Accounting Unplugged


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.

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.