Pamela Travel Journal » Accounting

How accounting works

NailaIntan — Mon, 28 Jun 2010 10:20:18 +0000

This article is for beginners of accounting profession who just started their long way and already struggling to understand the basics. The starting point of almost any accounting course is an explanation of the double-entry bookkeeping system which then stands as a core of any further studies. If you did not clearly understand how it works in the beginning the effect of further education will be zero.

I’ll try to illustrate the basics of accounting in the simplest possible way, avoiding in the beginning the use of such confusing terms like assets, liabilities, debits and credits, etc.

Let’s start:

Assume we have some Company X, which was established a year ago and now we are at the year-end, trying to draft accounts of Company.

All we can guess from the ‘accounting’ word itself, that it is a bunch of accounts. Great! That would be a starting point for us. Let’s put down some accounts on a paper (if you’re reading this article on your PC, it’s advised to do the below manipulations in Excel spreadsheet):

Account A

Account B

Account C

Account D

Account E

Account F

Account G

Account H

Account I

What you see above is just a list until we put some values opposite every account. The only point to bear in mind is that overall total of listed values should eventually be equal to 0:

Account A         12

Account B    9

Account C         -4

Account D -8

Account E    -13

Account F -5

Account G -7

Account H    6

Account I           10

Total = 0

Coming back to accounting, each value above is called an Account balance. List itself is usually called a Trial balance. Let’s assume that these account balances were actual ones for our Company X at the year-end.

Now it’s time to understand how the double-entry system actually works. Basically the purpose of the double-entry system is to reflect transactions that Company was involved into. Not going deep into details let’s imagine that Company X made a credit sale on the first day of current year amounted to 5 dollars. The effect on our accounts will be the following:

Before                      Entry           After

transaction    transaction

Account A                  12                                                     12

Account B                   9                            5                        14

Account C                  -4    -4

Account D                  -8                                                       -8

Account E                 -13    -1

Account F                  -5    -5                        -10

Account G    -7       -7

Account H                 6                                                        6

Account I 10                                                       10

Total 0 0

Above sample illustrates the main principle of accounting. So, every transaction, whatever the substance of it, simultaneously increase one account and decrease the another. In our case Account B that was increased by 5 and Account F – decreased by 5. That’s why the Total of accounts equal to 0 remains unchanged.

To make the example more practical let’s define what each account actually indicates and call these accounts respectively:

Account A Cash – The balance of this account shows how much cash our Company has in hand at the moment.

Account B Receivables – This account shows how much money our customers owe to us as at the moment.

Account C Payables – Shows the total amount that we owe to our suppliers at the moment.

Account D Borrowings – Shows how much we are due on Bank loan at the moment.

Account E Share capital – Shows how much money the Company owes to its Shareholder, i.e. money invested into business by owners.

Account F Revenue – This account shows how much Company earned from its main activity for the period of time (usually year to date).

Account G Other income – This account shows any other revenues earned out of main activities for the period of time.

Account H Operating expenses – Shows cumulatively how much Expenses Company incurred to run it’s main business for period of time.

Account I Interest expense – Shows the amount of interest paid to Bank for the period of time.

Let’s now get back to our transaction when Company sold the goods for 5 dollars on credit. It resulted in increasing of Account B and decreasing of Account F. Let’s see why. Account B showing us an amount receivable from customers and since we sold goods on credit this amount should increase from 9 to 14. On the other hand by selling goods we earned a revenue which must be reflected on Revenue account. Before the transaction Revenue balance was -5, showing us that we earned 5 dollars so far – negative sign should be ignored, as it’s used only for the purpose of getting equality. Surely by selling more at the amount of 5 dollars, we should increase our Revenue to make it 10. However because of the negative sign in place, mathematically we decrease the -5 and it becomes -10.

Let’s take another example. Company pays 3 USD rental for the office in cash. Consequently we should decrease Account A (Cash) by 5 and increase Account H (Operating expenses) by 5.

Now, when we understand how double entries work, let’s see how these accounts form financial statements which are usually the ultimate purpose of any accounting. For that purpose we’ll allocate our accounts to certain groups: Assets, Liabilities, Equity, Incomes and Expenditures. Accounts A (Cash) and B (Receivables) will form Assets of the Company. Assets are what Company actually possess(e.g. Cash) or suppose to possess (e.g. Receivables). Next group is Liabilities. That’s what Company owes to suppliers, banks, other partners. In our case Liability group will include: Accounts C (Payables) and D (Borrowings). Another group is Equity, which comprises of accounts showing how much Company owes to its shareholders. Also this group can be called share capital. All 3 above – Assets, Liabilities and Equity eventually constitute Balance Sheet of the Company. Balance sheet accounts are always showing information as of particular date. E.g. if Cash account balance equal to 3, it means that as of present moment Company has 3 USD of cash in hand.

Other groups are Incomes and Expenditures. Income or revenue accounts reflect all incoming money that Company earn from its activities. E.g. for supermarket it would be revenue from goods sold, for bank – interest income, etc. Expenditures reflect amounts expended to maintain business. Main point to remember about Income and Expenditure accounts is that they are always showing us amounts earned or expended FOR the period of time (usually year to date). E.g. if Revenue account balance equals to 500 USD as at March 31 it
usually means that Company made sales totaling to 500 USD since the beginning of year up to date.

Let’s now draft financial statements out of Trial Balance we have above. They will look like this:

Balance Sheet

Assets

A Cash    12

B Receivables                          14

Total Assets                            26

Liabilities

C Payables                              -4

D Borrowings    -8

Total Liabilities    -12

Equity

E Share capital 13

Current year’s profit    -1

Total Equity                            -14

Total Liabilities and Equity -26

Income Statement

F Revenue    -10

G Other income    -7

Total income                           -17

H Operating expenses                 6

I Interest expense                       10

Total expenses                         16

Net Profit    -1

Now we came to the last point – introduction of Debits and Credits. In above example we were calling accounting entries like Increase of Account B and Decrease of Account F. However to making life easier accountants use Debits and Credits to formulate accounting entries. There is following rule:

Assets and Expenses accounts increase by debit and decrease by credit. Liabilities, Equity and Income accounts increase by credit and decrease by debit.

To apply this rule, let’s formulate above entry:

Dr Receivable     5

Cr Revenue       -5

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How to Use QuickBooks for Job Costing: Setting Up Preferences and Items

NailaIntan — Sun, 28 Mar 2010 10:03:01 +0000

Accurate job costing is one of the most critical tasks for managing job-based business like construction companies, professional services firms, and even nonprofits that are awarded grants. Many owners put it off because it seems too complicated or time-consuming. But if you’re serious about helping your business grow and prosper, it’ll help you:

- Analyze how each of your jobs us doing financially

- Identify problem jobs as early as possible

- Identify jobs that weren’t as profitable as expected

- Create better estimates for future jobs

Luckily, QuickBooks is an inexpensive program that can do powerful job costing with the data you’re already entering – as long as you set it up and use it correctly.

This is the first of a four-part series about how to use QuickBooks for job costing. Intuit, the creators of QuickBooks, has also asked me to host a free Small Business Town Hall series covering the same topics. This is your chance to get your job costing questions answered live.

The first step to setting up QuickBooks for job costing is to set your preferences (Edit > Preferences > Company Preferences)

1. Go to Jobs & Estimates and check the box next to “Do you create estimates”. You might also want to check the box next to “Do you do progress invoicing”.

2. If you use QuickBooks for payroll, and every business doing job costing should, go to Payroll & Employees and check the box next to “Job costing, class and item tracking for paycheck expenses”

3. If you use QuickBooks for payroll, go to Time & Expenses and check the box next to “Do you track time”. If you do time & material billing, you should also check “Create invoices from a list of time and expenses”.

The second step is to setup your customer:jobs and use them on every transaction.

1. Go to the Customer Center and click on the New Customer & Job button.

2. If you are using Contractors edition, you might also want to create a customer called Overhead or Administrative for non-job expenses, so you can use the “Expenses Not Assigned to Jobs” report (only found in the contractors edition) to make sure you didn’t accidentally leave off a customer:job. If you are using classes, you might want to consider doing the same thing so you can use the Profit & Loss Unclassified report to make sure you didn’t accidentally leave off a class.

The third step is to setup items and use them on every transaction.

1. Go to Lists > Item List, click on the List button, and select New.

2. Add a new service item for every job phase you want to job cost. For subcontractors, this could be as simple as Labor and Materials. For general contractors, it could be quite lenghty: plans, site work, excavation, concrete, masonry, framing, etc. In this case, you might want to add sub-items for Labor and Materials to your items if you want to track those costs separately. This also makes it easier to report only the Labor portion of a subcontractor’s invoice on their 1099.

3. If you are a contractor with short-term jobs make sure to set up all your Service Items as two-sided, with both an expense and an income account. This doesn’t occur automatically and unfortunately it isn’t very intuitive. You need to put a check next to “This service is used in assemblies or is performed by a subcontractor or partner” for the expense box to be added to the setup screen. Contractors often use a cost of goods sold account called something like “job related costs” for job-related expenses.

4. Builders and many professional service firms have projects that span several months or more generally use a work in progress (WIP) or construction in progress (CIP) asset account because job related costs aren’t usually expensed until the project is completed. In this case, they should map the expense account to their WIP or CIP asset account.

5. Depending on your circumstances, there are also several Other Charge items you should set up. These don’t need to be two-sided:

- If you use WIP or CIP accounts, you should setup two items: (1) Transfer out of WIP – with WIP as the account and note in the description that the amount should be positive, and (2) Transfer into COS – with COS as the account and note in the description that the amount should be negative

- If you accept customer deposits or retainers, you should setup an item mapped to a current liability account. For better tracking, you should consider setting up a separate current liability account just for deposits.

- If you have customer retention or retainage, you should setup an item mapped to an accounts receivable account and a negative for the Amount (for instance, -10% if your retainage is 10%). For better tracking, you should consider setting up a separate accounts receivable account just for retainage.