Coding Systems

1 Introduction

This chapter looks at how coding systems can be devised and used in accounting systems.

2 The use of codes in categorising and processing transactions

It is universal practice in accounting systems to use coding systems to refer to customers, suppliers, accounts and employees. Codes are used because they are concise and precise, and can be subject to computer checking

Concise:   instead of referring to a product as a “50cm, high resolution LED monitor”, the product is given a code such as 50HRL. This is much quicker to write or type.

Precise:   there might be several makes of 50cm high resolution LED monitors and information might be confusing and ambiguous if the manufacturer (Sony, Panasonic, Samsung, LG etc) wasn’t specified. A code number can therefore be used to ensure that products and people are referred to uniquely eg 50HRLLG.

Checking:   if all inventory codes are 7 digits long then forms and input screens can be designed for this. Computers can check that all 7 digits are present; sometimes more sophisticated checks can be carried out on the structure of the code. This reduces the chance of errors.

Processing:   Codes can also help in processing transactions. For example if all income-related accounts have the structure 1xxxx, all expense-related accounts have the structure 2xxxx, all asset-related accounts 3xxxx and all liability accounts 4xxxx, then this will help the production of the income statement (all 1xxxx amounts less all 2xxxx amounts) and the statement of financial position (3xxxx as asset amounts and 4xxxx amounts as liabilities). This is particularly needed in computerised accounting systems because the computer cannot understand that, say, rent is an expense, but doesn’t need this understanding so long as rent is coded, say 21892. Because it starts with ‘2’ it will be treated as an expense.

3 Different methods of coding

There are several methods of coding. Codes should be:

• Simple to use
  

• Understandable
  

• Concise
  

• Precise
  

• Expandable
  

As we will see, these requirements can be in conflict.

Sequential codes

In this method products or customers are simply allocated numbers in sequence:

0001     Abrahams

0002     Adkins

0003     Ahmad

.

.

.

It is simple and concise, but as constructed might have some faults:

1. There is no relationship at all between the code and the item/person being encoded .

2. Expansion might be difficult once you have over 9999 customers if documents and computer files can hold only four digits. Additionally, if someone called Affleck becomes a customer, he will have to be tagged onto the end of the sequence ie not reflecting alphabetical order. To avoid this problem, often sequence codes proceed as 0010, 0020, 0030…etc so that gaps are built in for future use.

Hierarchical (or significant digit) codes

Here, as you progress through the code, information becomes increasingly specific. Many libraries use this system to code their books using the Dewey Decimal System

500 Natural sciences mathematics

.

.

510 Mathematics
520 Astronomy & allied sciences
530 Physics
540 Chemistry & allied sciences
550 Earth sciences
560 Paleontology, paleozoology
570 Life sciences
580 Botanical sciences
590 Zoological sciences

.

.

555 Earth sciences of Asia

In a business, hierarchical codes could be used to code the accounts in the general ledger. For example a code such as 3112 could be interpreted as the Machinery Cost Account, using the following system.

The great advantage of this type of code is that its structure provides information both to human users and to computers. For example, it would be easy to program the computer to work out the total cost of all non-current assets: simply add up all accounts starting 311.

Block codes

These lie somewhere between simple sequence codes and the full, detailed hierarchical code. They start off giving some information but then lose enthusiasm. So for general ledger codes you might have

1xxx = expenses

2xxx = income

3xxx = assets

4xxx = liabilities

Faceted codes

These are an improvement of block codes and provide more information but lack a logical hierarchical structure. The code is broken down into sections or groups of digits and each group codes for a particular attribute.

For example an employee code could be:

Facet 1 Sex of employee:       1 = male; 2 = female

Facet 2 Department:       01 = accounts; 02 = sales; 03 = IT etc

Facet 3 Full or part time       1 = full time; 2 = part time

Facet 4 Weekly or monthly paid:     01 = weekly; 02 = monthly

Mnemonic

All the codes illustrated so far have been purely numerical. Mnemonic codes contain letters to help humans to learn what the codes mean. The hierarchical code above:

could then become

It is not common to have full mnemonic codes and often just the first character will be mnemonic and the rest will follow another system.

4 Identifying and correcting errors in coding of revenue and expenses

Identifying errors in sequence codes is almost impossible because there is no logical connection between the code and the object or person that can be used to spot an error. The only type of error that can really be identified is if the format of the code is wrong. For example, 4 or 6 digits are used when only 5 are expected.

Once the coding system has more structure then identifying errors is much easier.

Two kinds of check are possible:

• Does the code exist and have the right format? A five-digit system cannot have a four-digit code, and 5xxx does not exist in a system whose first digit runs 1–4.

• Does the code describe the item? This is the check a structured code makes possible. If the first digit says 'expense' and the item is a machine, the code is wrong however well formed it is.

A miscoding does not break the trial balance — the debit and the credit are still equal — so it will not be found by casting. It has to be found by looking at what the account contains.