For a quick overview of the Accounting System Structure including the Chart of Accounts, Journals and Ledgers please see my New Post (#16).

For More on How to Make use of Financial Statements and Financial Ratios, please see New Post # 17

<< General Ledger

>> Financials – Trial Balance

This Post is a listing of which General Ledger Accounts are used by which Financial Statement.

Trial Balance: All Accounts

Trial Balance: Income Statement Accounts Only

Trial Balance: Balance Sheet Accounts Only

These example accounts do not have beginning balances and no equity contributions. If there had been equity contributions the equity accounts would also be included in this section of the trial balance.

Statement of Cash Flows: This Statement documents both the change in Cash Position and the change in Financial Position.  The Statement of Cash Flows is essentially a Yearly Balance Sheet with an emphasis on Cash.

Notice that debits and credits are presented in the way that they contribute to cash. This report might take some adjusting to as the +/- of all debit and credit accounts except Cash are reversed.

Next up: >> Financials – Trial Balance

<< General Ledger

**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.

<< Financials – Balance Sheet

>> Cost of Goods Sold and Inventory

The Cash Flow Statement (Statement of Cash Flows) provides an overview of the way Funds move through an Entity, how they impact Overall Value and eventually reconcile with Cash Balances and determine Net Cash Flow in any given year.  There are formatting methods for the Cash Flow Statement, I demonstrate the Indirect Method in this post because it is the method preferred by most analysts.

The Cash Flow Statement is essentially the same as a yearly Balance Sheet – it’s just organized a little bit differently and is more summarized.  The Balance Sheet accumulates its amounts from the beginning, the Cash Flow Statement only accumulates its balances over one business year.  Since the Balance Sheet Accounts carry their balances from year to year, the Cash Flow Statement presents its amounts as either Increases or Decreases to groups of Accounts throughout the year.

Balance Sheet:

The Balance Sheet uses the three categories: Assets, Liabilities and Equity.

• Assets
  • Current Assets (including Cash)
  • Fixed Assets (Net of Accumulated Depreciation)
• Liabilities
  • Current Liabilities
  • Long Term Liabilities
• Equity
  • Owners’ Capital (Contributions, Stock and Paid in Capital)
  • Retained Earnings
  • Net Income

Cash Flow Statement:

You’ve heard the term “Bottom Line” well, that term refers to the end result – the numbers at the bottom of the page.  Since the end result of the Cash Flow Statement is Net Cash, it is at the bottom of the report and everything else on the report funnels down to the bottom to come to the final Net Cash number.

The Cash Flow Statement uses the three categories: Operating, Investing and Financing.

• Operating Activities
  • Net Income
  • + Depreciation Expense (and other non-cash expenses)
  • + Increases in Current Liabilities
  • + Decreases in Current Assets
  • - Increases in Current Assets
  • - Decreases in Current Liabilities
• Investing Activities
  • + Decreases in Long Term/Fixed Assets (Independent of Accumulated Depreciation)
  • - Increases in Long Term/Fixed Assets (Independent of Accumulated Depreciation)
• Financing Activities
  • + Increases in Long Term Liabilities/Debt
  • - Decreases in Long Term Liabilities/Debt
  • + Increases in Owners’ Capital
  • - Decreases in Owners’ Capital
  • - Increases in Dividends
• Cash (Beginning Cash Balance – Net Increase/Decrease = Ending Cash Balance)

The net contribution to cash is summarized for each section and then combined to equal Net Cash Flow.  Net Cash Flow is then combined with the Beginning Cash Balance to reconcile to the Ending Cash Balance for the year.  Net Cash Flow is the difference between the Beginning and Ending Cash Balances.

The Cash Flow Statement is an important indicator of available cash for operations but also of how an entity is generating cash, if it is able to sustain itself and its growth through its operations or if it generated cash through increased debt and equity and/or decreased capital assets.

Statement of Cash Flows (Including Depreciation Entries from Balance Sheet Post)

Statement of Cash Flows
Cash Flows From Operating Activities
Net Income	$45,104
Depreciation	$496
Increase in Payables	$1,700
	————
Net Cash Provided by Operating Activities	$47,300
	————
Cash Flows From Investing Activities
Increase in Fixed Assets	-$2,950
	————
Net Cash Used by Investing Activities	-$2,950
	————
Cash Flows From Financing Activities
	$0
	————
Net Cash Provided by Financing Activities	$0
	————
Increase in Cash and Cash Equivalents (Net Cash Flow)	$44,350
Cash and Cash Equivalents at Beginning of Year	$0
	————
Cash and Cash Equivalents at End of Year	$44,350

Remember that accrual accounting records revenues and expenses when they are earned or incurred regardless of when the related Cash is either received or disbursed.  This means that the amounts due for Payables or Receivables have impacted the Financials but have not yet impacted Net Cash Flow and so they must be added back to Net Cash Flow for Payables and deducted from Net Cash Flow for Receivables.

Next up: >> Cost of Goods Sold and Inventory

<< Financial Statements – Balance Sheet

**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.

<< Financials – Income Statement

>> Financials – Statement of Cash Flows

The Balance Sheet is the financial statement that summarizes the value of an entity’s resources and the claims on those resources at any given time.  Balance Sheet accounts start accumulating their balances from the beginning of the entity and continue until the end.  This contrasts with the Income Statement whose accounts are reset to zero at the end of each fiscal (business) year.

The Accounting Types reported on the Balance Sheet are:

Assets – Assets are items of value that are owned by the business and their value is expected to last beyond the current fiscal (business) year.

Liabilities are essentially debts, they are agreements to delay payments and so, are sources of funds because they provide a way to acquire or pay for goods and services without a direct transfer of cash at the time of the exchange.

Equity (Owners Equity) is a source of funds through direct owner investment (stock or owners capital accounts  or owner “re-investment” (retained earnings) when some or all of the income from the previous year is retained by the business rather than distributing it to the owners.

The Balance sheet Equity Section refers to Total Equity which is Owners Equity + Net Income.  The Net Income portion is easily calculated because since the total debits and total credits of all financial accounts must be equal, and the Balance Sheet and Income Statement split the Accounts between them.  The difference between the Balance Sheet Accounts will equal the difference between the Income Statement Accounts – which is Net Income.

Since Owners Equity is only part of Total Equity, Net Income can also be calculated using a rewrite of the Accounting Equation to Assets – Liabilities = Total Equity (Owners Equity + Net Income)  so move Owners Equity to the other side of the equation as well and the equation becomes Assets – Liabilities – Owners Equity = Net Income.

Also, given the Accounting Equation: Assets = Liabilities + Equity.  The value of any one of the three elements can be determined given any two of the three.

Important financial ratios can be calculated directly from the numbers on the Balance Sheet.  Among these ratios is current ratio and quick ratio each of these help to determine if the business is able to fulfill its short term debt obligations.

• Current Ratio = Current Assets/Current Liabilities
  • A Current Ratio of at least 1:1 (or >= 1) indicate that there is at least one dollar of current assets for each dollar of debt.
• Quick Ratio = Current Assets – Inventory/Current Liabilities
  • A Quick Ratio of at least 1:1 indicates that there is at least one dollar of cash or cash equivalent (including accounts receivable) for each dollar of debt.

Balance Sheet Example:

At the end of each year when the Income Statement accounts are reset to zero, the difference between their debit and credit balances (Net Income/(Loss)) is posted to a Balance Sheet Equity account called Retained Earnings (for corporations or Owners’ Capital for other types of organizations).  An example of this entry can be found at the end of the Income Statement post.

The Balance Sheet does not contain any of the same accounts as the Income Statement, but it does summarize the Income Statement on one line called “Net Income” that is inserted (without an account #) at the end of the Equity Section of each Balance Sheet.  The Net Income entry completes the Accounting Equation for the Balance Sheet:  Assets = Liabilities + (Total) Equity (Owners Equity + Net Income)

So, the listing of balance sheet accounts from the Income Statement post gives us a start in creating a Balance Sheet prior to year end closing entries.

The Balance Sheet has a section for each of the elements of the Accounting Equation, Assets, Liabilities and Equity.  The the first thing I check when I read a Balance Sheet is whether it is “in balance”/the accounting equation is true.  Once I know it balances, I can focus on the substance of the report.

To convert the account listing above to a Balance Sheet format, I’ll add some section headings and a line for the Net Income from the previous Income Statement post.

Assets = Liabilities + Equity

Notice that the Net Income entry doesn’t have an account number beside it. Net Income does not have an account, it is the difference between the Balance Sheet Accounts.  It is also the difference between the Income Statement Accounts.

Each item on the Balance Sheet is stated at its original value or cost.  Since the accounts accumulate their balances from “the beginning of time”, each balance sheet item also stays there at its original value until it is sold, written off or satisfied (debts paid off or equity repurchased).

Items that are listed on the Balance Sheet do lose their value over time so instead of reducing their original account values, contra accounts are used to write down, depreciate or amortize them. Contra Accounts are the same Accounting Type as their counterparts but if their counterpart is a debit account, the contra account is a credit account. The Net Value of the Original Account and the Contra Account together reflects the decrease in book value without losing the historical value. Contra Accounts like Accumulated Depreciation prevent items from “falling off” the Balance Sheet while they are still owned by the entity because when the item’s value eventually depreciates to zero, it is still part of the original account balance.

Depreciation is determined by type of fixed asset. Depreciation methods, classes of assets and examples are listed in IRS Publication 946. Sometimes entities use different depreciation methods for book/tax purposes. Always ask a tax professional for guidance in making decisions that have tax implications.

The purpose of this entry is to demonstrate basic depreciation entries rather than depreciation calculations. I will use straight-line depreciation and assume that the assets were put into service on January 1st. Publication 946 (pg 31) indicates that office equipment is depreciated over 5 years and office furniture is depreciated over 7 years. For the depreciation entry I will add a contra asset account and a depreciation expense account.

After the depreciation entry above, expenses were increased and net income was decreased by $496.  After the depreciation entry and closing entries to the Income Statement, our Balance Sheet looks like this.  Note the change from Net Income with no account number to Retained Earnings with the account number 3500.  The entry to account 3500 is is part of the year end income statement accounts closing entry.

Next up: >> Financial Statements – Statement of Cash Flows

<< Financial Statements – Income Statement

**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.

<< Financial Statements – Trial Balance

>>Financial Statements – Balance Sheet

One of the Principles of GAAP is the Matching Principle.  Matching requires that when you post sales into the system for an accounting period (month), you must also post the costs of the products or services you sold during that period in the same accounting period (month). The Matching Principle essential to Financial Statements, particularly the Income Statement, because it makes them meaningful.

The Income Statement is a “Current Year” statement, it does not cross years. The Income Statement provides cumulative “To Date” financial data for the current business (Fiscal) year. So, the March Income Statement shows the totals for January, February and March together in one column and the totals for the previous December would not be part of the totals for that column.

Unlike the Trial Balance, the Income Statement and Balance Sheet each only show a portion of the General Ledger Accounts. The GL Accounts are split between the Income Statement and the Balance Sheet by their Accounting Types. The Income Statement Accounting Types are Revenue, Cost of Goods Sold and Expenses. The Accounts that are not on the Income Statement are on the Balance Sheet.

As its name suggests, the purpose of the Income Statement is to report Income. Income = Revenue – Expenses. It is almost that simple, but there is more to the Income Statement than a simple calculation.

The format for the Income Statement is:

The Income Statement uses intermediate steps to reach Net Income. The first of these steps is Gross Margin.  Gross Margin = Revenue – Cost of Goods Sold and represents the amount of revenue that is left after costs to cover operating expenses. Gross Margin is meaningful because it shows the direct relationship between the costs of products or services and their sales.

The Gross Margin % can be compared to industry standards to make sure your pricing and costs are competitive. It is calculated as:

• Gross Margin = Revenue – Cost of Goods Sold
• Gross Margin % = Gross Margin ($) / Revenue

The next intermediate step towards Net Income is Operating Income. Operating Income = Gross Margin – Expenses and is the amount of profit (income) from normal (usual) operations.

The final step in calculating Net Income is to add the amounts for the Accounts categorized as “Other Revenue” and to subtract the amounts for the Accounts categorized as “Other Expenses”. Other Revenues include any “money in” (gain) that is not received from the sale of the usual business products or services, this might be a gain on the sale of an asset like a vehicle. Other Expenses include any “money out” (loss or expense) that is not part of the usual expenses or cost of goods sold. Other Expenses might include some interest charges or a loss on the sale of an asset.

This Income Statement is produced from the transactions that have been posted in previous posts.  The presence of sales but no costs on this Income Statement indicate that either my entries for the period are incomplete or I’ve violated the matching principle because if I have sales, I must have some associated costs.

Net Income is the amount of revenue that was not spent on operations, it represents the amount of the increase in overall value.  Remember not to confuse the terms Revenue or Income with Cash. The Net Income amount here is $45,600 and if you check the Trial Balance from the previous post, the Checking Account Balance is $44,350.

Let’s look at the Income Statement again in terms of debits and credits.

Remember from the Trial Balance report which shows all accounts and their balances that the total debit amounts were equal to the total credit amounts.  The Income Statement splits the accounts with the Balance Sheet and so the total debits and total credits on each of these statements will not be equal, but the debits and credits of their combined accounts are equal.  So, let’s take a look at the Accounts that are not listed on the Income Statement.

The difference between the balances of the Income Statement Accounts, $45,600, is equal to the difference between the Balance Sheet Account balances.  This listing of the Balance Sheet Accounts shows where the Net Income went.  $47,300 increase in assets – money still due $1,700 = $45,600 = Net Income of $45,600.

The Income Statement Accounts accumulate their balances throughout the fiscal year and at the end of the year, the accounts are reset to zero (closed out) and the difference between their total debits and total credits (Net Income) is transferred to the Balance Sheet. The Balance Sheet account used in the transaction is an Equity account and is either Retained Earnings or Owners Capital depending on the structure of the business.

The entry to close out the year for the Income Statement Accounts in our examples is:

Next up: >>Financial Statements – Balance Sheet

<< Financial Statements – Trial Balance

**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.

<< General Ledger – Accounting Periods

>>Financials – Income Statement

I decided to skip ahead a little and introduce the financial statements.  We’ve covered the basics well enough to make sense of them so for now, let’s stick to the subject of the Payoff and go back to cover the details of subledgers and month ends in future posts.

The General Ledger takes the information from transactions and summarizes it by Account and by Accounting Period.  The four basic Financial Statements present General Ledger (GL) Accounts and their balances for specific date ranges, usually accounting periods. The four basic financial statements are:

• Trial Balance
• Income Statement (Profit and Loss)
• Balance Sheet
• Cash Flow Statement

In this Post, I’ll introduce the most basic and simple of the statements -The Trial Balance. The Trial Balance is a listing of all General Ledger (GL) Accounts and their balances at any given time in order of GL Account Number.

The Trial Balance is different from the other Financial Statements because it is the only one that lists all Accounts, the Income Statement and the Balance Sheet split the Accounts and the Cash Flow Statement uses the same Accounts as the Balance Sheet.

The Standard Trial Balance is straight forward and doesn’t require any further explanation. It is a quick report that can be printed or viewed to check the balance of specific accounts and to make sure that the books are in balance – that debits = credits.

The Comparison Trial Balance is also straight forward and provides the same information as the standard version but it gives balances both by account and by accounting period. Time analysis is essential in managing and securing resources because it can quickly pinpoint changes that indicate errors or fraud as well as the unexpected changes that might require adjustments to cash planning and/or operations.

We have already seen both versions of the Trial Balance and I’ll reprint them here for review.

Standard Trial Balance as seen in Post #4 (with Account Numbers that were added in Post #5)

This is the Comparison Trial Balance Report from post # 7

**This example starts with June because of space limitations here.

Next Up: Financial Statements – Income Statement

<< General Ledger – Accounting Periods

**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.