Sunday, July 17, 2011

Coding Systems for Accountants



Introduction

Before we look at the theory of coding systems, let’s have a look at a few familiar examples, although they are not necessarily exclusively used by accountants.
telephone
numbers
eg +7 3272 64 19 60 will reach an office in Almaty, Kazakhstan AND NOWHERE ELSE since the system of telephone numbers ensures that it is uniquely allocated to that office. Simply dial the number, 641960 if you are already in Almaty; or 00 7 3272 641960 if you are calling the number from virtually anywhere else in the world and you will connect to that office in Almaty.
UK Post code system In 1996, the United Kingdom Post Code system was being used with
1.7 million post codes; and
24.5 million addresses
The UK system is based on a system of a maximum of seven characters + house or building number. Therefore, if you are sending a letter to me at 1 Williamson Street, Todmorden, Yorkshire; all you need to write on the envelope or parcel is
1 OL14 5BU: that is house number 1, post code OL14 5BU
The mail will get through with only this small amount of information.
International Standard Book Numbers (ISBN)
Look at almost any regularly published book and somewhere in or on it you will find a number that looks something like 0-13-205923-1: this is an ISBN. This book number is a unique identifier that will tell publishers, booksellers and anyone who is interested that the book that this relates to is
Author:Duncan Williamson
Title:Cost and Management Accounting
Publisher:Prentice-Hall (Europe)
Year:1996

Definition of a code

A code is
A system of symbols designed to be applied to a classified set of items to give a brief accurate reference, facilitating entry, collation and analysis.
CIMA Terminology

Motivations for coding: why do we use codes?

The motivations for coding an organisation's financial transactions include:
  • efficiency of data capture, entry and analysis: a code such as a telephone number is usually much easier to remember and/or input and store than, for example, Duncan Williamson, 1 Williamson Street, Todmorden, Yorkshire, United Kingdom:, this could become, simply 01706 81 2893
  • frequency of use and familiarity: if we are going to be capturing and storing data on a frequent basis, then coding makes sense because it helps to standardise our procedures; we learn codes quickly, too
  • consistency and understanding of use within the organisation: every time you telephone me at 1 Williamson Street, you will use the same telephone number, every time you write to me, you use the same house number and post code … within organisations, the coding system is structured so that it fits the strategy of what it is we are trying to achieve by being consistently used and easily understood
  • saving on computer processing time and storage: just think of having to store my full address and that of, say, 24.5 million other addresses on all computers within a large organisation. We don’t recommend that: store the full details on one central server that can be addressed by all workstations on demand and then use a coding system to write and read to and from the server.
  • similar items can be related by means of a coding system, whereas a verbal description could be very inefficient: just compare the combination of two codes with the combination of their full text versions
CodesFull text
Tel: 01706 81 2893Duncan Williamson
Postcode: OL14 5BU1 Williamson Street
 Todmorden
 Yorkshire
 United Kingdom
That’s why we use coding systems. Let’s have a look now at what systems are available to us as accountants.

Coding systems and their structure

We will discuss five different coding systems:
(a) sequential or serial coding
(b) block coding
(c) hierarchical coding
(d) mnemonic coding
(e) faceted coding

(a) Sequential or Serial Code

The word sequential means in sequence, of course. A sequential code, therefore, simply follows a sequence. Imagine we are drafting a register for employees for salary purposes. We begin with the first employee being assigned the number 00, the second employee is assigned the number 01 and so on. In this code, we have allowed for there to be as many as 100 employees, since we have allocated 2 digits to the code and can assign all of the numbers from 00 to 99, 100 numbers, to that number of employees:
00 Bloggs 01 Smith 02 Jones 03 Brown … 34 Smythe … 67 Williams …
If a new employee were to join this group? He would become employee 68.

(b) Block Code

Block codes are very common in accounting circles in that they commonly form the basis of charts of accounts, as depicted below:
1000 - Fixed assets
2000 - Quick assets
3000 - Stocks
4000 - Long term liabilities
5000 - Current liabilities
6000 - Equity
7000 - Revenues
8000 - Expenditures
The 1000 “Block” is allocated to Fixed Assets and only fixed assets. This means that it is possible to classify up to 1,000 different fixed assets using this block. Of course, there may be sub blocks so that we can extend the range of fixed assets we can have.

(c) Hierarchical Code

The coding systems used by libraries, such as the Dewey Decimal system and the Library of Congress system, are both examples of hierarchical codes. The major advantage of such systems is that they are, in theory at least, infinitely expandable: they can be extended for ever; but in a logical, structured, way.
If we assume that code 657 is the library classification number for accounting, then we can develop the code hierarchically:
657 Accounting
 657.01 Financial accounting
  657.02 Financial management
   657.03 Management accounting
    657.03.001 Management accounting, standard costing
     657.03.001.01 Management accounting, standard costing, setting standards
      657.03.001.02 Management accounting, standard costing, variance analysis
and so on ...
The drawback of infinite expandability is that it would need an infinitely large storage device to store an infinitely large code! A bit flippant, perhaps, but it is true that the more the code is expanded, the more unwieldy and difficult it becomes to write to read to understand and to store.

(d) Mnemonic Code

Mnemonic means something that aids the memory and examples of mnemonic codes are found almost everywhere. A good example of a mnemonic code is the three character code used to designated international airports:
London Heathrow isLHR
Hong Kong isHKG
Almaty isALA
Johannesburg isJHB
Toronto is???

The major advantage of mnemonic codes is that they are very easy to memorise: once we have understood the pattern or system, learning them really should be easy. Devise your own mnemonic coding structure and you’ll see how easy it really is.

(e) Faceted Code

A faceted code is one that is broken down into a number of facets or fields, each of which signifies a unit of information. We could use a chart of accounts, that is commonly faceted; but let’s work through the faceted code of a furniture manufacturer. We’ll consider a code that will deal with direct materials, direct labour, and indirect costs.
In this example, there are three facets, or fields, to the code:
Facet 1 is the department or cost centre, and is 2 digits long
Facet 2 is the cost heading, and is 2 digits long
Facet 3 is the cost item, and is 4 digits long
Facet 1:00 Preparation
 01 Carpentry
 02 Assembly
 03 Finishing
 04 Upholstery
Facet 2:00 Direct materials
 01 Direct labour
 02 Direct expenses
 03 Indirect costs
Facet 3:0000 - 0100 Direct material descriptions
 0101 - 0150 Direct labour grades
 0151 - 0500 Factory overhead cost items

Facets 1 and 2 should need little further explanation; but let’s expand Facet 3.
Facet 3:0000 Oak batten 2 cm x 4 cm
 0003 Oak plank 20 cm x 4 cm
  
 0020 Seat covering, plain
 0025 Seat covering, striped
  
 0040 Foam padding
  
 0050 Chair brackets, metal, steel
 0055 Chair brackets, metal, brass
  
 0101 Preparation department labour grade 1
 0102 Preparation department labour grade 2
  
 0111 Carpentry department labour grade 1
 0112 Carpentry department labour grade 2
  
 0151 Factory rent
 0152 Factory rates
  
 0160 Insurance: machinery
 0161 Insurance: buildings
 0162 Insurance: public liability

Let's use this code shown now to determine the code for grade 2 labour costs incurred by the carpentry department. The code is:
     01 01 0112;
and the code for buildings insurance for the upholstery department is:
     04 03 0161
So much effort for such a simple outcome. Faceted codes might look daunting to start with; but they usually don’t take a lot of getting used to.

Other aspects of coding systems and structures

Mixing codes

It is possible to mix coding structures. A good example of a mixed code is BA602 which could represent a British Airways flight from London Heathrow to The Bahamas: a mnemonic alphanumeric code.
Mixed codes can sometimes offer the flexibility that, for example, a straightforward or simple system does not.
Find other examples of mixed codes for yourself: are there similarities between mixed codes: are they always mixtures of numbers and letters (that is, alpha numeric) or are they always numerical? Are mixed codes usually longer or shorter than other code types?
Features of a good code
Good codes display the following characteristics
  • Uniform
  • Exhaustive
  • Expandable
  • Unique

Uniform

Uniformity means presenting the code in the same way every time it is used. For example, a telephone number might be written as
01706.812893; or
0 17081.289.3; or
017.0681.2893; or
01706.81.28.93
and so on: there are more possibilities.
Note I have added the decimal points simply to demonstrate the different field structure that could be used. It follows from the uniformity principle that everyone must present the codes in the same way to avoid confusion. Of course, pre printed input/data capture forms help with consistency as do pre programmed fields on computer screens.

Extraneous symbols

Keep the code to codes and nothing but codes. In the Uniformity example, I added decimal points for demonstration purposes. However, it is not unusual for organisations to allow for extraneous, additional and unnecessary, symbols to become part of the coding structure: symbols such as . , / * > < and so on. By definition, extraneous symbols are not necessary and shouldn’t be used: in fact, they add to the complexity of the code but they add no value. We can consider a few examples by way of demonstration:
01 01 0151 is better than 01/01/0151 and 01.01.0151 and even 01:01:0151

Exhaustive

The code system and structure we use must be able to cope with everything we can throw at it. It must be able to take into account every possible item of income, expense, asset, liability, wood, metal, fabric … whatever it is we are coding.

Expansion

Despite the fact that a code should be exhaustive, it should be capable of simple expansion. This is the same as building a factory on a very small site that is bounded by other buildings or site development restrictions. If it is not possible to add on blocks or facets or fields as the business expands, then a new code will have to be devised or painful decisions might have to be taken that mean a massive overhaul of the coding structure. Take a look at telephone numbers in the UK: they are about to be changed for the second time in five years, in part, because of a partial lack of expandability.

Changes in the code structure

Don’t change the structure if at all possible. If changes have to be made, make sure they are infrequent otherwise resentment builds in, trust breaks down and, more importantly, perhaps, mistakes are made.

Unique allocation

On top of everything else, and this takes us right back to the beginning of this paper, each code must uniquely identify only one person, one company or one characteristic. Like fingerprints, codes must relate only to one thing. If the telephone number +7 3272 61 19 60 can relate both to an office in Almaty AND a home in Edinburgh, how do we decide who should answer the phone?

Conclusion

Coding systems are widely used by organisations; and with a little bit of effort they are simple to devise, use and update. Nevertheless, as an organisation expands, the more that forethought has been applied to the coding system the more that organisation will reap the rewards stemming from that forethought. A poorly drawn up coding system will hamper expansion rather than help it.
However, if an organisation grows in such a way that it becomes inevitable that a revision to the coding system has to be made, make that change; but make it quickly, effectively and as painlessly as possible. The changes that British Telecommunications are about to undertake are unpopular but we must assume that they will prove to be the benefit of business and individuals alike. That is, when cost is compared to benefit, benefit comes out on top.

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