BALANCE SHEET

The fundamental accounting equation is the backbone of the accounting and reporting system. It is central to understanding a key financial statement known as the balance sheet (sometimes called the statement of financial position). The following illustration for Edelweiss Corporation shows a variety of assets that are reported at a total of $895,000. Creditors are owed $175,000, leaving $720,000 of stockholders' equity. The stockholders' equity section is divided into the $120,000 originally invested in Edelweiss Corporation by stockholders (i.e., capital stock), and the other $600,000 that was earned (and retained) by successful business performance over the life of the company.

Does the stockholders' equity total mean the business is worth $720,000? No! Why not? Because many assets are not reported at current value. For example, although the land cost $125,000, the balance sheet does not report its current worth. Similarly, the business may have unrecorded resources to its credit, such as a trade secret or a brand name that allows it to earn extraordinary profits. If one is looking to buy stock in Edelweiss Corporation, they would surely give consideration to these important non-financial statement based valuation considerations. This observation tells us that accounting statements are important in investment and credit decisions, but they are not the sole source of information for making investment and credit decisions.

HOW TRANSACTIONS IMPACT THE ACCOUNTING EQUATION
THE IMPACT OF TRANSACTIONS: The preceding balance sheet for Edelweiss was static. This means that it represented the financial condition at the noted date. But, each passing transaction or event brings about a change in the overall financial condition. Business activity will impact various asset, liability, and/or equity accounts; but, they will not disturb the equality of the accounting equation. So, how does this happen? To reveal the answer to this question, let's look at four specific transactions for Edelweiss Corporation. You will see how each transaction impacts the individual asset, liability, and equity accounts, without upsetting the basic equality of the overall balance sheet.

EDELWEISS COLLECTS AN ACCOUNT RECEIVABLE: If Edelweiss Corporation collected $10,000 from a customer on an existing account receivable (i.e., not a new sale, just the collection of an amount that is due from some previous transaction), then the balance sheet would be revised as follows:

Variance Analysis Practice Question

This is the First and very basic question on Variance Analysis

Try this. Answer to this has been published Now.

Types of Accounts

Category Types of Accounts Category Types of Accounts Category Types of Accounts
Assets Cash
Accounts Receivable

Supplies

Equipment

Automobiles

Land

Buildings

Prepaid Insurance

Prepaid Rent

Liabilities Accounts Payable
Notes Payable

Long Term Notes Payable

Rent Payable

Salaries Payable

Owner’s Equity Owner’s Capital
Fees Earned (Revenue)

Unearned Fees

Owner’s Withdrawals

Rent Expense

Telephone Expense

Utilities Expense

Insurance Expense

Salaries Expense

NOW, in order to proceed successfully with accounting, you need to do the following: 1. forget about the banking system; and 2. remember that accounting is a "building block" type of course.

Let me explain these two points. Most of us have bank accounts and are familiar with the system of withdrawing and depositing money. When we withdraw money from our accounts, the bank debits our accounts. In fact, most of us now own and frequently use ‘Debit cards’, cards which directly debit our accounts upon making a transaction. On the other hand, when we add money to our accounts (unfortunately, with less regularity than we withdraw), the bank credits our accounts to show the increase.

Now, back to the accounting system. Accountants have developed a system for crediting and debiting that is quite different from that of their banking cousins. Credits and debits are used not only to indicate increases, but also to indicate decreases to certain groups of related accounts.

Let me demonstrate.

Asset accounts (such as Cash, Accounts Receivable) are increased with a DEBIT and decreased with a CREDIT! The exact opposite to what happens with our bank accounts.

Ex. If we were to increase the Cash account of our business by $1000.00, we would record it as follows:

Cash T-Account

Debit side - increases Credit side - decreases
$1000.00
Liability accounts (i.e. Accounts Payable), on the other hand, handle debits and credits differently. When a Liability account is decreased by a specified amount, the account is Debited. Alternatively, the account is Credited when the balance is increased.

Ex.

Accounts Payable T-Account

Debit side - decreases Credit side - increases

Owner Equity accounts such as Capital and Revenue increase with Credits and decrease with Debits. However, Owner Equity accounts such as Expenses and Owner Withdrawals, normally are only debited because expenses and withdrawals, for the most part, decrease equity.

Ex.

Rent Expense T-Account

Debit side - increases Credit side - decreases



Don’t start to fret yet. Mastering the art of debits and credits takes a little bit of patience and a lot of practice. The more accounting problems that you attempt and successfully complete, the better. Thus, a word of advice, do all of your homework all of the time - advice which conveniently leads me to my next point.

As previously mentioned, accounting is a ‘building block’ type of course. By this I mean accounting is progressive. What is learned in the first few chapters lays the foundation for the next few chapters and so on and so on. Therefore, it is important that you spend the time necessary to conquer and master the basics of accounting in the first few chapters of your text. It will not go away. In fact, it will only become more difficult if you do not carry a fundamental understanding of accounting terminology, practices, and principles with you.

One last thing, accounting is a very structured discipline governed by set rules and principles. These rules have been formulated to standardize and regulate accounting practices, not to make your introduction to accounting difficult. If you take the time to understand and learn the basics of accounting, accounting may not become entirely enjoyable to some of you, but it may become "do-able".

Good luck.

Accounting Basics

Ledger: A group of accounts.
General Accounting Equation: Assets = Liabilities + Owner’s Equity
Assets: Items owned by the business that have a future worth
Liabilities: Debts of the business (or what the business owes)
Owner’s Equity: Net worth of the business (after deducting liabilities from assets)
Expenses: costs that are incurred running the business (e.g. rent, hydro)
Credit: recorded on the right side of a T-Account
Debit: recorded on the left side of a T-Account
T-Account: a simple account form used to demonstrate relationships between accounts and to show recording of Credits and Debits

Debits and Credits

These are the backbone of any accounting system. Understand how debits and credits work and you'll understand the whole system. Every accounting entry in the general ledger contains both a debit and a credit. Further, all debits must equal all credits. If they don't, the entry is out of balance. That's not good. Out-of-balance entries throw your balance sheet out of balance.

Debits and Credits vs. Account Types

Account Type Debit Credit
Assets Increases Decreases
Liabilities Decreases Increases
Income Decreases Increases
Expenses Increases Decreases
Notice that for every increase in one account, there is an opposite (and equal) decrease in another. That's what keeps the entry in balance. Also notice that debits always go on the left and credits on the right.

Let's take a look at two sample entries and try out these debits and credits:

In the first stage of the example we'll record a credit sale:

Accounts Receivable $1,000
Sales Income $1,000
If you looked at the general ledger right now, you would see that receivables had a balance of $1,000 and income also had a balance of $1,000.
Now we'll record the collection of the receivable:

Cash $1,000
Accounts Receivable $1,000
Notice how both parts of each entry balance? See how in the end, the receivables balance is back to zero? That's as it should be once the balance is paid. The net result is the same as if we conducted the whole transaction in cash:

Cash $1,000
Sales Income $1,000
Of course, there would probably be a period of time between the recording of the receivable and its collection.

That's it. Accounting doesn't really get much harder. Everything else is just a variation on the same theme. Make sure you understand debits and credits and how they increase and decrease each type of account.

Assets and Liabilities
Balance sheet accounts are the assets and liabilities. When we set up your chart of accounts, there will be separate sections and numbering schemes for the assets and liabilities that make up the balance sheet.

A quick reminder: Increase assets with a debit and decrease them with a credit. Increase liabilities with a credit and decrease them with a debit.

Identifying assets
Simply stated, assets are those things of value that your company owns. The cash in your bank account is an asset. So is the company car you drive. Assets are the objects, rights and claims owned by and having value for the firm.

Since your company has a right to the future collection of money, accounts receivable are an asset-probably a major asset, at that. The machinery on your production floor is also an asset. If your firm owns real estate or other tangible property, those are considered assets as well. If you were a bank, the loans you make would be considered assets since they represent a right of future collection.

There may also be intangible assets owned by your company. Patents, the exclusive right to use a trademark, and goodwill from the acquisition of another company are such intangible assets. Their value can be somewhat hazy.

Generally, the value of intangible assets is whatever both parties agree to when the assets are created. In the case of a patent, the value is often linked to its development costs. Goodwill is often the difference between the purchase price of a company and the value of the assets acquired (net of accumulated depreciation).

Identifying liabilities
Think of liabilities as the opposite of assets. These are the obligations of one company to another. Accounts payable are liabilities, since they represent your company's future duty to pay a vendor. So is the loan you took from your bank. If you were a bank, your customer's deposits would be a liability, since they represent future claims against the bank.

We segregate liabilities into short-term and long-term categories on the balance sheet. This division is nothing more than separating those liabilities scheduled for payment within the next accounting period (usually the next twelve months) from those not to be paid until later. We often separate debt like this. It gives readers a clearer picture of how much the company owes and when.

Owners' equity
After the liability section in both the chart of accounts and the balance sheet comes owners' equity. This is the difference between assets and liabilities. Hopefully, it's positive-assets exceed liabilities and we have a positive owners' equity. In this section we'll put in things like

Partners' capital accounts
Stock
Retained earnings
Another quick reminder: Owners' equity is increased and decreased just like a liability:

Debits decrease
Credits increase
Most automated accounting systems require identification of the retained earnings account. Many of them will beep at you if you don't do so.

By the way, retained earnings are the accumulated profits from prior years. At the end of one accounting year, all the income and expense accounts are netted against one another, and a single number (profit or loss for the year) is moved into the retained earnings account. This is what belongs to the company's owners-that's why it's in the owners' equity section. The income and expense accounts go to zero. That's how we're able to begin the new year with a clean slate against which to track income and expense.

The balance sheet, on the other hand, does not get zeroed out at year-end. The balance in each asset, liability, and owners' equity account rolls into the next year. So the ending balance of one year becomes the beginning balance of the next.

Think of the balance sheet as today's snapshot of the assets and liabilities the company has acquired since the first day of business. The income statement, in contrast, is a summation of the income and expenses from the first day of this accounting period (probably from the beginning of this fiscal year).

Income and Expenses
Further down in the chart of accounts (usually after the owners' equity section) come the income and expense accounts. Most companies want to keep track of just where they get income and where it goes, and these accounts tell you.

A final reminder: For income accounts, use credits to increase them and debits to decrease them. For expense accounts, use debits to increase them and credits to decrease them.

Income accounts
If you have several lines of business, you'll probably want to establish an income account for each. In that way, you can identify exactly where your income is coming from. Adding them together yields total revenue.

Typical income accounts would be

Sales revenue from product A
Sales revenue from product B (and so on for each product you want to track)
Interest income
Income from sale of assets
Consulting income
Most companies have only a few income accounts. That's really the way you want it. Too many accounts are a burden for the accounting department and probably don't tell management what it wants to know. Nevertheless, if there's a source of income you want to track, create an account for it in the chart of accounts and use it.

Expense accounts
Most companies have a separate account for each type of expense they incur. Your company probably incurs pretty much the same expenses month after month, so once they are established, the expense accounts won't vary much from month to month. Typical expense accounts include

Salaries and wages
Telephone
Electric utilities
Repairs
Maintenance
Depreciation
Amortization
Interest
Rent

Financial Formulas

How much your friendly neighborhood pawnshop or bank profits just because you need that killer amp!

Simple Interest Future Value

FV = PV * (1 + ( i * N ) ]

FV - future value (or maturity value)
PV - principal or present value
i - interest rate per period
N - number of periods

Simple Interest

I = PV * i * N

PV - principal or present value
i - interest rate per period
N - number of periods

Compound Interest Future Value

FV = PV * ( 1 + i )N

PV = present value
FV = future value (maturity value)
i = interest rate in percent per period
N = number of periods

Compounded Interest

i = FV - PV

PV = present value
FV = future value (maturity value)
i = interest rate in percent per period

Annuity

FV = PMT * [ ( ( 1 + i )N - 1 ) / i ]

FV = future value (maturity value)
PMT = payment per period
i = interest rate in percent per period
N = number of periods

Simple Interest Amortized Loan Formula

PV * ( 1 + i )N = PMT * [ ( 1 + i )N - 1 ] / i

PMT = the payment per period
i = interest rate in percent per period
PV = loan / mortgage amountjavascript:void(0)
N = number of periods

Double Entry

The accounting equation is the very heart of a double entry accounting system. For every change in value of one account in the Accounting Equation, there must be a balancing change in another. This concept is known as the Principle of Balance, and is of fundamental importance for understanding GnuCash and other double entry accounting systems. When you work with GnuCash, you will always be concerned with at least 2 accounts, to keep the Accounting Equation balanced.

Double entry accounting serves two purposes. The first is to create an accounting trail, money always has to come from somewhere and go to somewhere. Additionally, double entry accounting historically served to double check the math of an accountant. Because the numbers are entered into multiple accounts simultaneously, there are multiple places to check to make sure the totals match. Of course, with the advent of computers, the chances of a mathematical problem are low, but it is good to know that the concept still exists!

Double entry accounting has been around since the late 15th century, when it was described by an Italian friar, Luca Pacioli. Traditional double entry accounting involves recording each transaction in a book called a ledger, then copying each part of the transaction to separate books called journals. This method is still used in businesses today as a way to avoid entry errors and to track the source of those errors. GnuCash simplifies this traditional accounting by copying part of each transaction for you, so it may not catch some of the entry errors that would show up in traditional accounting. But it will flag transactions that are not balanced, and it will let you know when an account name is missing.

The Accounting Equation

With the 5 basic accounts defined, what is the relationship between them? How does one type of account affect the others? Firstly, equity is defined by assets and liability. That is, your net worth is calculated by subtracting your liabilities from your assets:

Assets - Liabilities = Equity

Furthermore, you can increase your equity through income, and decrease equity through expenses. This makes sense of course, when you receive a paycheck you become "richer" and when you pay for dinner you become "poorer". This is expressed mathematically in what is known as the Accounting Equation:

Assets - Liabilities = Equity + (Income - Expenses)

This equation must always be balanced, a condition that can only be satisfied if you enter values to multiple accounts. For example: if you receive money in the form of income you must see an equal increase in your assets. As another example, you could have an increase in assets if you have a parallel increase in liabilities.


A graphical view of the relationship between the 5 basic accounts. Net worth (equity) increases through income and decreases through expenses. The arrows represent the movement of value.

The 5 Basic Accounts

Basic accounting rules group all finance related things into 5 fundamental types of “accounts”. That is, everything that accounting deals with can be placed into one of these 5 accounts:

Assets - things you own.

Liabilities - things you owe.

Equity - overall net worth.

Income - increases the value of your accounts.

Expenses - decreases the value of your accounts.

It is clear that it is possible to categorize your financial world into these 5 groups. For example, the cash in your bank account is an asset, your mortgage is a liability, your paycheck is income, and the cost of dinner last night is an expense.

Accounting Concepts

GnuCash is easy enough to use that you do not have to have a complete understanding of accounting principals to find it useful. However, you will find that some basic accounting knowledge will prove to be invaluable as GnuCash was designed using these principals as a template. It is highly recommended that you understand this section of the guide before proceeding.

Intangible Assets

Learn the meaning of an intangible asset. Discover methods of depreciation and amortization. How is the valuation of a financial capital intangible asset calculated?


Intangible assets for the most part are treated like any other assets. They’re recorded on the balance sheet and valued as part of owner’s equity. Like other assets, intangibles are used to generate revenue. They are however more difficult to put a value on. This article looks at how intangible assets are valued as well as methods of depreciation. First off it’s important to understand the definition of an intangible asset.

Definition of an Intangible Asset
Current assets, like cash and accounts receivables, are an accumulation of a monetary figure usually generated by revenue. Fixed assets, like equipment and furniture, have a physical form (tangible) and are easier to put a value on. Intangible assets on the other hand do not have a physical form. Just like any other assets, intangibles do have a value and are part of the owner’s equity of a company.

Patents
License
Copyright
Goodwill
Contracts
Trademark
Franchise
Every one of the above examples plays a role in generating income. Patents for example allow a company to generate revenue with restraints on the competition. A license to sell a product, like alcohol for example, allows a business to increase revenue with the sale of alcohol.

Operating Activities Provided and Used in the Cash Flow Statement

The Cash Flow Statement of a business is one of the most important schedules in Accounting. Balancing the activities section can be difficult.


Public businesses are required to present three financial statements

Income Statement
Balance Sheet
Statement of Cash Flows
Information in the Cash Flow Statement adds to the picture that the other statements provide. A company may have a solid financial position, and it may be generating income, but if it consistently does not convert that income to cash, it will have difficulty surviving.

Components of the Cash Flow Statement
The Cash Flow Statement is broken down into three sections:

Operating Activities
Investing Activities
Financing Activities
The term operating activities is fairly self-explanatory. It relates to items found on the income statement and in the current assets and liabilities sections of the balance sheet

The other two statements pull from the company’s books and usually relate to long term assets or liabilities. Like the income statement, the cash flow statement concerns a period of time, while the balance sheet is shows the assets and liabilities on a specific date. On the Cash flow statement, Net income is listed first, before the other main three parts of the statement.


Operating Activities
Investing Activities
Financing Activities
The term operating activities is fairly self-explanatory. It relates to items found on the income statement and in the current assets and liabilities sections of the balance sheet

The other two statements pull from the company’s books and usually relate to long term assets or liabilities. Like the income statement, the cash flow statement concerns a period of time, while the balance sheet is shows the assets and liabilities on a specific date. On the Cash flow statement, Net income is listed first, before the other main three parts of the statement.

Cash Flow Statement Operating Activities August 31, 2010

Cash sales receipts $7.000
Cash receipts from accounts receivable $40,000
Cash paid from petty cash ($3,000)
Cash paid from accounts payable ($27,000)
Cash paid payroll ($10,000)
Cash paid income taxes ($5,000)
Net increase in cash $2,000
Cash beginning of month $5,000
Cash end of month $7,000

How to Prepare a Journal Entry

Find out about the five parts to a journal entry and how to decide between debiting or crediting journal entry accounts.


One area of concern for first year accounting students, business students that are only taking accounting because it is a required core class or brand-new bookkeepers is how to prepare journal entries. It is not so much the logistics of presenting the journal entry that causes the most concern but how to figure out which account is debited and which is credited.

Components of a Journal Entry

There are five components to a journal entry:

Date: The day on which the account updates are made. For any adjusting journal entries, the date will normally be backdated to the last day of the previous month. Many professional accounting software systems allow the accountant to set up recurring journal entries so in theory a whole year or more of adjusting journal entries could be programmed to post on the last day of each month.
Account: This refers to the specific type of asset, liability, revenue, expense or equity account that is being affected by whatever is going on. For example, Cash in Bank is an asset account and Sales is a revenue account.
Debit versus Credit: One of the immutable laws of accounting states that assets and expenses are always debited to add to them and credited to subtract from them. Liability, revenue and equity accounts are just the opposite - these accounts are always credited to add to them and always debited to subtract from them. Always, always, always - there is no exception to this rule.
Dollar Amount: How much money is changing hands or under the accrual method being accounted for.
Description: When writing a description for a journal entry there is a fine line between writing one that is too brief and one that is excessively long. The accountant's goal is to keep the description to the minimum yet be understandable to anyone that might review the journal entry after it has been prepared and posted - for example an external auditor.

Journal Entry Example

On June 5, A retail shop buys $500 of inventory merchandise from ABC Inc.; $100 was paid in cash and $400 of the cost was charged on account.

Accounting 101 – Journal to General Ledger
Understanding how journals relate to the general ledger is one of the first steps to learning accounting basics. Learn the steps from journal to general ledger.
Credit: Cash $100.00

Credit: Accounts Payable $400

accounting

Definition
The systematic recording, reporting, and analysis of financial transactions of a business. The person in charge of accounting is known as an accountant, and this individual is typically required to follow a set of rules and regulations, such as the Generally Accepted Accounting Principles. Accounting allows a company to analyze the financial performance of the business, and look at statistics such as net profit.