me keep track of individual truck repair costs without bothering to use classes." Sure, let's suppose you do that. If you have 20 trucks you'll need 20 subaccounts of the Repairs account. Simple and easy.  But tomorrow you decide "Hey, I'd like to keep track of fuel expenses for each truck, too." What then? You'll have to create 20 sub accounts of the Fuel expense account. And if you later want to track Lubricants expense for each truck, you'll need 20 more Lubricants sub accounts... You can see where this is going. Eventually your Chart of Accounts would grow to be large, messy, and difficult to use. There'd be other problems too. Getting a report showing the total Repair, Fuel, and Lubricants expense for one particular truck would be tedious: you'd have to filter the report to include the correct subaccounts of each of several main accounts. And what if buy another truck? You'll need to locate every account where trucks are identified as subaccounts, and add a new subaccount for the new truck in all of those places. In the long run, using classes to identify individual trucks is by far the simpler approach. You'll find additional discussion on this concept below, see:  The Golden Rule of Account and Class Setup.

If you've assigned truck classes to all the appropriate expense transactions, then at the end of the year or whenever you like, you can get a Profit & Loss by Class report in QuickBooks, showing expenses separately for each truck:

Useful? ...Well Almost

Being the sharp manager you are, you already see a problem with the report shown above. Just knowing the total repair expenses for each truck isn't very useful information, because some trucks may have run 175,000 miles last year while others only ran 100,000 miles. 

What you need to know is repair cost per mile--that would give you something really useful for deciding which trucks to keep or to trade, how many miles to run trucks before rising repair costs suggest swapping them out for newer models, and so on. Unfortunately, QuickBooks' Class reports only provide dollar amounts. They cannot associate production or use information with each class, such as the number of miles driven by each truck, and get a report that shows expenses on a cost-per-mile basis.

But is there a way I can get a report like that? Yes, but you'll need a third-party reporting tool specifically designed for to reveal cost-per-unit types of information, such as our ManagePLUS for QuickBooks product.

ManagePLUS imports a copy of QuickBooks lists like the Chart of Accounts and Classes list, lets you associate "extra" information with list items--like associating mileage driven with each truck class. Using this extra information it can generate reports that show revenue and expenses on a per-unit basis (in this case, per mile) and other related statistics and information. 

Here's a screen shot of the Classes tab in ManagePLUS, where units of production or use can be entered to associate them with individual classes:

And here are a couple of Profit and Loss with Classes Report examples, showing cost-per-unit detail for individual classes. The first relates to our discussion of trucking costs. The second is a report for a farm business (demonstrating that this reporting approach applies to any business where classes are used).

Click on either thumbnail image below to see it full size. Then if the pop-up image is too small, click on it to zoom in.
Profit & Loss with Classes report - Trucking Example This one is based on the discussion above, and shows truck revenue, fuel, and repair expenses on a per-mile basis for a small set of example transactions. (Created with ManagePLUS for QuickBooks)
Profit & Loss with Classes report - Farm Example This image shows the income section (only) of a profit & loss report for a farm business. It shows average per-unit prices received (price per bushel of grain, per pound of livestock, etc.), average crop gross income per acre and crop yield per acre, average weights of livestock sold, etc. (Created with ManagePLUS for QuickBooks)

This kind of reporting capability greatly enhances the management value of information provided by classes:

• A farmer can see his fertilizer, seed, fuel, chemicals and repair expenses on a per-acre basis, or per bushel produced, or per dollar of crop revenue, etc.
   
• An apartment manager cab see apartment unit maintenance expenses on a per-tenant-month or per-rental-dollar basis.
    
• A manufacturer of running shoes can determine his direct labor and materials costs per shoe, for each shoe model he produces.
    
• A trucking/transportation company can get reports of various truck operating costs per mile driven, or per driver hour, or per dollar of freight revenue, etc. 

Allocating Overhead (Moving Toward Cost Accounting)

The kind of per-unit analysis of revenue and expenses described above is something any business can accomplish with little additional accounting effort beyond that needed for entering transactions--whether you use QuickBooks alone, or an add-on like ManagePLUS. But this simple approach is only helpful for getting information only about direct costs--costs that can be associated directly with a specific department or activity, like repairs to a specific truck, fertilizer applied to a specific crop, maintenance on a specific apartment unit, or materials costs for a specific model of running shoe. 

And while this approach is simple and easy, it doesn't describe the full costs of producing something. For that, you need to include indirect or overhead costs--things like office expenses, deprecation on machinery, utilities expenses, and so on. The usual approach to handling these kinds of expenses is to allocate them to your various classes on some kind of reasonable basis.

For instance, you might divide total office expenses by the number of trucks in the fleet and allocate the resulting amount to each truck as its fair share of office expense overhead. If you're a rental property manager, you would allocate things like lawn mowing, maintenance wages, and maintenance supplies expenses to each apartment complex you oversee, or even to individual apartments (doing the latter would help you get an idea of total expenses per apartment unit, as a comparison against the rental rate you're charging). In fact, all indirect/overhead types of expenses should normally be allocated among the profit-generating parts or departments of the business.

How do you allocate overhead in QuickBooks?

1. Accumulate costs by class in the normal way, assigning classes when you enter expense transactions in QuickBooks. But set up some additional classes for overhead cost areas of the business, and assign those to transactions wherever appropriate. These might be classes like Office and Administrative or Maintenance Shop. 
    
2. At the end of the period (month, quarter, year, etc.), run a Profit and Loss by Class report to get totals for the overhead classes. You need to know the amounts available for allocating to other classes.
    
3. Add a new account to use in making allocation Journal entries (in step 4 below). Call it Overhead Allocation, or anything else that will remind you its purpose is to represent allocated expenses. Assign the Other Expense account type, so reports won't list this account along with other (direct) Expense account type's lines. Rather, this account will appear separately on reports, below the subtotaled expenses.
    
   Note: On the Profit and Loss reports of any individual class, this account will show the balance allocated to that class; however, the balance of this account will always be zero, because it will only be used for transferring amounts between classes. (The next step illustrates this.)
    
4. Make Journal entries to allocate the overhead classes' amounts to your profit center classes on some reasonable basis. Each Journal entry should include (1) a line debiting the Overhead Allocation account for the total amount to be allocated, with the overhead class identified in the Class column, and (2) multiple lines--one for each profit center class--crediting Overhead Allocation for the amount that class is to be allocated.
    
   Note that the net effect of each Journal entry will be to leave the Overhead Allocation account's balance at zero, because it is debited and credited by the same amount. 

   A profit center is an area or department of your business that you operate for the purpose of generating a profit.  A main goal of cost accounting is to evaluate whether each of those areas is profitable. To do that, you prepare a profit and loss reports for each profit center after (1) accumulating its direct incomes and expenses by applying classes when you enter transactions, and (2) allocating each profit center an appropriate share of overhead costs.

The tough part of making allocations this way is that last step. You have to understand debits and credits, and the total for the credit lines must equal the amount of the debit line. But that's not even close to being the tedious part:  what's worse is that you'll have to figure out what dollar amount to allocate to each profit center. 

Suppose you accumulated $4355 for the Office & Administrative class for the month, and you will allocate it among five profit centers. If you want to allocating 15% to one profit center, 20% to each of two others, 18% to a fourth, and the remainder (37%) to a fifth profit center...well, it's time to grab your calculator and get to work! If you have four overhead classes and five profit centers you have twenty calculations to do...and a lot of opportunities for error, both in the calculations and in entering all those numbers in your Journal entries.

In the real world, anyone who does much allocation typically uses a spreadsheet program for the calculations. But the calculated dollar amounts still have to be manually entered in your Journal entries. So there remain plenty of places for errors to creep in, which means you'll be spending a lot of time getting everything checked over and entered correctly. 

Is there a more automated way? Yes! You can use a QuickBooks add-on to handle all the allocations. Our ManagePLUS Gold for QuickBooks product is one of those. It gathers the amounts assigned to each of your classes by QuickBooks transactions, then lets you allocate among classes by drag-and-drop with the mouse--no journal entries nor a calculator or spreadsheet are needed.

 

If you allocate based on percentages, ManagePLUS Gold stores them so you can re-use them again next period if you want. It also gives you the option of allocating costs based on management quantities like hours of labor or units of production associated with the target profit centers. For example, if each truck operated by a trucking company is viewed as a profit center--i.e., there's a profit center class for each truck--you can associate the number of miles driven with each truck class. ManagePLUS Gold could then automatically split Office & Administrative expense among all of the truck classes based on mileage driven during the period.

Want to know more? A good place to start is with learning about basic cost accounting concepts, like profit centers and cost centers.

• See: Classes as Enterprise Profit Centers and Cost Centers

Getting Off to a Good Start...

The Classes list in QuickBooks can have up to five levels (classes and subclasses), and class reports summarize information at each of those levels. To have class information arranged in reports in a way that provides the most benefit, it helps to give some thought to how the list should be structured.

• See: Setting Up Classes that Meet Your Information Goals

One last point about classes: Originally Intuit designed the classes feature to work just with income and expense transactions. Using and getting reports on classes used in income and expense transactions is simple and straightforward--there are no pitfalls involved and no surprises. However, recent QuickBooks releases--of QuickBooks Premier and higher editions--also let you apply classes to balance sheet-related (asset, liability, or equity account) transactions, and get a Balance Sheet by Class report. This feature can provide useful information, but there are a lot of potential "gotcha's" involved. So be sure you understand the accounting requirements and limitations before you begin attaching classes to balance sheet-related transactions.
 

In the discussion of using accounts versus classes for truck repair costs, above, we asked:  "Why should I use classes? Couldn't I just set up a Repairs sub account for each truck? That would let me keep track of individual truck repair costs without bothering to use classes." And we answered these questions by describing the problems of using subaccounts for tracking information that might be better tracked with classes. 

Here's a bit more elaboration on the same concept...

"Accounts or classes...which should I use?" Here are excerpts from The QuickBooks Farm Accounting Cookbook™ (a book I authored), telling how to answer this question. (In these excerpts, management subunits of the farm business are referred to as "farm enterprises". While that is a common term used in farm/ranch accounting discussions, a more common term in general business parlance would be "departments".) * * * Resist the temptation to set up subaccounts for farm enterprises. In almost all cases you should identify enterprises using classes, not accounts. This keeps your chart of accounts simple and brief. It also makes reports less complicated and easier to prepare, especially when you want a report for a specific enterprise. The basic idea is summed up as... The Golden Rule of Account and Class Setup: Use accounts to identify the "what" of a transaction and classes to identify the "why" or "what for". Here's an example of this Golden Rule: if you buy fertilizer to apply to corn, the "what" is fertilizer; the "what for" is corn.  So fertilizer [expense] should be an account and corn should be a class. Creating lots of enterprise-specific subaccounts is a common mistake among new QuickBooks users.  To illustrate the problem, consider this fragment from a simple chart of accounts: Fertilizer Chemicals Storage & Warehousing Now here's part of the same chart of accounts, but with subaccounts added to represent Corn and Soybean enterprises: Fertilizer       Corn Fertilizer       Soybean Fertilizer Chemicals       Corn Chemicals       Soybean Chemicals Storage & Warehousing       Corn Storage Fees       Soybean Storage Fees The account list quickly grows large and unwieldy when enterprise-specific subaccounts are added. It's also redundant and time-consuming to set up, because Corn-and Soybean-specific subaccounts must be added in many places. But consider how things would be different if the Class list contain the following two classes. Corn Soybeans If these were used in transactions instead of the enterprise-specific subaccounts, the first (simple) chart of accounts would do.  The result would be just as much information but with much less clutter and confusion. The excerpt above is Copyright (c) 1999. Flagship Technologies, Inc. All rights reserved.

Though we've focused on accounts and classes as ways to categorize transaction data, really any QuickBooks list can be used for categorizing transaction data in some way. The Customer:Job list lets you categorize transactions by customer and by the jobs or projects you've performed for them. The Items list lets you get reports of sales or purchases by Item. And the same is true for most other QuickBooks lists.

QuickBooks provides lots of report types based on these lists, designed to meet common information needs. But QuickBooks cannot provide every conceivable report combination or arrangement, and QuickBooks reports don't offer much in the way of analyzing transaction data. You may often recognize that QuickBooks has the data you need but has no report available to get it out in the format you want or need. That's when the best solution is usually to turn to a third-party reporting tool, like ManagePLUS or one of the many general-purpose QuickBooks reporting tools.

Where can you ask questions about third-party reporting software for QuickBooks? Two good ones are the user forums at forums.QuickBooksUsers.com and Intuit's forums at community.Intuit.com. You can also search in the Intuit Marketplace site, marketplace.intuit.com.