Comment on Equity Accounts – It’s Your Money by Accountants Airdrie

Equity is the difference between assets and liabilities as shown on a balance sheet. In other words, equity represents the portion of assets that are fully owned by the owners (stockholders, partners, or proprietor) of a business.

When I prepare financial statements, I always review the general ledger (GL) account numbers that the client has coded on the check register. Whenever I see a balance sheet GL account number, I automatically double-check it. The reason I do this is that the balance sheet is the least understood part of the financial statements for most clients. This is especially true regarding the equity section. In a way, this is rather strange, since the equity section represents the owner’s share of the business. I would want to keep a very close eye on my investment and, to do that effectively, I would need to know the nature of each equity account and how to interpret the changes in those accounts as they occur.

If I am a sole proprietor, it’s not as crucial because everything in the equity section is mine. That’s not to diminish the importance of knowing what the accounts mean, as there are other good reasons to track the increases and decreases that occur within them. However, if I am a partner in a partnership or a stockholder in a corporation, it is my responsibility to protect my investment interest from mistakes and/or deliberate misstatements. This can be a challenge and accounting knowledge is required.

It is in this light that I thought a review of the equity accounts for a sole proprietor, partnership, and corporation could prove useful. In order to do this, you need to understand how debits and credits work. If you need a reminder, you can click on this link: http://www.reallifeaccounting.com/accounting_model.asp and print out a copy of the “Accounting Model” for a guide.

Sole Proprietor

The equity section title in a sole proprietorship is most commonly called “Owner’s Equity”. The accounts within this section are usually laid out in this fashion:

Owner’s Equity
Current Year Capital Contributions
Owner’s Draw
Net Profit or Loss

Look at the accounting model chart and find the equity section. An increase to the equity section requires a “credit” entry, while a decrease requires a “debit” entry. Following this “accounting logic”,
it makes sense that a contribution of personal money to the business requires a debit entry to Cash and a credit entry to Current Year Capital Contributions. On the other hand, if cash is removed from the business for personal reasons, a debit entry to Owner’s Draw and a credit entry to Cash would be required.

Furthermore, if the business showed a profit, that would indicate an increase in equity (credit), or if it showed a loss, that would indicate a decrease (debit) in equity.

Since the Owner’s Equity account (a credit balance account) is an “accumulation account”, all the other accounts are closed out at the end of the year into the Owner’s Equity account. This makes perfect sense when you follow the journal entries required to close out the accounts. For Instance:

Net Profit or Loss is automatically closed into Owner’s Equity at the end of the year by your computer. If a journal entry were written, it would look like this:

Or

As you can see the function of the sole proprietor equity accounts is not complicated or difficult to understand.

Partnership

Depending on how many partners there are, partnership equity accounts usually are organized as follows under the title, “Partner’s Equity”:

Partner A, Capital Account
Partner B, Capital Account
Partner C. Capital Account
Net Profit or Loss

All the increases or decreases occur within the partner’s capital accounts. In other words, the partner capital accounts are the equity accounts. If a partner makes a capital contribution, then his/her capital account is increased (credit). If the partner takes a distribution, then the capital account is decreased (debit). If the business has a profit or a loss at the end of the year, then that profit
or loss is distributed among the partners at whatever ownership interest or other arrangement is appropriate.

General partners who work in the business are paid a management fee called a “guaranteed payment”. This fee is a legitimate business expense and therefore acts to lower the net profit of the business. This fee is similar to a salary paid to a working stockholder in a corporation, except, according
to U.S. tax law, a fee paid to a working partner cannot be run through payroll. It is treated as a draw, subject to self-employment taxes. Both the general partner’s guaranteed payment and share of the profits are taxable and subject to self-employment taxes.

Sometimes a business may not have enough cash to make a distribution to the partners even though the business realized a profit. Partners may have a rude awakening to discover that they still have to pay taxes on those profits regardless of whether they received any money.

Another scenario to be aware of if you are a non-working general partner or a limited partner is this one: You and your partner contributed an equal amount of cash for working capital. The reason for investing your money is because you expect to share in the profits. Your partner is a working partner and is entitled to receive a management fee for services rendered. You need to keep an eye on the books because there may never be a profit to share in if your partner simply continues to increase his/her management fee. It can be a sticky situation because the working partner may feel he/she is never making enough money to justify all the work he/she has to do. It is best to define what the management fee is going to be in the partnership agreement beforehand.

Corporation (Primarily closely held corporations)

Closely held (private) corporation equity accounts are a little more complicated than a sole proprietorship or partnership. These are the typical accounts found in the corporation equity section under the title, “Stockholder’s Equity”:

Retained Earnings
Paid-in-Capital
Dividends Paid
Common and/or Preferred Stock
Net Profit or Loss

Retained Earnings is similar to the Owner’s Equity account in that the Net Profit or Loss is closed into that account at the end of each accounting year. Paid-in-Capital is the account used to record capital contributions made by stockholders. Keep in mind, as in the examples above, that increases to an equity account are credits. For example:

If dividends were paid the journal entry would look like this:

When common stock is sold or issued to raise money or acquire property:

When Net Profit is closed out for the year:

These accounts are also found on public corporations, however they may have additional equity accounts that are necessary to explain more complex activities.

You can see that the equity accounts in all three business entities function in a similar manner. From year to year, there should be continuity. This means there should be a logical explanation for any increases or decreases in theequity accounts. As an investor or owner, you have a right to know the reasons for any changes. If there has been a mistake, willful or otherwise, it is most likely going to show up in the equity section. Stay vigilant and protect your investment.

View the original article here

Comment on Equity Accounts – It’s Your Money by Atishay jain

Equity is the difference between assets and liabilities as shown on a balance sheet. In other words, equity represents the portion of assets that are fully owned by the owners (stockholders, partners, or proprietor) of a business.

When I prepare financial statements, I always review the general ledger (GL) account numbers that the client has coded on the check register. Whenever I see a balance sheet GL account number, I automatically double-check it. The reason I do this is that the balance sheet is the least understood part of the financial statements for most clients. This is especially true regarding the equity section. In a way, this is rather strange, since the equity section represents the owner’s share of the business. I would want to keep a very close eye on my investment and, to do that effectively, I would need to know the nature of each equity account and how to interpret the changes in those accounts as they occur.

If I am a sole proprietor, it’s not as crucial because everything in the equity section is mine. That’s not to diminish the importance of knowing what the accounts mean, as there are other good reasons to track the increases and decreases that occur within them. However, if I am a partner in a partnership or a stockholder in a corporation, it is my responsibility to protect my investment interest from mistakes and/or deliberate misstatements. This can be a challenge and accounting knowledge is required.

It is in this light that I thought a review of the equity accounts for a sole proprietor, partnership, and corporation could prove useful. In order to do this, you need to understand how debits and credits work. If you need a reminder, you can click on this link: http://www.reallifeaccounting.com/accounting_model.asp and print out a copy of the “Accounting Model” for a guide.

Sole Proprietor

The equity section title in a sole proprietorship is most commonly called “Owner’s Equity”. The accounts within this section are usually laid out in this fashion:

Owner’s Equity
Current Year Capital Contributions
Owner’s Draw
Net Profit or Loss

Look at the accounting model chart and find the equity section. An increase to the equity section requires a “credit” entry, while a decrease requires a “debit” entry. Following this “accounting logic”,
it makes sense that a contribution of personal money to the business requires a debit entry to Cash and a credit entry to Current Year Capital Contributions. On the other hand, if cash is removed from the business for personal reasons, a debit entry to Owner’s Draw and a credit entry to Cash would be required.

Furthermore, if the business showed a profit, that would indicate an increase in equity (credit), or if it showed a loss, that would indicate a decrease (debit) in equity.

Since the Owner’s Equity account (a credit balance account) is an “accumulation account”, all the other accounts are closed out at the end of the year into the Owner’s Equity account. This makes perfect sense when you follow the journal entries required to close out the accounts. For Instance:

Net Profit or Loss is automatically closed into Owner’s Equity at the end of the year by your computer. If a journal entry were written, it would look like this:

Or

As you can see the function of the sole proprietor equity accounts is not complicated or difficult to understand.

Partnership

Depending on how many partners there are, partnership equity accounts usually are organized as follows under the title, “Partner’s Equity”:

Partner A, Capital Account
Partner B, Capital Account
Partner C. Capital Account
Net Profit or Loss

All the increases or decreases occur within the partner’s capital accounts. In other words, the partner capital accounts are the equity accounts. If a partner makes a capital contribution, then his/her capital account is increased (credit). If the partner takes a distribution, then the capital account is decreased (debit). If the business has a profit or a loss at the end of the year, then that profit
or loss is distributed among the partners at whatever ownership interest or other arrangement is appropriate.

General partners who work in the business are paid a management fee called a “guaranteed payment”. This fee is a legitimate business expense and therefore acts to lower the net profit of the business. This fee is similar to a salary paid to a working stockholder in a corporation, except, according
to U.S. tax law, a fee paid to a working partner cannot be run through payroll. It is treated as a draw, subject to self-employment taxes. Both the general partner’s guaranteed payment and share of the profits are taxable and subject to self-employment taxes.

Sometimes a business may not have enough cash to make a distribution to the partners even though the business realized a profit. Partners may have a rude awakening to discover that they still have to pay taxes on those profits regardless of whether they received any money.

Another scenario to be aware of if you are a non-working general partner or a limited partner is this one: You and your partner contributed an equal amount of cash for working capital. The reason for investing your money is because you expect to share in the profits. Your partner is a working partner and is entitled to receive a management fee for services rendered. You need to keep an eye on the books because there may never be a profit to share in if your partner simply continues to increase his/her management fee. It can be a sticky situation because the working partner may feel he/she is never making enough money to justify all the work he/she has to do. It is best to define what the management fee is going to be in the partnership agreement beforehand.

Corporation (Primarily closely held corporations)

Closely held (private) corporation equity accounts are a little more complicated than a sole proprietorship or partnership. These are the typical accounts found in the corporation equity section under the title, “Stockholder’s Equity”:

Retained Earnings
Paid-in-Capital
Dividends Paid
Common and/or Preferred Stock
Net Profit or Loss

Retained Earnings is similar to the Owner’s Equity account in that the Net Profit or Loss is closed into that account at the end of each accounting year. Paid-in-Capital is the account used to record capital contributions made by stockholders. Keep in mind, as in the examples above, that increases to an equity account are credits. For example:

If dividends were paid the journal entry would look like this:

When common stock is sold or issued to raise money or acquire property:

When Net Profit is closed out for the year:

These accounts are also found on public corporations, however they may have additional equity accounts that are necessary to explain more complex activities.

You can see that the equity accounts in all three business entities function in a similar manner. From year to year, there should be continuity. This means there should be a logical explanation for any increases or decreases in theequity accounts. As an investor or owner, you have a right to know the reasons for any changes. If there has been a mistake, willful or otherwise, it is most likely going to show up in the equity section. Stay vigilant and protect your investment.

View the original article here

Comment on Replenishing Petty Cash by audrey palmer

How to properly replenish petty cash has been a surce of confusion for many small business owners. As a practicing accountant, I find clients making the same mistake constantly, and it come from not understanding the full concept of petty cash. The concept is not difficult to understand; you just need to make sure you understand it.

First, think about what you are doing. You take a certain amount of money out of the bank; let’s say $100, and put it into a cash box. Remember, that the general ledger account, Cash-in-Bank, is an asset. An asset, you may recall, if you have taken my Accounting for Non-Accountants course, is an unused economic resource that your business owns (has possession or controf of). All you have done, is shift $100 from Cash-in Bank to another asset account called Petty Cash. You deplete the cash in the box when you purchase such items as postage, office supplies, meals, gas for an auto, etc. When most of the cash is gone, you must replenish the fund. You do that by withdrawing more cash from the bank for the amount that has been depleted; let’s say $92.50. You should have $92.50 in receipts for expenses in the box. Those expenses are posted to their respective categories and the offset is, of course, Cash. Here is the journal entry:

DESCRIPTION DEBIT CREDITPostage 37.00Office 14.50Meals 36.50Auto 15.00 Cash 92.50

The mistake occurs when you try to do this:

DESCRIPTION DEBIT CREDITPetty Cash 92.50 Cash 92.50

If you went with this second journal entry, you would end up with $192.50 in the Petty Cash account, which is an asset on your balance sheet, and zero in the expense accounts for postage, office, meals, and auto. This doesn’t seem right, does it? If you audited the petty cash box you would not find $192.50 in cash, vouchers and receipts. You would only find $100.00. The Petty Cash amount remains the same as originally established, unless you purposefully decide to increase it. Otherwise, petty cash expenditures must be recorded to their appropriate expense categories.

Go to the articles section of the blog to read my article, “Why Petty Cash” to find out why using a petty cash fund is a good accounting practice.

View the original article here

Comment on Internal Control: A Preventive Mainentance Program by Orange County CPA gu

You read about this in every newspaper in every town in the entire country: Some bookkeeper, trusted by the owner of a small business, embezzles thousands of dollars. If the theft doesn’t put owner out of business, it certainly causes a major headache.

The reason we hear of these cases so often is that, in a small business, theremay only be the owner and a bookkeeper. The owner doesn’t like doing the books, doesn’t understand them, and relies on this one person to take care of things. The bookkeeper, who is usually having personal financial difficulties, takes a small amount of money intending to pay it back. No one seems to notice, so more is taken. Over a period of time, it starts to mount up to a lot of money.

This is where the concept of “internal control” comes in. Essentially, every business should have, at some level, an internal control system in place to protect against losses, both intentional and unintentional. This is because “internal control” systems will: 1) protect cash and other assets; 2) promote efficiency in processing transactions; and, 3) ensure reliability of financial records. An internal control system consists primarily of policies and procedures designed to provide reasonable assurance that these three objectives will be achieved. The size and complexity of the business will determine the extent of the internal control system.

Regardless of size, one of the most important aspects of an internal control system is the concept of separation of duties. Separating duties makes it more difficult for theft and errors to go undetected. It is highly unusual for two employees to “collude” in an effort to steal from the company.

I worked as an internal auditor for a newspaper chain for three years. My job was to walk in to the newspaper offices unannounced and go directly to the cash boxes, count them, and verify receipts. One of my most important audit steps was to make sure the internal control procedures were in place and working properly. Here are a few suggestions for internal control procedures regarding
handling of cash:

Allow only specific designated individuals to handle cash.Give responsibility for bookkeeping to an individual who does not handle cash.Use numbered receipts to document all payments.Make all bank deposits promptly.The person who prepares the bank reconciliation should be different than the one handling cash.If possible, the person who makes the bank deposit should be different than the one who handles
the cash and the one who prepares the bank reconciliation.Make deposits intact with no amounts withdrawn to pay expenses.Keep cash and checkbook in a locked drawer or cash register.Since tills will never be 100% correct all the time, establish a tolerance level for overages and shortages to determine the point at which corrective measures will be triggered.Make all disbursements by check, except minimal amounts paid from petty cash.Make certain every payment is related to a paper document, such as a voucher,
to ensure that a paper trail exists for all disbursements.Conduct random surprise counts of petty cash and cash drawers.Count inventory and other assets frequently and compare with company books.

An internal control system set up early as a preventative measure is more efficient than establishing a corrective system in reaction to a loss. If it so happens, that there is just you and the bookkeeper in your small business, you need to learn how to do some of the bookkeeping tasks so you can spot check the bookkeeper’s work. That, in itself, is an excellent preventative measure.

View the original article here

Comment on Journalizing Payroll by Natalia Payroll

If you are a business owner or manager, chances are you have had to deal with payroll and all of its complexities. If you haven’t dealt with payroll yet, you may have to in the future. There are many parts to payroll. First you have to learn how to calculate withholding taxes for employees and understand all the federal and state rules associated with those taxes. If you don’t stay on top of the rules, which can change from year to year, you risk miscalculating the taxes and/or missing reporting deadlines. The price for not conforming to the rules can be severe penalties.

Faced with these hurdles, many small businesses opt for a payroll tax service. This is usually a good idea, as these services tend to be inexpensive and can lift a heavy burden from the shoulders of an owner or manager. However, the information provided by the payroll service company has to be entered into the company’s books. There is a simple way to do this, but first, you must have an understanding of what you are trying to accomplish.

It is imperative to understand the difference between “employee withholding taxes” and “employer payroll taxes”. In the U. S., it works like this:

Federal:
FIT (Federal Income Tax)
FICA Tax (Social Security)
Medicare Tax
State:
SIT (State Income Tax)
SDI (State Disability Insurance)Federal:
FICA Tax
Medicare Tax
FUTA Tax (Federal Unemployment)
State:
SUTA Tax (State Unemployment)

The state I use in the example is California. The state, in which you live may have different withholdings, so be sure to find out what they are, if any. Either way, you will have to follow the same accounting procedures.

Many of the larger payroll service companies provide a ton of information in the form of payroll reports. Unfortunately, the payroll information you need for your general ledger is often not easily discernable. I have had a payroll service business in Santa Barbara for 20 years, and even I have a hard time deciphering the large payroll service companies’ reports.

The larger payroll companies insist that you pay your payroll taxes “the day” of payroll. Therefore, you must set up an agreement between your bank and the payroll company so that the payroll company can automatically withdraw funds from your account to their account. They pay the taxing agencies directly. Your taxes may not be due on that exact date, so the payroll company has use of your money until the time the taxes are paid. It has been reported that they make millions on the interest alone from the float. (Well, anyway they used to).

If you use a smaller, perhaps local, payroll service company, they may simply process your payroll data and then provide you with the information you need to write your own checks to employees and the federal and state taxing authorities.

The challenge for you is to record the gross wages and withholdings in the proper accounts, and to reconcile what you actually owe for each tax against what has been paid. It’s a bit of pain, but once you get the hang of it, it’s not too difficult. Here’s how I do it:

One of your reports should be a payroll history that lists each employee, his/ her gross wages, FIT, FICA, Medicare, SIT, SDI, and net wages. For instance:

There should be another report that clearly shows the employer payroll taxes.

This is the information you need to write your payroll journal entry. Here is an example of a journal entry for the employee side:

To record payroll for xx/xx/xx

Here is the example for employer payroll taxes:

To record employer payroll taxes: FICA, Med, FUTA, SUTA

Look at what you have accomplished with these journal entries. In the first journal entry (A), you recorded your gross wages to the appropriate expense account. You set up the liability for the employee taxes payable. You recorded a credit in the employee advance account, assuming an employee was given a $20.00 advance earlier. You recorded a credit to the Payroll Clearing account for the correct amount of net checks that were paid out. This amount should clear out all the individual checks posted to the Payroll Clearing account that were paid to employees via your cash disbursements system.

For those unfamiliar with a payroll clearing account, it is a general ledger account that is normally set up in the asset section of the balance sheet. The purpose it serves is to reconcile all the net payroll checks paid to employees during an accounting period with a general journal entry that summarizes the total of all the net payroll checks. If an error occurs, the difference will remain in the payroll clearing account. This difference can then be researched to find the cause of the error.

If you write your payroll checks directly out of your cash disbursements system, along with all your other checks, then I recommend using a payroll clearing account. If you use a separate bank account just for payroll, then you probably don’t need a payroll clearing account.

In the second journal entry (B), you recorded all the employer payroll taxes to the expense account and set up the liability for those payroll taxes. When the taxes are actually paid, the amounts will be recorded as a debit to Accrued Employer Payroll Taxes, and the employee FIT, FICA, Medicare, SIT, SDI tax liability accounts, which will zero out those accounts. For instance:

An advantage of using a smaller payroll service company or using your own payroll software program in your business is that you have the use of your money until the taxes become due. This can be critical if you happen to be suffering from a cash flow shortage. In addition, small payroll service companies tend to be more flexible when it comes to reversing mistakes, running a special payroll, researching tax inquiries, handling worker’s compensation audits, etc.

Whether you use an outside payroll service or buy your own payroll software, I would make sure that the reports you receive are simple to read and clearly display the critical information you need to record your payroll activity quickly and accurately. A payroll software program should post all the information automatically. However, you should be able to verify and prove that the information is correct, as mistakes do happen. This requires good reports and a solid understanding of how recording payroll works.

View the original article here

Comment on Internal Control: A Preventive Mainentance Program by geop

You read about this in every newspaper in every town in the entire country: Some bookkeeper, trusted by the owner of a small business, embezzles thousands of dollars. If the theft doesn’t put owner out of business, it certainly causes a major headache.

The reason we hear of these cases so often is that, in a small business, theremay only be the owner and a bookkeeper. The owner doesn’t like doing the books, doesn’t understand them, and relies on this one person to take care of things. The bookkeeper, who is usually having personal financial difficulties, takes a small amount of money intending to pay it back. No one seems to notice, so more is taken. Over a period of time, it starts to mount up to a lot of money.

This is where the concept of “internal control” comes in. Essentially, every business should have, at some level, an internal control system in place to protect against losses, both intentional and unintentional. This is because “internal control” systems will: 1) protect cash and other assets; 2) promote efficiency in processing transactions; and, 3) ensure reliability of financial records. An internal control system consists primarily of policies and procedures designed to provide reasonable assurance that these three objectives will be achieved. The size and complexity of the business will determine the extent of the internal control system.

Regardless of size, one of the most important aspects of an internal control system is the concept of separation of duties. Separating duties makes it more difficult for theft and errors to go undetected. It is highly unusual for two employees to “collude” in an effort to steal from the company.

I worked as an internal auditor for a newspaper chain for three years. My job was to walk in to the newspaper offices unannounced and go directly to the cash boxes, count them, and verify receipts. One of my most important audit steps was to make sure the internal control procedures were in place and working properly. Here are a few suggestions for internal control procedures regarding
handling of cash:

Allow only specific designated individuals to handle cash.Give responsibility for bookkeeping to an individual who does not handle cash.Use numbered receipts to document all payments.Make all bank deposits promptly.The person who prepares the bank reconciliation should be different than the one handling cash.If possible, the person who makes the bank deposit should be different than the one who handles
the cash and the one who prepares the bank reconciliation.Make deposits intact with no amounts withdrawn to pay expenses.Keep cash and checkbook in a locked drawer or cash register.Since tills will never be 100% correct all the time, establish a tolerance level for overages and shortages to determine the point at which corrective measures will be triggered.Make all disbursements by check, except minimal amounts paid from petty cash.Make certain every payment is related to a paper document, such as a voucher,
to ensure that a paper trail exists for all disbursements.Conduct random surprise counts of petty cash and cash drawers.Count inventory and other assets frequently and compare with company books.

An internal control system set up early as a preventative measure is more efficient than establishing a corrective system in reaction to a loss. If it so happens, that there is just you and the bookkeeper in your small business, you need to learn how to do some of the bookkeeping tasks so you can spot check the bookkeeper’s work. That, in itself, is an excellent preventative measure.

View the original article here

What is the IRS mileage rate for use of a car for business?

The standard rate allowed by the Internal Revenue Service for the business use of an automobile in the year 2011 is 51 cents per mile. (The rate for the year 2010 was 50 cents per mile.) In addition to the standard rate of 51 cents per mile, you are also allowed to claim an expense for parking fees and tolls associated with the business use of your car.

An alternative to the standard rate per mile is to compute the business portion of the actual expenses for gasoline, repairs, insurance, depreciation, licenses, etc.

You can learn more about income tax issues at www.irs.gov.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here

Comment on Internal Control: A Preventive Mainentance Program by localizer method

You read about this in every newspaper in every town in the entire country: Some bookkeeper, trusted by the owner of a small business, embezzles thousands of dollars. If the theft doesn’t put owner out of business, it certainly causes a major headache.

The reason we hear of these cases so often is that, in a small business, theremay only be the owner and a bookkeeper. The owner doesn’t like doing the books, doesn’t understand them, and relies on this one person to take care of things. The bookkeeper, who is usually having personal financial difficulties, takes a small amount of money intending to pay it back. No one seems to notice, so more is taken. Over a period of time, it starts to mount up to a lot of money.

This is where the concept of “internal control” comes in. Essentially, every business should have, at some level, an internal control system in place to protect against losses, both intentional and unintentional. This is because “internal control” systems will: 1) protect cash and other assets; 2) promote efficiency in processing transactions; and, 3) ensure reliability of financial records. An internal control system consists primarily of policies and procedures designed to provide reasonable assurance that these three objectives will be achieved. The size and complexity of the business will determine the extent of the internal control system.

Regardless of size, one of the most important aspects of an internal control system is the concept of separation of duties. Separating duties makes it more difficult for theft and errors to go undetected. It is highly unusual for two employees to “collude” in an effort to steal from the company.

I worked as an internal auditor for a newspaper chain for three years. My job was to walk in to the newspaper offices unannounced and go directly to the cash boxes, count them, and verify receipts. One of my most important audit steps was to make sure the internal control procedures were in place and working properly. Here are a few suggestions for internal control procedures regarding
handling of cash:

Allow only specific designated individuals to handle cash.Give responsibility for bookkeeping to an individual who does not handle cash.Use numbered receipts to document all payments.Make all bank deposits promptly.The person who prepares the bank reconciliation should be different than the one handling cash.If possible, the person who makes the bank deposit should be different than the one who handles
the cash and the one who prepares the bank reconciliation.Make deposits intact with no amounts withdrawn to pay expenses.Keep cash and checkbook in a locked drawer or cash register.Since tills will never be 100% correct all the time, establish a tolerance level for overages and shortages to determine the point at which corrective measures will be triggered.Make all disbursements by check, except minimal amounts paid from petty cash.Make certain every payment is related to a paper document, such as a voucher,
to ensure that a paper trail exists for all disbursements.Conduct random surprise counts of petty cash and cash drawers.Count inventory and other assets frequently and compare with company books.

An internal control system set up early as a preventative measure is more efficient than establishing a corrective system in reaction to a loss. If it so happens, that there is just you and the bookkeeper in your small business, you need to learn how to do some of the bookkeeping tasks so you can spot check the bookkeeper’s work. That, in itself, is an excellent preventative measure.

View the original article here

Most popular Q&A from 2010

Here are the 20 most popular posts from the Accounting Coach Blog during 2010. New questions will be answered starting January 2011.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here

Comment on T-Accounts: A Great Tool for Solving Accounting Transactions by AccountanQueenstown

A T-Account is a template or format shaped like a “T” that represents a particular general ledger account. Debit entries are recorded on the left side of the “T” and credit entries are recorded on the right side of the “T”. It is a tool for organizing journal entries and analyzing accounting transactions.

There are a few business owners or managers who have a fantastic ability to remember details, but I would venture to say that most of us find our memory diminishing over time. T-Accounts come in handy when a series of journal entries are required and it becomes too difficult to keep all of them in your head.

When solving accounting problems, you have to think of accounting transactions in terms of the “accounting model”. Click this link if you need to refresh your memory regarding the accounting model:

http://www.reallifeaccounting.com/accounting_model.asp

The “accounting model” is a template you can use to remember how debits and credits work. The two most common scenarios for using T-Accounts are: 1) determining why certain transactions were previously posted to the general ledger; or, 2) working out the most appropriate place to post certain accounting
transactions.

T-Accounts work because they are visually effective. This means they are simple to understand and usually it is possible to portray all the T-Accounts on one page. Let’s look at a basic accounting transaction and then translate it into T-Account form. Assume you sold an accessory to one of your rental inventory assets for $35 cash and deposited the money into the bank. You originally bought the accessory for $20 and put it into inventory until it was sold. The journal entries for the transaction would look like this:

The T-Accounts would look like this:

You can easily see that the debits equal the credits. Let’s look at a more complex accounting transaction. You bought a company van to delivery your rental inventory for $25,000 and you did this by putting $5,000 down and setting up a liability (Notes Payable) for $20,000. You made your first payment of $380, of which $80 was interest, and your first month’s depreciation was $833. To the unfamiliar, these transactions might appear confusing until T-Accounts are used.

A critical step is to make sure that the debits equal the credits. If not, you have made a mistake that must be solved. Next, simply put these T-Accounts in journal entry form:

View the original article here

Comment on Working with the Equity section of your Balance Sheet by John

As I say in my newly posted article, “Equity Accounts – It’s Your Money“, the equity section of the balance sheet is the least understood. I give examples of the general ledger accounts that are found in the equity section for a sole proprietor, partnership, and corporation along with an explanation of how the accounts function.

The key to understanding these accounts is having a working knowledge of how debits and credits are recorded depending on whether a transaction calls for an increase or a decrease. Use the Accounting Model link in the article if you need brusing up.

For example, if you are a sole proprietor and you take money out of your business for personal purposes then you would record an entry on the debit side of the general ledger account “Owner’s Draw”. Increases to Equity require a credit entry, while decreases to Equity require a debit entry.

In the example, if you wrote yourself a check you would be decreasing Cash, which is an asset. Since you wrote the check to yourself, it makes sense that you decreased your Equity. Here is the tricky part and why you need to “think out” what you are doing using the Accounting Model:

You decreased your Equity by making a debit entry to Owner’s Draw and you decreased cash in your bank account when you withdrew money for personal reasons and made a credit entry to CASH. Seems straightforward doesn’t it?

But you increased the Owner’s Draw account while at the same time decreasing your equity. Sometimes this concept is hard for people to grasp. You just have to remember that Owner’s Draw is a general ledger account found within the Equity Section.

It is useful to remember the fundamental accounting equation:

ASSETS = LIABILITIES + EQUITY

When Cash, an asset, was decreased then either Liabilities or Equity would also have to be decreased in order to stay in balance. In this case, the decrease was in Equity.

The rule is that in any transaction recorded the DEBIT SIDE MUST EQUAL THE CREDIT SIDE of the ledger.

Any questions?

View the original article here

Comment on T-Accounts: A Great Tool for Solving Accounting Transactions by Business Tax Account

A T-Account is a template or format shaped like a “T” that represents a particular general ledger account. Debit entries are recorded on the left side of the “T” and credit entries are recorded on the right side of the “T”. It is a tool for organizing journal entries and analyzing accounting transactions.

There are a few business owners or managers who have a fantastic ability to remember details, but I would venture to say that most of us find our memory diminishing over time. T-Accounts come in handy when a series of journal entries are required and it becomes too difficult to keep all of them in your head.

When solving accounting problems, you have to think of accounting transactions in terms of the “accounting model”. Click this link if you need to refresh your memory regarding the accounting model:

http://www.reallifeaccounting.com/accounting_model.asp

The “accounting model” is a template you can use to remember how debits and credits work. The two most common scenarios for using T-Accounts are: 1) determining why certain transactions were previously posted to the general ledger; or, 2) working out the most appropriate place to post certain accounting
transactions.

T-Accounts work because they are visually effective. This means they are simple to understand and usually it is possible to portray all the T-Accounts on one page. Let’s look at a basic accounting transaction and then translate it into T-Account form. Assume you sold an accessory to one of your rental inventory assets for $35 cash and deposited the money into the bank. You originally bought the accessory for $20 and put it into inventory until it was sold. The journal entries for the transaction would look like this:

The T-Accounts would look like this:

You can easily see that the debits equal the credits. Let’s look at a more complex accounting transaction. You bought a company van to delivery your rental inventory for $25,000 and you did this by putting $5,000 down and setting up a liability (Notes Payable) for $20,000. You made your first payment of $380, of which $80 was interest, and your first month’s depreciation was $833. To the unfamiliar, these transactions might appear confusing until T-Accounts are used.

A critical step is to make sure that the debits equal the credits. If not, you have made a mistake that must be solved. Next, simply put these T-Accounts in journal entry form:

View the original article here

Comment on Working with the Equity section of your Balance Sheet by liran

As I say in my newly posted article, “Equity Accounts – It’s Your Money“, the equity section of the balance sheet is the least understood. I give examples of the general ledger accounts that are found in the equity section for a sole proprietor, partnership, and corporation along with an explanation of how the accounts function.

The key to understanding these accounts is having a working knowledge of how debits and credits are recorded depending on whether a transaction calls for an increase or a decrease. Use the Accounting Model link in the article if you need brusing up.

For example, if you are a sole proprietor and you take money out of your business for personal purposes then you would record an entry on the debit side of the general ledger account “Owner’s Draw”. Increases to Equity require a credit entry, while decreases to Equity require a debit entry.

In the example, if you wrote yourself a check you would be decreasing Cash, which is an asset. Since you wrote the check to yourself, it makes sense that you decreased your Equity. Here is the tricky part and why you need to “think out” what you are doing using the Accounting Model:

You decreased your Equity by making a debit entry to Owner’s Draw and you decreased cash in your bank account when you withdrew money for personal reasons and made a credit entry to CASH. Seems straightforward doesn’t it?

But you increased the Owner’s Draw account while at the same time decreasing your equity. Sometimes this concept is hard for people to grasp. You just have to remember that Owner’s Draw is a general ledger account found within the Equity Section.

It is useful to remember the fundamental accounting equation:

ASSETS = LIABILITIES + EQUITY

When Cash, an asset, was decreased then either Liabilities or Equity would also have to be decreased in order to stay in balance. In this case, the decrease was in Equity.

The rule is that in any transaction recorded the DEBIT SIDE MUST EQUAL THE CREDIT SIDE of the ledger.

Any questions?

View the original article here

Comment on Detail of the General Ledger Report by Gerald

How in the world could anyone working in accounting get along without a Detail of the General Ledger report? That would be like working with your hands tied and your eyes blindfolded. Without this report you would have a very difficult time determining how a final balance in a particular account was derived. Here is why:

Picture this: Back in the not-to-distant past (before computers really caught on) we accountants recorded each transaction of the business manually into a great big hard-bound, three-leaf binder book with yellow pre-printed ledger pages. Obviously, this was a very time-consuming, tedious process. Each page not only recorded the numbers associated with the transaction, it also recorded where the numbers came from, the date, and, when appropriate, a very brief note to the side describing additional detail. Here is an example of a general ledger account page:

Account 1010 – Cash-in-Bank

Transactions may come from a variety of journals, but they all pyramid into the General Ledger. I use the word “pyramid” because it is helpful to visualize the shape of a pyramid with all the source documents spread out at the base. The information is being summarized from each document and “migrates” upward to the General Ledger and eventually to the financial statements, which are at the top of the pyramid:

Fin State
Trial Balance
General Ledger
Gen Jour, Cash Rec, Cash Disb, Acct Rec, Acct Pay
Sales Invoices, Purchase Invoices, Bank Rec, Check Register

If I wanted to find out how a particular balance came to be, all I had to do was look at the detail on the general ledger page. That detail would then tell me which source documents contained the numbers that contributed to the final balance. I did not have search all over kingdom come to find what I was looking for.

Nowadays, your computer accounting software should give you a report of the detail in your General Ledger that is laid out as cleanly and clearly as presented above. Just like you would find in a manual general ledger. The report should not be encumbered with all kinds of other information that makes it hard to decipher. Some software programs don’t call this report a Detail of the General Ledger, they call it a transaction report or something similar.

Furthermore, you should be able to print a report for any period your heart desires, for instance: a year-to-date report; from February to July; for just one month; or whatever. You need that flexibility. If you need to see all twelve months of activity for a particular account, then you need to see all twelve months. You should not have to print out each month separately and then manually piece them together. And, if you only need to look at one month, you don’t want to have to print out the entire year.

A good report will enable you to use it as an analytic tool to find mistakes. Let’s assume that after printing your financial statements you looked at the Cash-in-Bank account and it said the balance was $3,556.38. Being the good accountant that you are, you verified that balance with the bank reconciliation balance and found that it said the balance should be $3,583.38. The difference between the two totals is $27.00. Your first step should be to run a Detail of the General Ledger report for the month, which you do and it is our example above. The first thing you notice is a $27.00 credit entry. This is suspicious and worth investigating. You can see that this entry came from the General Journal so you turn to page 4. Let’s hypothesize and assume that you really meant for this credit entry to go to Employee Advance, which is 1110. You simply wrote the wrong GL Account number.

We used to call this procedure “smoking out the error”. Sometimes the errors are easy to find, sometimes not so easy. The process consists of verifying the final balances that are on the financial statements. What is in the General Ledger should be what is on the financial statements. Therefore, you must use another document as a means of verifying the account balance. In our example above, we used the Bank Reconciliation. Other documents used to verify balances could be the Accounts Payable Ledger, Accounts Receivable Ledger, Sales Tax Report, Payroll History Report, Inventory Control Report, Notes Payable Amortization Schedule, and so on.

Just like a carpenter who uses a level before nailing up a board, you will want to verify your balances with these other control reports before accepting the financial statements as being correct. If the board isn’t level, the carpenter must figure out why. If an account balance is different than the balance found on the control document, then use your analytical tool called the Detail of the General Ledger Report to discover why.

View the original article here

What is a condensed income statement?

A condensed income statement is one that summarizes much of the income statement detail into a few captions and amounts.

For example, a retailer’s condensed income statement will summarize hundreds of categories of sales into one amount with the description Net Sales. Its detailed purchases and changes in inventory will be presented as one amount with the description Cost of Goods Sold. Perhaps thousands of operating expenses will be presented as one amount with the description Selling, General and Administrative, or SG&A.

The readers of a condensed income statement will be able to easily and quickly focus on the company’s net income and its key components.

Learn more about the Income Statement.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here

Comment on Equity Accounts – It’s Your Money by John

Equity is the difference between assets and liabilities as shown on a balance sheet. In other words, equity represents the portion of assets that are fully owned by the owners (stockholders, partners, or proprietor) of a business.

When I prepare financial statements, I always review the general ledger (GL) account numbers that the client has coded on the check register. Whenever I see a balance sheet GL account number, I automatically double-check it. The reason I do this is that the balance sheet is the least understood part of the financial statements for most clients. This is especially true regarding the equity section. In a way, this is rather strange, since the equity section represents the owner’s share of the business. I would want to keep a very close eye on my investment and, to do that effectively, I would need to know the nature of each equity account and how to interpret the changes in those accounts as they occur.

If I am a sole proprietor, it’s not as crucial because everything in the equity section is mine. That’s not to diminish the importance of knowing what the accounts mean, as there are other good reasons to track the increases and decreases that occur within them. However, if I am a partner in a partnership or a stockholder in a corporation, it is my responsibility to protect my investment interest from mistakes and/or deliberate misstatements. This can be a challenge and accounting knowledge is required.

It is in this light that I thought a review of the equity accounts for a sole proprietor, partnership, and corporation could prove useful. In order to do this, you need to understand how debits and credits work. If you need a reminder, you can click on this link: http://www.reallifeaccounting.com/accounting_model.asp and print out a copy of the “Accounting Model” for a guide.

Sole Proprietor

The equity section title in a sole proprietorship is most commonly called “Owner’s Equity”. The accounts within this section are usually laid out in this fashion:

Owner’s Equity
Current Year Capital Contributions
Owner’s Draw
Net Profit or Loss

Look at the accounting model chart and find the equity section. An increase to the equity section requires a “credit” entry, while a decrease requires a “debit” entry. Following this “accounting logic”,
it makes sense that a contribution of personal money to the business requires a debit entry to Cash and a credit entry to Current Year Capital Contributions. On the other hand, if cash is removed from the business for personal reasons, a debit entry to Owner’s Draw and a credit entry to Cash would be required.

Furthermore, if the business showed a profit, that would indicate an increase in equity (credit), or if it showed a loss, that would indicate a decrease (debit) in equity.

Since the Owner’s Equity account (a credit balance account) is an “accumulation account”, all the other accounts are closed out at the end of the year into the Owner’s Equity account. This makes perfect sense when you follow the journal entries required to close out the accounts. For Instance:

Net Profit or Loss is automatically closed into Owner’s Equity at the end of the year by your computer. If a journal entry were written, it would look like this:

Or

As you can see the function of the sole proprietor equity accounts is not complicated or difficult to understand.

Partnership

Depending on how many partners there are, partnership equity accounts usually are organized as follows under the title, “Partner’s Equity”:

Partner A, Capital Account
Partner B, Capital Account
Partner C. Capital Account
Net Profit or Loss

All the increases or decreases occur within the partner’s capital accounts. In other words, the partner capital accounts are the equity accounts. If a partner makes a capital contribution, then his/her capital account is increased (credit). If the partner takes a distribution, then the capital account is decreased (debit). If the business has a profit or a loss at the end of the year, then that profit
or loss is distributed among the partners at whatever ownership interest or other arrangement is appropriate.

General partners who work in the business are paid a management fee called a “guaranteed payment”. This fee is a legitimate business expense and therefore acts to lower the net profit of the business. This fee is similar to a salary paid to a working stockholder in a corporation, except, according
to U.S. tax law, a fee paid to a working partner cannot be run through payroll. It is treated as a draw, subject to self-employment taxes. Both the general partner’s guaranteed payment and share of the profits are taxable and subject to self-employment taxes.

Sometimes a business may not have enough cash to make a distribution to the partners even though the business realized a profit. Partners may have a rude awakening to discover that they still have to pay taxes on those profits regardless of whether they received any money.

Another scenario to be aware of if you are a non-working general partner or a limited partner is this one: You and your partner contributed an equal amount of cash for working capital. The reason for investing your money is because you expect to share in the profits. Your partner is a working partner and is entitled to receive a management fee for services rendered. You need to keep an eye on the books because there may never be a profit to share in if your partner simply continues to increase his/her management fee. It can be a sticky situation because the working partner may feel he/she is never making enough money to justify all the work he/she has to do. It is best to define what the management fee is going to be in the partnership agreement beforehand.

Corporation (Primarily closely held corporations)

Closely held (private) corporation equity accounts are a little more complicated than a sole proprietorship or partnership. These are the typical accounts found in the corporation equity section under the title, “Stockholder’s Equity”:

Retained Earnings
Paid-in-Capital
Dividends Paid
Common and/or Preferred Stock
Net Profit or Loss

Retained Earnings is similar to the Owner’s Equity account in that the Net Profit or Loss is closed into that account at the end of each accounting year. Paid-in-Capital is the account used to record capital contributions made by stockholders. Keep in mind, as in the examples above, that increases to an equity account are credits. For example:

If dividends were paid the journal entry would look like this:

When common stock is sold or issued to raise money or acquire property:

When Net Profit is closed out for the year:

These accounts are also found on public corporations, however they may have additional equity accounts that are necessary to explain more complex activities.

You can see that the equity accounts in all three business entities function in a similar manner. From year to year, there should be continuity. This means there should be a logical explanation for any increases or decreases in theequity accounts. As an investor or owner, you have a right to know the reasons for any changes. If there has been a mistake, willful or otherwise, it is most likely going to show up in the equity section. Stay vigilant and protect your investment.

View the original article here

What is the difference between residual value, salvage value, and scrap value?

Residual value, salvage value and scrap value are three terms that refer to the expected value at the end of the useful life of the property, plant and equipment used in a business. This estimated amount is used in the calculation of an asset’s depreciation expense, and often the amount is assumed to be zero.

The term residual value can also refer to the estimated value of a leased asset at the end of the lease term.

Learn more about Depreciation.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here

What is the difference between an accrual and a deferral?

An accrual occurs before a payment or receipt. A deferral occurs after a payment or receipt. There are accruals for expenses and for revenues. There are deferrals for expenses and for revenues.

An accrual of an expense refers to the reporting of an expense and the related liability in the period in which they occur, and that period is prior to the period in which the payment is made. An example of an accrual for an expense is the electricity that is used in December, but the payment will not be made until January.

An accrual of revenues refers to the reporting of revenues and the related receivables in the period in which they are earned, and that period is prior to the period of the cash receipt. An example of the accrual of revenues is the interest earned in December on an investment in a government bond, but the interest will not be received until January.

A deferral of an expense refers to a payment that was made in one period, but will be reported as an expense in a later period. An example is the payment in December for the six-month insurance premium that will be reported as an expense in the months of January through June.

A deferral of revenues refers to receipts in one accounting period, but they will be earned in future accounting periods. For example, the insurance company has a cash receipt in December for a six-month insurance premium. However, the insurance company will report this as part of its revenues in January through June.

Learn more about accruals and deferrals at Adjusting Entries.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here

What is the Social Security tax rate for 2011?

The Social Security tax withheld from employees during 2011 will be 6.2% of the first $106,800 of each employee’s taxable earnings. The employee’s earnings in excess of $106,800 are not subject to the Social Security tax. In addition to the Social Security tax, the entire amount of each employee’s taxable earnings is subject to the Medicare tax of 1.45%. These rates and the Social Security wage base limit are unchanged from the years 2010 and 2009.

Both the Social Security tax and the Medicare taxes must be matched by the employer. This means that the employer must remit to the federal government 12.4% of each employee’s first $106,800 of taxable earnings plus 2.9% of each employee’s earnings regardless of the amount.

Self-employed individuals are responsible for paying both the employee and the employer portions of the Social Security tax and the Medicare tax.

Learn more about Payroll Accounting.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here

What is a cash discount?

A cash discount is a deduction allowed by the seller of goods or by the provider of services in order to motivate the customer to pay within a specified time. The seller or provider often refers to the cash discount as a sales discount. The buyer often refers to the same discount as a purchase discount.

Not all sellers offer cash discounts, but a common cash discount is 1/10, net 30 and it will appear on the sales invoice. If the invoice is $1,000 and the buyer returns $100 the net amount due to the seller is $900 if paid within 30 days. However, the buyer can deduct $9 (1% of $900) if the buyer pays the seller $891 within 10 days of the invoice date. The seller often records the $9 cash discount as Sales Discounts. The buyer will record the $9 savings as Purchase Discounts or as a reduction to the cost recorded in inventory.

Occasionally some service providers allow a cash discount if their fee is paid at the time of the service. For example, my dentist allows a cash discount of 5% to patients without insurance if they pay on the day of the service. This cash discount saves the time and cost of billing, mailing statements, receiving partial payments, and can result in the dentist having more cash and less receivables.

Learn more about Accounts Receivable and Bad Debts Expense.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here

What is a rolling budget?

A rolling budget is also known as a continuous budget, a perpetual budget, or a rolling horizon budget. We will use the following example to explain the meaning of a rolling budget.

Let’s assume that a company’s accounting year ends on each December 31. Prior to the start of the year 2011, the company prepares its annual budget which is detailed by month for January through December 2011. This budget could become a rolling budget if after January 2011 the company drops the budget for January 2011 and adds the budget for January 2012. This rolling budget now covers the one year, or 12-month, period of February 1, 2011 through January 31, 2012. At the end of February 2011, the rolling budget will drop February 2011 and will add February 2012. At this point the rolling budget will cover the one year period of March 1, 2011 through February 29, 2012.

The benefit of a rolling budget is that the company’s management will always have a budget that looks forward for one full year.

A rolling budget could use 3-month periods or quarters instead of months. Also, a company might have a 5-year rolling budget for capital expenditures. In this case a full year will be added to replace the year that has just ended. This 5-year rolling budget means that management will always have a 5-year planning horizon.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here

Is the drawing account a capital account?

Yes, an owner’s drawing account is a capital account. However, the drawing account is expected to have a debit balance, whereas the owner’s main capital account is expected to have a credit balance.

The drawing account will have a debit balance for two reasons. First the draw or withdrawal by the owner reduces the capital account. Second, because each transaction involves a debit and a credit, and because a withdrawal of cash requires a credit to the Cash account, the owner’s drawing account will need a debit for the same amount.

At the end of the accounting year, the debit balance in the drawing account is closed by transferring the debit balance to the owner’s capital account.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here

Why do bonds rarely sell for their maturity value?

The reasons why bonds rarely sell for their maturity value are:

1. The interest paid is usually fixed at the interest rate that is stated on the face of the bond. As a result, the amount of interest paid each year does not change during the life of the bond.

2. The market interest rate—the rate that bond buyers demand—is changing daily.

To illustrate, let’s assume that a 6% bond will mature in ten years and has a maturity value of $100,000. This means that the bondholders will be receiving $6,000 in interest in each of the ten years. If there is a day when the bond buyers demand an interest rate of 6.2% then the bond’s value on that day will be less than $100,000. If on another day the bond buyers demand 5.9% interest, the bond’s value on that day will be greater than $100,000.

Learn more about Bonds Payable.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here

How does the aging of accounts receivable determine bad debts expense?

The aging of accounts receivable allows you to quickly identify the credit customers that are past due and the length of time that the amounts have been past due. Focusing on the past due accounts receivable will assist you in estimating how much of the accounts receivable will never be collected.

The estimated amount of accounts receivable that will never be collected should be the credit balance in the general ledger account Allowance for Doubtful Accounts. This credit balance when combined with the debit balance in Accounts Receivable will mean that the amount that is likely to be collected will be reported on the balance sheet.

When the Allowance for Doubtful Accounts is credited to increase its balance, the entry will debit the general ledger account Bad Debts Expense.

Learn more about Accounts Receivable and Bad Debts Expense.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here

Comment on Working with the Equity section of your Balance Sheet by naveen14

As I say in my newly posted article, “Equity Accounts – It’s Your Money“, the equity section of the balance sheet is the least understood. I give examples of the general ledger accounts that are found in the equity section for a sole proprietor, partnership, and corporation along with an explanation of how the accounts function.

The key to understanding these accounts is having a working knowledge of how debits and credits are recorded depending on whether a transaction calls for an increase or a decrease. Use the Accounting Model link in the article if you need brusing up.

For example, if you are a sole proprietor and you take money out of your business for personal purposes then you would record an entry on the debit side of the general ledger account “Owner’s Draw”. Increases to Equity require a credit entry, while decreases to Equity require a debit entry.

In the example, if you wrote yourself a check you would be decreasing Cash, which is an asset. Since you wrote the check to yourself, it makes sense that you decreased your Equity. Here is the tricky part and why you need to “think out” what you are doing using the Accounting Model:

You decreased your Equity by making a debit entry to Owner’s Draw and you decreased cash in your bank account when you withdrew money for personal reasons and made a credit entry to CASH. Seems straightforward doesn’t it?

But you increased the Owner’s Draw account while at the same time decreasing your equity. Sometimes this concept is hard for people to grasp. You just have to remember that Owner’s Draw is a general ledger account found within the Equity Section.

It is useful to remember the fundamental accounting equation:

ASSETS = LIABILITIES + EQUITY

When Cash, an asset, was decreased then either Liabilities or Equity would also have to be decreased in order to stay in balance. In this case, the decrease was in Equity.

The rule is that in any transaction recorded the DEBIT SIDE MUST EQUAL THE CREDIT SIDE of the ledger.

Any questions?

View the original article here

Comment on Detail of the General Ledger Report by John

How in the world could anyone working in accounting get along without a Detail of the General Ledger report? That would be like working with your hands tied and your eyes blindfolded. Without this report you would have a very difficult time determining how a final balance in a particular account was derived. Here is why:

Picture this: Back in the not-to-distant past (before computers really caught on) we accountants recorded each transaction of the business manually into a great big hard-bound, three-leaf binder book with yellow pre-printed ledger pages. Obviously, this was a very time-consuming, tedious process. Each page not only recorded the numbers associated with the transaction, it also recorded where the numbers came from, the date, and, when appropriate, a very brief note to the side describing additional detail. Here is an example of a general ledger account page:

Account 1010 – Cash-in-Bank

Transactions may come from a variety of journals, but they all pyramid into the General Ledger. I use the word “pyramid” because it is helpful to visualize the shape of a pyramid with all the source documents spread out at the base. The information is being summarized from each document and “migrates” upward to the General Ledger and eventually to the financial statements, which are at the top of the pyramid:

Fin State
Trial Balance
General Ledger
Gen Jour, Cash Rec, Cash Disb, Acct Rec, Acct Pay
Sales Invoices, Purchase Invoices, Bank Rec, Check Register

If I wanted to find out how a particular balance came to be, all I had to do was look at the detail on the general ledger page. That detail would then tell me which source documents contained the numbers that contributed to the final balance. I did not have search all over kingdom come to find what I was looking for.

Nowadays, your computer accounting software should give you a report of the detail in your General Ledger that is laid out as cleanly and clearly as presented above. Just like you would find in a manual general ledger. The report should not be encumbered with all kinds of other information that makes it hard to decipher. Some software programs don’t call this report a Detail of the General Ledger, they call it a transaction report or something similar.

Furthermore, you should be able to print a report for any period your heart desires, for instance: a year-to-date report; from February to July; for just one month; or whatever. You need that flexibility. If you need to see all twelve months of activity for a particular account, then you need to see all twelve months. You should not have to print out each month separately and then manually piece them together. And, if you only need to look at one month, you don’t want to have to print out the entire year.

A good report will enable you to use it as an analytic tool to find mistakes. Let’s assume that after printing your financial statements you looked at the Cash-in-Bank account and it said the balance was $3,556.38. Being the good accountant that you are, you verified that balance with the bank reconciliation balance and found that it said the balance should be $3,583.38. The difference between the two totals is $27.00. Your first step should be to run a Detail of the General Ledger report for the month, which you do and it is our example above. The first thing you notice is a $27.00 credit entry. This is suspicious and worth investigating. You can see that this entry came from the General Journal so you turn to page 4. Let’s hypothesize and assume that you really meant for this credit entry to go to Employee Advance, which is 1110. You simply wrote the wrong GL Account number.

We used to call this procedure “smoking out the error”. Sometimes the errors are easy to find, sometimes not so easy. The process consists of verifying the final balances that are on the financial statements. What is in the General Ledger should be what is on the financial statements. Therefore, you must use another document as a means of verifying the account balance. In our example above, we used the Bank Reconciliation. Other documents used to verify balances could be the Accounts Payable Ledger, Accounts Receivable Ledger, Sales Tax Report, Payroll History Report, Inventory Control Report, Notes Payable Amortization Schedule, and so on.

Just like a carpenter who uses a level before nailing up a board, you will want to verify your balances with these other control reports before accepting the financial statements as being correct. If the board isn’t level, the carpenter must figure out why. If an account balance is different than the balance found on the control document, then use your analytical tool called the Detail of the General Ledger Report to discover why.

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Can a cost be both a direct cost and an indirect cost?

A cost can be both a direct cost and an indirect cost. One of many examples is the cost of a supervisor in a department within a factory.

Let’s assume that Sam earns $50,000 per year as the supervisor of the machining department of a factory. Sam’s $50,000 is a direct cost of the machining department because Sam works only in the machining department. Hence, this $50,000 is directly traceable to the machining department.

Sam’s $50,000 is also an indirect product cost. It is an indirect cost because the supervisor of the machining department is part of the factory overhead costs that must be assigned to the products. (Instead of being assigned we could say that manufacturing overhead must be allocated or applied to products by using an overhead rate.) We might also say that Sam’s $50,000 is part of the factory overhead costs that must be absorbed by the products by means of a factory overhead rate.

Learn more about Manufacturing Overhead.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

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Where can I get official information for federal payroll taxes?

For official information on federal payroll taxes we recommend the Internal Revenue Service Publication 15 which is known by two names: Circular E and Employer’s Tax Guide. This free publication is available at the website IRS.gov.

The Employer’s Tax Guide is updated each year by the IRS and contains approximately 70 pages of information on payroll. The information includes required withholdings, employer’s payroll taxes, required reporting, federal income tax withholding tables, and more.

Learn more about Payroll Accounting.

About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the author of the 2010 Master Accounting Download Package which has been praised for it's ability to simplify accounting in a way that anybody can understand.

View the original article here