Accounting Unplugged


Understand your Numbers

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

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.

General Ledger Analysis – Accounting Periods

<< Chart of Accounts – Accounting Types >>Financial Statements – Trial Balance

This is where the Double Entry System starts to Pay Off.  The addition of the time element introduced in this post completes the basics of how to organize and operate this system.  From this point forward, you will start to experience nothing but increasing rates of return on your investment of time in learning it.  The next few posts will introduce Financial Statements and how to put them to work for you and will complete the circle for the basics.

The General Ledger is more than just another important element in the Accounting System, it is where the goods are.  The General Ledger is the combination of the Chart of Accounts, Financial Transactions, Account Balances and Accounting Periods.  In practice, once the Chart of Accounts has been established, the term “Chart of Accounts” is considered more in terms of a report than as an object.  From this point forward, Accounts from the Chart of Accounts will be called General Ledger Accounts.

The General Ledger adds the essential organizational element of Time (Accounting Periods) to the Accounting System, so in addition to the original three organizational methods of the Chart of Accounts, the General Ledger is organized in four ways.

  • 1. Accounting Type
  • 2. Order of Liquidity
  • 3. Account Number
  • 4. Accounting Periods

Accounting Periods are generally date/time intervals of Months, Quarters and Years.  The term Accounting Period can mean any of those in different situations.  For purposes of this discussion, Accounting Periods will refer to Months within a given year.

If the General Ledger is going to organize around accounting periods, then we need to add dates to the data we gather with transactions.  There can be a variety of dates that are relevant to a transaction, the transaction date, the invoice date, the due date, the expiration date etc. but for purposes of this post, the date we’ll focus on is the transaction date.

The transaction grid introduced in the previous posts needs to be expanded to 5 columns to accommodate the new data requirements of date and account number.

Transaction Date Account Description Debit Credit
9/01/08 7000 Rent $3,000
1000 Checking Account $3,000

The Transaction Date is only required to be entered on the first line of a transaction (in a manual ledger) because it is assumed to be (and must be) the same for each entry in a transaction.  In addition to the requirement that total Debits = total Credits for each Transaction, Total Debits must also equal Total Credits for each Accounting Period. This requirement fulfills the original intent of double entry, a balanced view of uses and sources of funds (debits = credits) by Transaction, by Accounting Period and by default, Overall.

Both entries in the transaction post to their Accounts in Accounting Period 9/08.

This is a Comparison Trial Balance Report from the General Ledger and this is where you can take a step back from the details of transactions and see the larger picture.

Account Description Jun Jul Aug Sept Oct Nov Dec Total
1000 Checking $0 $0 $0 -$3,000 $0 $0 $0 $-3,000
….. ……….
7000 Rent $0 $0 $0 $3,000 $0 $0 $0 $3,000
Totals $0 $0 $0 $0 $0 $0 $0 $0

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

The only accounts listed are the two from the transaction example but they demonstrate the ability to compare accounts against themselves and against other accounts from period to period.  Notice that the totals on the bottom line are all zeros, this shows that the books are in balance because total debits (positive amounts on this report) combined with total credits (negative amounts on this report) = Zero.

When reports do not have two columns to display amounts, the credits will be displayed as negatives.  In reports like this, *Debit Accounts should have positive balances and Credit Accounts should have negative balances.  There is only cause for concern if the +/- of the amount does not match its accounting type.  In this case, the Checking Account is a Debit Account so that is an indication of trouble. (*See 6. Chart of Accounts – Transaction Types)

Accounting Periods are an essential analysis tool in accounting.  They provide the opportunity to compare account balances not just one account against another but also against itself over time.  Time analysis provides the data to detect unusual changes in account balances from period to period that may indicate errors or unintentional over or under payments of critical obligations such as taxes, rents, utilities, insurance etc.  Time analysis is also essential to management and owners for cash planning, establishing correlations between expenses and revenues to help make operational adjustments, and detecting changes that may indicate theft or fraud.

Next Up: >>Financial Statements – Trial Balance

<< Chart of Accounts – Accounting Types

**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.

Chart of Accounts – More on Accounting Types

<< Chart of Accounts – Organization >> General Ledger Accounts by Acctng Period

This post completes the basics in the discussion about methods of organizing transactions with the Chart of Accounts – specifically the method of Accounting Types. The Chart of Accounts is really just a list of the descriptions that you have chosen to use in transactions and the Accounting Types help to organize the descriptions (accounts) in meaningful ways. The most important concept to transactions is Double Entry but the Chart of Accounts makes sense of the transactions and provides mission critical information to owners and managers.

The Basic Accounting Types (In order) Are:

  • Assets – Things you own
  • Liabilities – Things you owe
  • Equity – Owners’ Stake in Company
  • Revenue – Income through Sales of the Products of the Business
  • Costs of Goods Sold – Costs to provide the service or to manufacture or acquire the product the business sells
  • Expenses – Things that are paid for that are consumable, they have no lasting value but are part of the cost of running a business
  • Other Revenue and Expenses – Revenue and Expenses that are unusual cases and are not directly related to the business product and are not usual costs of running a business.

There are at least 7 basic Accounting Types, but each Accounting Type can be categorized more simply under the 2 Double Entry Accounting Categories as either Funds/Uses of Funds or as Sources of Funds.

Funds/Use of Funds (Debit) Accounting Types:

  • Assets – Things you own
  • Costs of Goods Sold – Costs to provide the service or to manufacture or acquire the product the business sells
  • Expenses – Things that are paid for that are consumable, they have no lasting value but are part of the cost of running a business
  • Other Expenses – Expenses that are unusual cases and are not directly related to the business product and are not usual costs of running a business.

–finish reading this post on my new site—>>

Next Post:  >>Accounting Periods – General Ledger Analysis – The Big Picture

<< Chart of Accounts – Organization

**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.