Accounting Unplugged


Workbook revisited

Posted in Uncategorized by Erin on May 22, 2009

A few months ago I proposed the idea of selling a workbook for the purposes of supporting my site. I changed the dates and then just never delivered the workbook.

This is what happened. I wrote it and agonized over its release because there was always just one more thing I wanted to add.  It has sat quietly in my files for over a month waiting for me to release it and now I am going to set it free (so to speak). I just finished reviewing it and changing a key word in it that was troubling me Click here to read more..

Or Click Here for free access to the workbook.

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Understand your Numbers

Posted in 0. Rants by Erin on March 28, 2009
Tags: , ,

The process of setting up and maintaining your accounting is a crucial part of understanding whether your business can/does make money. Sit down and brainstorm about the numbers. What will you charge for your product or service? What will it cost you to purchase, manufacture and/or provide your products and services, what are the other costs of running a business?

For more about the importance of being involved in your own accounting setups, please see my New Post (#20) Understand Your Numbers

Accounting System Structure – Financial Statement Ratios

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

Accounting Journals and Ledgers – Transaction Posting

<< Percentage of Completion and WIP Statement Accounting Structure – Quick Ref >>

The process of gathering and storing Financial Transaction data in the Accounting System is accomplished through the use of both:

  • Ledgers: which maintain Account Balances
  • Journals: which maintain the line by line detail of each Transaction.

Ledgers:

I’m starting with Ledgers because we’ve gone through the basic organization of the Accounting System from Double Entry (debit/credit) Transaction Posting, to the Chart of Accounts and finally the General Ledger. I’ll stay on the topic of the General Ledger first and then back up to the Journals where each transaction is originally posted.

In Accounting, there are two types of ledgers, the General Ledger (Book of final entry) and Subsidiary (Sub) Ledgers. The Accounts for the General Ledger come from the Chart of Accounts. The Accounts for the Subledgers depend on the specific purpose of the Subledger.

If you remember in the “Chart of Accounts – Basics”, I said that Accounts should only be created to describe types of things not individual things themselves. Well, in some cases especially in the case of cash substitutes like Accounts Payable and Accounts Receivable more detail is required. So, to maintain the summary nature of the Chart of Accounts/General Ledger and to provide more detail, Subsidiary (Sub) Ledgers were developed.

Everything that is posted into Subledgers is also posted into the General Ledger and they act together to provide progressive levels of detail/summary.

The two most common Subledgers are:

  • The Accounts Payable Subledger: which maintains a list of Vendors (or creditors) and their individual Account Balances. Each individual Vendor represents a Subledger (Accounts Payable – Vendor) Account.
  • The Accounts Receivable Subledger: which maintains a list of Customers and their individual Account Balances. Each individual Customer represents a Subledger (Accounts Receivable – Customer) Account.

—more on Subledgers and Journals—>>

Next: Accounting Structure – Quick Reference>>

<< Percentage of Completion and Work in Progress

**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 Accounts on Financial Statements

<< 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

Account Description Debits Credits
1000 Checking Account (Cash) $44,350
1200 Accounts Receivable $0
1500 Office Equipment $1,300
1520 Office Furniture $1,650
1590 Accumulated Depreciation $496
2000 Accounts Payable $1,700
4000 Sales $50,000
7000 Rent $3,000
7020 Office Supplies $150
7040 Subscriptions $300
7060 Utilities $125
7100 Fuel $275
7200 Repairs and Maintenance $500
7240 Depreciation Expense $496
7300 Credit Card Interest and Fees $50
Totals $52,196 $52,196

Trial Balance: Income Statement Accounts Only

Account Description Debits Credits
4000 Sales $50,000
7000 Rent $3,000
7020 Office Supplies $150
7040 Subscriptions $300
7060 Utilities $125
7100 Fuel $275
7200 Repairs and Maintenance $500
7240 Depreciation Expense $496
7300 Credit Card Interest and Fees $50
Totals $4,896 $50,000
Difference = Net Income $45,104

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.

Account Description Debits Credits
1000 Checking Account $44,350
1200 Accounts Receivable $0
1500 Office Equipment $1,300
1520 Office Furniture $1,650
1590 Accumulated Depreciation $496
2000 Accounts Payable $1,700
Totals $47,300 $2,196
Difference = Net Income $45,104

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.

Statement of Cash Flows
Cash Flows From Operating Activities
Net Income $45,104
(add back expenses that did not involve cash or cash substitutes)
Depreciation (see Bal Sheet Account 1590) $496
Increase in Payables (see Bal Sheet Account 2000) $1,700
————
Net Cash Provided by Operating Activities $47,300
————
Cash Flows From Investing Activities
Increase in Fixed Assets (see Bal Sheet Accounts 1500 & 1520) -$2,950
————
Net Cash Used by Investing Activities -$2,950
————
Cash Flows From Financing Activities
(no increase in long term liabilities or equity) $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 (see bal sheet acct 1000) $44,350

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 – Statement of Cash Flows

<< 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.

Percentage of Completion and Work in Progress

<< Cost of Goods Sold and Inventory

The Revenue Principle of GAAP requires Revenue to be recorded in the period it is Earned regardless of when it is billed or when cash is received.

In some cases, it is simple to determine the timing for Revenues Earned, once ownership of a product is transferred or a service is complete, revenue is considered to have been earned. But if revenue recognition were delayed until the end of a long term contract, the Matching Principle of tying revenues and their direct costs to each other would be violated. The solution to this problem is the Percentage of Completion method of Revenue Recognition.

Contract Revenues are tied to Costs, but Billings on Contracts are not always tied to Costs. Sometimes elements of a contract are billed in advance or sometimes they are delayed by mutual agreement (or disagreement). This mismatch between actual billed revenue and earned revenue will require an adjusting entry but since the Percentage of Completion method adjusts billed revenue to reflect earned revenue, billings are posted to revenues and adjusted later to reflect the correct earned revenue amount. (Debit Accounts Receivable, Credit Sales).

Long Term Contracts will have estimates for both sides of a contract, Costs and Revenues. Calculating Percentage of Completion requires both total actual and total estimated numbers to calculate a percentage so it uses the side where both the actual and estimated numbers can be known, Costs.

  • Percent Complete = Actual Costs to Date / Total Estimated Costs

The Percent Complete is then applied to the Total Estimated Revenue to determine Earned Revenue to Date.

  • Earned Revenue to Date = Percent Complete * Total Estimated Revenue

Finally, the Earned Revenue to Date is compared to the Billings on Contract to Date. The difference is either added to or subtracted from the Revenue.

  • Earned Revenue to Date – Total Billings on Contract = Over/Under Billed Revenue

The Over/Under Billed Revenue accounts are Balance Sheet Accounts and they are often called either Billings in Excess of Costs (liability account that reflects over-billings) or Costs in Excess of Billings (asset account that reflects under-billings).

Work In Progress Statement:

–finish reading this post—>>

<< Cost of Goods Sold and Inventory

**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 – Balance Sheet

Posted in 5. Financial Statements by Erin on September 8, 2008
Tags: , , , ,

<< 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.

Account Description Debits Credits
1000 Checking Account $44,350
1200 Accounts Receivable $0
1500 Office Equipment $1,300
1520 Office Furniture $1,650
2000 Accounts Payable $1,700
Totals $47,300 $1,700

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.

Balance Sheet
Assets
Current Assets
1000 Checking Account $44,350
Fixed Assets
1500 Office Equipment $1,300
1520 Office Furniture $1,650
————
Total Fixed Assets $2,950
————
Total Assets $47,300
Liabilities and Equity
Current Liabilities
2000 Accounts Payable $1,700
————
Total Liabilities $1,700
Equity
Net Income $45,600
————
Total Liabilities and Equity $47,300

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.

Account Description Debits Credits
7240 Depreciation Expense $496
1590 Accumulated Depreciation (Office Equipment) $260
1590 Accumulated Deprectiation (Office Furniture) $236

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.

Balance Sheet
Assets
Current Assets
1000 Checking Account $44,350
————
Total Current Assets $44,350
————
Fixed Assets
1500 Office Equipment $1,300
1520 Office Furniture $1,650
1590 Accum. Depreciation $-496
————
Total Fixed Assets $2,454
————
Total Assets $46,804
Liabilities and Equity
Current Liabilities
2000 Accounts Payable $1,700
————
Total Liabilities $1,700
————
Equity
3500 Retained Earnings $45,104
————
Total Equity $45,104
————
Total Liabilities and Equity $46,804

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.

Cost of Goods Sold and Inventory

<< Financials – Statement of Cash Flows WIP Statement and Percent Complete>>

The purpose of an Inventory System in Financial Accounting is to account for resources and to match costs to their related sales as closely as possible.  Management Accounting is more concerned with the details of inventory management but for Financial Accounting, when inventory is purchased or sold, the objective is to satisfy the Matching Principle and to accurately represent the financial position of the entity.

The Matching Principle requires that revenues and their related costs be matched up and posted into the same accounting period.  When Inventory is purchased and before it is sold, there are no revenues to match it to so it cannot be considered a cost until it is sold.

The inventory examples assume that the entity has ownership of products purchased and that they are purchased and manufactured for sale as finished goods.  There are cases where the entity purchasing materials for and accounting for a project are not the owners of the product even as it is in the process of construction or manufacturing.  In these cases, purchases are debited directly to Income Statement Cost accounts.  The key concept is ownership.

There are two systems used to account for Inventory, the Periodic System and the Perpetual System.  Each has its own accounting methods and I’ll demonstrate those methods here.  I will not be explaining Inventory Valuation methods (FIFO, LIFO, Specific Identification etc.)

Periodic Inventory System – Assumes Entity Owns Inventory until Sale:

The first system I’ll demonstrate is the Periodic System.  The Periodic System may work well for companies where changes in sales can be tied closely to changes in inventory purchases. Under this system, as inventory is purchased, it is debited to the Income Statement Account “Purchases” and the Balance Sheet Account “Inventory” is adjusted at the end of the year when the available inventory is counted and valued.  At this time, the balances of the Inventory and Purchase Accounts are transferred to Cost of Goods Sold Account and the value of the Ending Inventory is transferred back from Cost of Goods Sold to Ending Inventory.

Entry for purchases throughout the year.

Account Description Debits Credits
5050 Purchases $10,000
2000 Accounts Payable $10,000

*In the entry above, the credit entry could be cash, I chose Accounts Payable because it will be the most common account used in this situation.

>> More on Cost of Goods Sold and Inventory

Financial Statements – Income Statement

<< 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:

Revenue
Cost of Goods Sold
—————-
= Gross Margin
Expenses
—————-
= Operating Income
+ Other Revenue
Other Expenses
—————-
= Net Income

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.

Income Statement
Sales $50,000
Cost of Goods Sold $0
————
Gross Margin $50,000
Rent $3,000
Office Supplies $150
Subscriptions $300
Utilities $125
Fuel $275
Repairs & Maintenance $500
Credit Card Interest 50
———–
Operating Income $45,600
Other Revenues and Expenses $0
Net Income $45,600

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.

Account Description Debits Credits
4000 Sales $50,000
7000 Rent $3,000
7020 Office Supplies $150
7040 Subscriptions $300
7060 Utilities $125
7100 Fuel $275
7200 Repairs and Maintenance $500
7300 Credit Card Interest and Fees $50
Totals $4,400 $50,000

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.

Account Description Debits Credits
1000 Checking Account $44,350
1200 Accounts Receivable $0
1500 Office Equipment $1,300
1520 Office Furniture $1,650
2000 Accounts Payable $1,700
Totals $47,300 $1,700

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:

Account Description Debits Credits
4000 Sales $50,000
3500 Retained Earnings $45,600
7000 Rent $3,000
7020 Office Supplies $150
7040 Subscriptions $300
7060 Utilities $125
7100 Fuel $275
7200 Repairs and Maintenance $500
7300 Credit Card Interest and Fees $50
Totals $50,000 $50,000

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.

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