Week 1 Transcript (English)
Week 1 Transcript (English)
Financial accounting creates standard financial statements that provide users with
information about a company's financial health. The users of financial statements are
typically external to the company. The data provided is in line with standards established by
the Financial Accounting Standards Board (FASB).
The FASB sets the Generally Accepted Accounting Principles (GAAP) that are used to
produce financial statements. This standard set of principles helps to make financial
statements comparable and reliable across companies. Following the financial accounting
definitions helps a company communicate information about its financial performance.
For example, a managerial report can be at a lower level than financial reports, perhaps
looking at the revenue and costs for a specific product versus the company as a whole. That
level of detail is typically not found in financial reports but is very helpful to the manager of
that product line. Or a managerial accounting report might include forecasts for future
revenue and costs while that detail Is not released externally.
The standards serve to ensure fair and reliable reporting. The FASB is a non-profit
organization whose goal is to raise confidence in published financial reports. The Securities
Exchange Commission (SEC) also promotes the disclosure of market information, but its
principal goal is to promote fair markets and trading, not specific to financial accounting.
Publicly traded companies must follow GAAP while private companies may not unless they
are borrowing publicly. The FASB provides a level of confidence and protection for investors
and creditors in these companies.
Under accrual accounting, it is standard that two entries are always made, called double-
entry accounting, which maintains the assets equaling liabilities plus credit relationship. One
entry is typically a debit, and one is usually a credit. A debit increases assets accounts and
lowers the balance of liability and equity accounts. In contrast, a credit will lower an asset
account and increase the balance of liability and equity accounts.
In the example where supplies are bought, the supplies account would be debited to show a
higher amount. If the company intends to pay later it will then also credit the accounts
payable account at the time of purchase to reflect the liability. When the invoice is later paid,
cash is credited and accounts payable is debited.
Cash Basis Accounting
An alternative accounting system calls for recording revenues and expenses only when cash
is received or paid. This is called cash basis accounting. In the example above where
supplies are bought on account, the supplies would only be added to the financial
statements when the invoice is paid in cash. This method can be more straightforward, and
easier to understand. It requires only a single-entry, rather than the double-entry
accounting used in the accrual method.
A balance sheet shows a company's assets, liabilities, and equity (net worth) at a
point in time
The income statement presents net income for a specific period after detailing
revenues and costs
Cash flow statements display cash inflows and outflows typically separated into
operating, investing, and financing activities
The statement of owner's equity shows how the owner's investment changes during
the period due to dividends, income, or losses, as well as deposits and withdrawals
Lesson Summary
The production of financial statements for an external audience is called financial
accounting. This differs from managerial accounts, which serve internal users and can be
produced in multiple different ways. The financial statements produced include the balance
sheet, income statement, cash flow statement, and statement of owner's equity.
The external standards to create the financial statements are called Generally Accepted
Accounting Principles (GAAP) and are set by the non-profit organization called
the Financial Accounting Standards Board (FASB). This differs from the SEC, who sets
regulates stock trading. All publicly traded companies must follow GAAP.
1. Analyze Transactions
In this step, every transaction will be looked at and analyzed to determine how it affects the
financial position or the accounting equation. In this step, documents such as receipts,
invoices, bank statements, etc., will be looked into, as they provide proof of each financial
activity taking place.
2. Journalize Transactions
This is a method to track all the transactions by recording them in chronological order as
they take place. Entries that are recorded are usually separated into credit and debit along
with the date and a summary of the transaction.
3. Post Transactions
Posting transactions refers to the posting of entries from the journal to the general ledger
accounts. General ledger accounts are accounts that have their own unique numbers and
categories. When posting entries, the entries will be transferred to the account that is
affected by the respective entry. For example, if the cash account in the journal is debited,
the entry will be posted to the respective cash ledger account, which will be debited the
same amount as recorded in the journal.
Lesson Summary
There are ten steps in an accounting cycle, which include analyzing transactions,
journalizing transactions, post transactions, preparing an unadjusted trial balance,
preparing adjusting entries, preparing the adjusted trial balance, preparing financial
statements, preparing closing entries, posting a closing trial balance, and recording
reversing entries. In these steps, an unadjusted trial balance is the first trial balance that
must be prepared; it sets a base for the future steps and acts as a guide to make sure all the
transactions recorded are accurate up to that step. When preparing the financial
statements, the income statement is prepared first, followed by the statement of retained
income, balance sheet, and cash flow statement.
A cash flow statement shows how much money came in and went out of a company
during a given time period. Closing entries are the entries that close temporary accounts by
transferring those data to permanent accounts or balance sheet. A budget cycle is a cycle
to plan for transactions that may happen in the future, while an accounting cycle is used to
record transactions that already happened.
There are various methods of recording transactions, but the most common and simplest
method is the double-entry bookkeeping system. Under this system, an accountant records
each transaction in at least two different accounts, with a corresponding debit and credit
entry. This system helps to ensure the accuracy of financial records and provides a clear
audit trail in case of any discrepancies.
Debits always increase asset and expense accounts, while debits always decrease them. The
converse is true for liability, equity, and revenue accounts; credits increase them, and debits
decrease them. These concepts help to ensure that the accounting equation is always in
balance.
It can be helpful to explore a brief example of the general transaction and recording in the
accounting process. Imagine that furniture company XYZ recently bought a new piece of
machinery. The accountant, Shelby, has entered into the accounting system in the form of a
journal entry. Shelby has considered which accounts this purchase will impact. She has also
determined what account she should debit and which she should credit for this particular
transaction. Shelby will now make the entries in the journal to record the proper debits and
credits.
There are different types of journals used in accounting. Some of these include the sales
journal, the purchases journal, the cash receipts journal, the cash disbursements journal,
and a general journal (also known as a proper journal). The type of journal an accountant
uses will depend on the type of business and their accounting software.
Example 1
Company ABC is a clothing retailer and recently purchased 1,000 pieces of clothing for its
inventory. The clothing cost $5,000 and was paid for with cash. In this case, the two
accounts that would be impacted are Inventory and Cash. The inventory account would be
debited $5,000 and the cash account would be credited $5,000. This would result in a $5,000
increase in the inventory account and a $5,000 decrease in the cash account because they
are both asset accounts. These entries would be made in the journal and/or ledger with the
date of their occurrence.
Example 2
Company ABC has also recently sold $10,000 worth of clothing to customers. The clothing
was purchased with cash. This entry for this transaction would be the reverse of the
previous one. The cash account would be debited $10,000 and the inventory account would
be credited $10,000. This is because cash is being received and inventory is being sold.
Lesson Summary
The recording of transactions in accounting is an extremely important process because it
provides the basis for financial statements and tax returns, helps in decision-making, can be
used to track trends and identify opportunities, and also aids in fraud prevention. In the
context of accounting, a transaction is an event that results in a change in the financial
position of a company. Transactions are recorded in a journal and then posted to a ledger.
The general flow of the process is as follows:
Doube-entry accounting ensures that the total amount of debits equals the total amount of
credits. Learn the basics of how this accounting system is reflected in journals and ledgers
through examples, and understand the concept of normal balances.
Double-entry accounting puts this equation to use by making sure that every financial
transaction is recorded with an entry that utilizes at least two accounts and where the total
amount of money on the left, the debit side, equals the total amount of money on the right,
the credit side.
This is where students taking their first accounting course often get confused. Thanks to the
banking industry's use of the terms, we tend to think of a debit as being like our debit cards
that take money out of our accounts and a credit as being like our credit cards that create a
liability on our part. In accounting, debit and credit are nothing more than directional
indicators meaning left and right. We could use them in well-known situations as nothing
more than directional indicators, and it would make perfect sense to anyone who
understands their use in accounting:
A journal is a record of the various financial transactions that happen in the course of
business. Entries are initially made to the journal and then posted, or copied, to the ledger,
which tracks the effects of those transactions on individual accounts. An individual account
is a group of similar items, such as cash, office equipment, accounts payable, or common
stock. This is a picture of part of a general journal page with a couple of entries to illustrate
the concept.
Notice that each entry has the date that the transaction happened, what accounts were
affected, how much money was involved, and a short description of what happened. Notice,
too, that both the debit and credit columns contain the same total amount of money for
each entry. It is important to remember that they need to contain the same total amount; as
many accounts as are needed may be used on each side, and any appropriate dollar
amounts may be entered. The entry below is just as valid as either entry above:
A journal entry that uses more than two accounts is called a compound entry. Notice in this
example that the entry uses six accounts; four are debited and two are credited. The entry
still meets the requirement that the total dollar amount is the same on each side:
You may have noticed the column labeled post ref, which stands for posting reference. This
column is used to indicate the page in the general ledger to which that line of the
transaction was posted. By keeping the dollar amounts on each side equal, we ensure that
we will also maintain the accounting equation, and assets will indeed equal liabilities plus
equity.
Accounts are said to have either debit or credit balances depending on which side has the
most money entered. Different types of accounts also have different normal balances.
Normal Balances
Using the word normal in association with accounting may seem like an oxymoron, but we
do say that certain types of accounts have either a debit or credit normal balance. This
means that they tend to have a balance that is either on the debit or credit side most of the
time.
In studying accounting, we notice that two types of accounts, assets and expenses, tend to
carry debit balances. The other three common types of accounts tend to carry credit
balances, which are liabilities, equity, and revenues. We can think of entries to the normal
balance side of an account as adding to the account and entries to the other side as
subtracting from the account. We saw this with the cash account earlier while looking at the
general ledger.
An easy way to remember the normal balances of the asset, liability, and equity accounts is
to simply remember the accounting equation:
This fails to cover revenues and expenses, but we also have a way to remember their
normal balances. The revenues earned and expenses incurred by a business are where the
company's income comes from. The income of the company belongs to the owners.
Therefore, we can think of revenues as adding to equity and expenses as subtracting from
equity. Equity has a normal credit balance, so credits add and debits subtract, and so, we
can remember that revenues (which add to equity) have a normal credit balance--just like
equity. Expenses, which subtract from equity, have a debit normal balance from equity.
Lesson Summary
Double-entry accounting is an accounting system that involves the recording of all
financial transactions in at least two accounts. Within the accounts, the total entries on each
side (the debit side and credit side) must be equal. The debit side is the left side. The credit
side is the right side. Certain accounts tend to carry normal debit balances (like assets and
expenses accounts), while others tend to carry normal credit balances (such as liabilities,
equity, and revenues accounts). This system is based on the equation developed centuries
ago by Luca Pacioli:
While this concept has been around for many years, it still finds use in the accounting field.
Periodic reporting and time period principle are common business methods of reporting
financial information. Learn about periodic reporting, time period principle, and the
importance of time periods in reporting financial information.
People, like investors, creditors, company executives and employees are all very much
interested in the financial status of a company. Because of that, the concept of periodic
reporting was created. Periodic reporting means that company finances are reported in
distinct time periods.
The time period principle states that the activities of a business can be broken down into
specific, short and distinct time intervals. These intervals can be monthly, quarterly,
semiannually or annually. It just depends on what the specific company feels is necessary to
accurately show their financial status at specific points in time.
Company leadership needs to see the financial reports of a business more than just once a
year, simply because they have to forecast the future sales, expenses, and staffing of their
company. Information that is reported on the financial statements allows them to do that
forecasting as accurately as possible.
For investors, creditors, and those that are potential investors and creditors, it lets them see
how well the company is performing at different times as well as comparing past and
present performance records. This allows them to make informative decisions on whether
they want to enter into or continue business relations with the company.
Employees are interested in the financial status of the company for two very good reasons.
First, employees may take part in profit sharing within a company. In that case, the better
the company performs, the more money that employees are building in retirement
accounts. Second, employees are interested in company finances because it can affect their
job security. They need to know that the company is on track financially, or if it isn't, they
need to prepare themselves for potential lay-offs and shut downs.
Regardless of the reason for periodic reporting and the time period principle, they are both
very important in the world of accounting.
Lesson Summary
Periodic reporting and the time period principle go hand in hand. Periodic
reporting means that company finances are reported in distinct time periods, while
the time period principle means that the activities of a company can be broken down into
specific, short, distinct time periods. These time periods can be weekly, monthly, quarterly,
semiannually or annually, whichever best suits the specific company and accurately portrays
their financial status at specific points in time.
The time period principle is one of the generally accepted accounting principles that have
been established by the Financial Accounting Standards Board (FASB). The FASB is the
governing board of accounting practices in the United States.
There are a number of individuals who use the data that's reported on the financial
statements, such as company leaders, investors, creditors and employees. Employers use
the financial data to aid them in forecasting the future sales, expenses and staffing needs of
their company. Investors and creditors want to see how well a company is performing so
they can decide whether to continue their current relationships or enter into new
relationships with the company. Now, employees may be interested in the financial data
that is reported for a company when they are participants in profit-sharing plans, and the
better the company does financially, the more their nest egg grows. A second reason
employees may find financial data important is that it gives them an insight into how well a
company is performing or not performing, which is important for job security.
Reporting financial data in a timely and orderly fashion is not only a requirement of the
FASB, but it's also a vital part of a company's livelihood.
Learning Outcomes
You'll have the ability to do the following after this lesson:
Income statement
Statement of retained earnings
Balance sheet
Cash flow statement
Income Statement
The income statement is used to determine whether a profit was made. It provides data
about a company's earnings within a specified time period, usually one year. The income
statement must include all revenue (the money made by a business through sales or other
means within a given period) and all expenses (the costs of the business within that same
period). The layout of an income statement typically includes the net sales at the top with
deductions of the cost of these sales, as well as operating expenses and non-operating
expenses right below it. Operating expenses are those incurred due to running the
business, such as employee salaries and conducting market research. Non-operating
expenses are those that are not used in the actual operations of the business, but must still
be recorded. A common example of this type of non-operating expense is taxes paid by the
business.
These figures can be used to calculate the net income, commonly referred to as the bottom
line or net earnings, which is the total amount of profit (or loss) the company experienced
for a given time period. For example, if the net income is equal to $50,000, this means the
company made a profit of $50,000 for that year. The basic formula for calculating net
income is:
Depending on the needs of the business, an income statement may be simple, or it may be
more detailed, with income and expenses further broken down into additional categories or
lines included on the statement, such as depreciation expenses, amortization, employee
wages, or the cost of goods sold (COGS). The income statement may also be comparable to
the statement of comprehensive income, which includes net income as well as
comprehensive income. Comprehensive income and comprehensive expenses are those
pertaining to sources such as retirement accounts or securities, which aren't included on a
traditional income statement.
Retained Earnings = Beginning Period Balance + Current Net Profit - Cash and Stock
Dividends
For example, if a company's beginning period balance equals $50,000, net profit equals
$10,000, and dividends paid equals $40,000, then the company would have $20,000 in
retained earnings left over to be reinvested.
Balance Sheet
A balance sheet is used by a business to ensure all assets are equal to its liabilities. This
statement essentially shows what a business is worth. It consists of two columns: the left
side for assets and the right side for liabilities and shareholder's equity. Assets are the
things that a business owns, whereas the liabilities are the things a business owes to
others. Liabilities may be owed to other businesses, suppliers, lenders, employees, or
customers. The left and right sides of the balance sheet must be equal, such that:
If a business owns $100,000 in total assets, then its shareholder's equity and liabilities
together must also equal $100,000.
Operating activities pertains to the cash flow from the operations of the business and
analyzes the net income of the business. This is the cash flow that is generated from
consumers as products are sold. Investing activities focuses on a company's long-term
assets and how they are sold or purchased. For example, if a company purchases a new
factory or sells some of its equipment, this would be an investing activity. Financing
activities shows the cash flow from activities that pertain to the continued operation of the
business, such as selling company stocks and bonds or paying interest on a bank loan.
Customers, market analysts, and government agencies may also use financial statements.
Customers may be impacted by data on financial statements as they may decide on
whether to continue purchasing a company's products or switch to a competitor. Market
analysts can conduct research based on the trends of the financial documents to forecast
sales. Government agencies, like the IRS, may use financial statements with regards to
audits or for other income verification methods.
Lesson Summary
Financial statements are important for businesses in order for them to keep track of items
such as revenue, expenses, and overall financial status. There are four main financial
statements which are most commonly used. The income statement indicates whether a
profit was made and includes all revenue and expenses of the business. The statement of
retained earnings shows the amount of money that can be reinvested back into the
business. The balance sheet shows a business's worth and ensures assets are equal
to liabilities. The cash flow statement shows how the money flows in and out and consists
of operating activities, investing activities, and financing activities. Each of these
statements may be used in decision making by business owners, as well as by other
individuals or entities outside of the business, such as customers, investors, lenders, and
government agencies.
What is an income statement? An income statement is a list of all the income entering the
business compared to all the money exiting the business through expenses; it is, essentially,
a profitability report. Investors are interested in how profitable, the ability to make more
than is spent, a business is, and an income statement gives this information clearly and
concisely.
Income entering the business is referred to as revenue. Money being paid out by the
business is called expenses. The income statement allows for a direct comparison between
a business's revenue and expenses with the result of a net income or loss, the profitability
of the business. The formula for calculating the net income (or loss) of a business is:
Income statements have many names, which all mean the same thing, a financial statement
to compare a business' revenue (income) to its expenses (outgo money) in order to
ascertain its profitability (net income). A few of the commonly used phrases synonymous
with income statements are:
Statement of Income
Statement of Earnings
Statement of Operations
Statement of Operating Results
Income Expense Statement
As stated, income statements are used to compare income to expenses, but how to prepare
an income statement depends on the specific needs of that business.
All companies list items on the income statement in different detail; their income statement
format is suited to the needs of the business. However, it is common to find certain items
on every income statement under the income statement revenue section and under the
income statement expense section.
Sales
o This could be broken into sales income for each item on a detailed income
statement.
Investment Income
Other Income
o This line might specify each other line of income.
Operating Expenses (may include costs of materials, rent, licenses required for
operation, salaries).
utility Expenses
o This may be broken down into specific line items such as water, electricity,
internet, etc.
Salaries/wages paid (if not included in the operating expenses)
Tax obligations
It is interesting to note that companies choose whether to list a single line for operating
costs, often called ''Selling, General and Administrative Expenses (SG&A)'', or list individual
lines to document each expense to the company. This fact is a good example of the purpose
of an income statement and what it shows the user. So, what does an income statement
show? It shows the efficiency of a company and details just how profitable the company is. A
company working on a loss would show negative numbers as the net income at the bottom
of the income statement. Companies can review income statements from different periods
to check for consistency, growth, or loss impact over time.
The next logical question to answer is how to prepare an income statement. There are two
main formats:
Each format can include as much or as little detail as desired by the company.
Here is a template for a basic multi-step income statement with an explanation for each
line:
Multi-Step Format Income or Expense Step of Comparison Line
Taxes Expense
Single-step income statements do not have subtotals throughout the statement. In this type
of income statement, revenues are listed first, and expenses come second. They can be
formatted in multiple columns with income and expense amounts listed in separate
columns, or they can be formatted in a single column for income/expense amounts. In the
instance that there is a single column for all monetary amounts, expenses are often listed
within brackets to indicate that they are to be subtracted from the income.
Utilities 1000
Company XYZ had the following income statement for the period January to February (Year
2).
Revenue Expense
Water 100
Electricity 500
Revenue Expense
Water 90
Electricity 400
1. The previous period's net income was $4,770, while the current year's net income was
$6,500.
2. Comparing the two income statements shows that the company was more profitable in
the current period than it was a year ago in the same period.
3. All of the expenses have increased over the year, but this is to be expected to some
degree in any working business. However, the internet data usage expense has increased by
a very large margin indicating there may be a concern that the company should investigate.
This increase is a sign that there is inefficiency in internet data usage that might be able to
be resolved.
By comparing these two income expense statements based on the same period in different
years, the CEO of this company can quickly compare profitability, income statement
revenue, and expense changes and identify problem areas within the company's financial
health. In this case, the CEO will likely have the IT department investigate the increase in
data usage and troubleshoot a solution to decrease this expense line item.
Lesson Summary
An income statement is a financial document that compares income to expenses within a
company. Revenue is the amount of money entering a company, while expenses are
payments going out of a company's account. Income statements show whether a company
is profitable, made or lost money in a given period, and indicates the company's general
operating efficiency by allowing owners and investors to compare income to outgoing
money.
There is a simple formula for calculating net income, the amount of profit or loss a
company sees. The formula equates to subtracting the amount paid out from the amount
brought in and can be formally stated: Net Income = Revenue-Expenses.
Balance sheets
Income statements
Cash flow statements
Statements of shareholders' equity
A balance sheet is used to help a business get loans, convince shareholders to invest with
the company, and demonstrate the financial health of the business. Without knowing how
much money a business owes, the cash flow and income may look a lot better than they
really are. On the other hand, without knowing how much a business holds in assets, lower-
income or cash flow may look less appealing.
The next section is liabilities. This section is also broken into sub-categories. These
subsections may include accounts payable, long-term debt, and unearned revenue.
Sometimes equities are included with liabilities; other times it becomes its own section.
Either way, equity gets added to total liabilities.
The four main financial reports are held to specific standards as outlined by the Generally
Accepted Accounting Principles (GAAP). This helps ensure shareholders or lenders can easily
look at a balance sheet and find what they are looking for. According to GAAP, the balance
sheet needs to list everything based on how easily it can be converted into cash. The items
that are most easily converted are listed first, and items that are least easily converted are
listed last. This means that current assets, such as cash and bank account holdings, are
always listed first since they are already in cash form or can easily be converted into cash to
use. Owner's or shareholders' equity is listed last; this equity can be very difficult to convert
into cash.
Importance of Balance Sheets
Overall the importance of a balance sheet is to help people better understand a company's
financial health. Together with the other financial statements, the balance sheet can help
give a good picture of a company's financial health. Specifically, some of the things that a
balance sheet can help with are:
When a merger is under consideration, a balance sheet will show the merging companies
whether they will be taking on extra debt or extra cash. A company can use a balance sheet
to help determine if asset liquidation should be considered or if more debt can be managed.
It can also help a company determine if it is stable enough to expand or if it needs to focus
on paying back debts.
Balance Sheet
Assets
Current Assets
Cash $5,497
Accounts Receivable $19,847
Inventory $26,497
Prepaid Expenses $6,497
Short Term Investments $649
Total Current Assets $58,987
Non-Current Assets
Property, Plant, and Equipment $305,978
(Less Accumulated Depreciation) ($59,847)
Intangible Assets
Total Non-Current Assets $246,131
Other Assets
Deferred Income Tax $5,497
Other $1,647
Total Other Assets $7,144
Total Assets $312,262
Liabilities and Owner's Equity
Current Liabilities
Accounts Payable $4,902
Short Term Loans $6,487
Income Taxes Payable $4,978
Accrued Salaries and Wages $16,497
Lease Obligations
Current Portion of Long Term Debt $52,198
Total Current Liabilities $85,062
Long-Term Liabilities
Deferred Income Tax
Long Term Lease Obligations $12,497
Total Long Term Liabilities $12,497
Equity Capital
Common Stock $64,973
Retained Earnings $110,252
Other Comprehensive Income Loss
Total Owner's Equity $175,225
Non-Controlling Interest $39,478
Total Equity Capital $214,703
Total Liabilities and Owner's
$312,262
Equity
Notice in this balance sheet that the line total for liabilities and owner's equity is the same as
the line total for assets, with both being equal to $312,262. Also, note that line items without
a value assigned to them are still included in the balance sheet. This is to show that these
line items have not simply been forgotten, but instead, have a $0 value.
Lesson Summary
A balance sheet is one of the four main financial statements that are standardized by
GAAP. It includes all assets and liabilities currently held by a company. Assets are the things
that a company owns. While liabilities are things that the company owes to others.
Included in the liabilities sections are owner's equity (for a privately held company) or
shareholders' equity (for a publicly held company), which is money that the shareholders or
owner have put into the business and it is now how much money is owed to them. A
balance sheet is a great tool for businesses or lending groups to use in determining the
financial health of a company. It can also be used to better understand if a company can
afford to grow or if it is time for a company to pay off debts.
A balance sheet is based on the formula Assets = Liabilities + Equity (either owner's equity or
shareholders' equity). On the balance sheet assets are listed first, in order of ease to convert
into cash, and the total is calculated. Liabilities and equities are listed, again in the order of
ease to convert into cash, and the total is calculated. The line that totals assets should equal
the line that totals liabilities and equities.
There are two methods to calculate cash flow: the direct method and the indirect method.
Both of the methods are compliant with both the international accounting standards (IAS)
and the generally accepted accounting principles (GAAP). The direct method provides the
most accurate and transparent view of cash flow. The direct method uses cash receipts and
cash payments to calculate cash flow from operating activities. In other words, all cash
inflows and outflows from operating activities are itemized and listed. From this
information, the net cash flow from operating activities can be calculated. For many
companies, this method is more time-consuming and difficult to calculate. This is because it
requires companies to track all cash receipts and cash payments.
The indirect method of statement of cash flows is the most commonly used method. It is not
as accurate or transparent as the direct method, but it is significantly easier to calculate. The
indirect method starts with net income and then adjusts for items that do not affect cash
flow. For example, depreciation is an expense that does not require the use of cash and
would be added back to net income. The indirect method is a simplified way of calculating
cash flow and does not require companies to track all cash receipts and payments to
calculate cash flow.
The cash flow statement is also important because it shows the sources and uses of cash.
The operating activities section provides significant insights into the day-to-day operations
of the business. This information can be used to make decisions about how to improve
operations. For example, if a business is not generating enough cash from operations, it
may need to increase prices or reduce expenses. The investing and financing activities
sections provide information about the long-term activities of the business. This type of
information is often used to make decisions related to the allocation of resources. For
example, a business may decide to use its cash flow to pay down debt or repurchase shares.
Example 1
ABC Ropes is interested in purchasing a retail storefront to sell their ropes, as they have
previously only been selling online. ABC takes a loan from the bank in order to purchase a
retail space outright. A $250,000 loan is received by ABC from the bank in order to make this
purchase. What is this $250,000 categorized as and what type of activity is it?
This $250,000 is categorized as a cash inflow financing activity because it is money that ABC
has received from a loan in order to finance its purchase of retail space. In other words, the
money borrowed from the bank is considered a cash inflow. The money that will later be
paid out to purchase the shop will be a cash outflow, which in this case will be a financing
activity.
Example 2
XYZ Corporation is a manufacturing company. They use cash to purchase raw materials,
which they then use to manufacture their products. They sell their products for cash. What
type of activity is this?
Example 3
ABC Corporation is a holding company. It owns shares of XYZ Corporation. ABC decides to
sell its shares of XYZ for cash. What type of activity is this?
Lesson Summary
A statement of cash flows, or cash flow statement, is a financial statement that shows the
cash inflows and outflows of a business. This statement explains any changes in the cash
balance of a company during a specific accounting period. The cash flow statement includes
three main sections known as operating activities, investing activities, and financing
activities. The operating section is the section of the cash flow statement that includes
activities that occur during the normal day-to-day operations of the company. The investing
section is the section of the cash flow statement that includes activities that are related to
long-term investments. The financing section of the statement of cash flows includes
activities that involve cash receipts or cash payments from changes on long-term liabilities.
An example of an activity that would be listed as a cash inflow in the financing section would
be if a company took out a $250,000 loan from the bank to purchase a new retail space.
There are several important uses for a cash flow statement. A cash flow statement can be
used to assess the solvency of a company, which is the ability of a company to pay its debts
as they come due. A cash flow statement can also be used to make important decisions
related to resource allocation. For example, a business may decide to use its cash flow to
pay down debt, reinvest in the business, or give back to shareholders in the form of
dividends.
The Generally Accepted Accounting Principles (GAAP) are used by accountants when
deciding how to account for different items while preparing financial statements. The GAAP
do not provide strict rules about how different items should be analyzed financially, rather
they provide guidelines that accountants must use to apply to their own organizations when
creating financial report statements. The notes to the financial statements often contain
information about how the accountants applied the GAAP to the financial reports of an
organization.
Different organizations use different accounting methods, and GAAP allows for variability
across organizations to best fit the organization's needs. An organization using cash basis
accounting will recognize revenue when the money for a sale or an expense is received or
dispensed, whereas an organization using an accrual basis of accounting will recognize
revenue when a transaction is completed, but before the money is exchanged. Accounting
for the value of inventory is completed using the lower cost or market method, which states
that inventory should be valued at a lower cost when comparing the historical cost to the
current market value.
The GAAP also provides guidance to accountants for which events must be reported. A
subsequent event is an event that takes place after the closing of the reporting period, but
before the date, the financial statements will release to the public. Subsequent events may
be recognized or unrecognized. Recognized events are events that are recognized in the
notes of a financial statement, whereas unrecognized events are not recognized in the notes
on a financial statement. Intangibles are entities that provide value but are difficult to
quantify because intangibles are not physical objects or tangible services that can receive a
numerical valuation. Intangibles could include assets such as notoriety provided by a
trademarked logo, value added by patents owned by the organization, or trade secrets. The
value of intangibles is heavily dependent on estimation, and valuation methods for
intangible assets will be detailed in the financial statement notes.
Consolidated financial statements report the financial position of an organization that holds
multiple subsidiary groups of businesses. A consolidated financial statement will report the
financial position of the organization as a whole and the consolidated statement will be the
financial report required by the SEC. The organization will often provide financial details for
separate entities in its annual report. A contingent liability is a liability for an event that has
not occurred but is likely to occur in the immediate future. Common contingent liabilities
that receive recognition on financial statements include pending lawsuits and financial
planning for product warranty claims.
A company that manufactures and sells automobiles will include a value for
contingent liability for warranty claims for the automobiles manufactured. The
company will use data from past warranty claims to calculate the expected future
liability expense, and include that expense on the financial statement. The notes for
the financial statements will detail how accountants at the company estimated the
expense.
Many companies have outlined the impact of the Covid-19 pandemic in the notes to
their financial statements. These notes provide the company the opportunity to
explain the losses in revenue that many companies experienced, and explain how
those losses were absorbed financially. Providing this information allows investors to
make informed decisions while taking into consideration the special impact of the
pandemic.
Lesson Summary
Financial statements are documents companies use to communicate financial data to
shareholders and the Securities and Exchange Commission (SEC). Notes to financial
statements explain why accounting decisions were made, outline extraneous factors that
impacted a company during an operational cycle, and detail factors that may impact a
company financially in the immediate future. The notes to the financial statements are used
to give additional company information to financial statement users. Generally Accepted
Accounting Principles (GAAP) are the guidelines that accountants use to determine how
things are reported in the financial statements.
The GAAP will also dictate what is reported in the body of the financial statements and what
is disclosed in the notes to the financial statements. The accrual basis of
accounting records income when a sale is made and expenses when a bill is received.
The cash basis of accounting records income when money is exchanged. Subsequent
events are events that happen after the date the financial statements are created but before
the financial statements have been issued to the public. Subsequent events are considered
either recognized or unrecognized. A contingent liability is a liability that has not occurred,
but the conditions are favorable for the event to occur in the immediate future.
This is the basic accounting equation. It gives meaning to the balance sheet structure and
is the foundation of double-entry accounting. Double-entry accounting is the practice where
one transaction affects both sides of the accounting equation. This is used extensively in
journal entries, where an increase or decrease on one side of the equation may be
explained by an increase or decrease on the other side. Buying raw materials for a
manufacturing business, for example, is an increase in assets but balanced with an increase
in liabilities if the money used for buying was from a credit line or an increase in equity if the
money used was from the owner's capital contribution.
The basic accounting equation balances the following three elements: Assets, Liabilities, and
Owner's Equity.
Assets
Assets are everything that a business owns. They are grouped into two main categories:
current and non-current assets. The current assets are cash and cash equivalents. The non-
current assets are the owned properties that may take time to sell to convert their value to
cash. Examples of assets are cash, accounts receivables, inventory, equipment, and land.
Liabilities
Liabilities are things that the business owes in debt and costs that it needs to pay. Debts
are in the form of lines of credit or loans. The business borrows money or purchases goods
from a lender or supplier and promises to pay after an agreed period with interest.
Examples of liabilities are accounts payable, short-term debt borrowings, and long-term
debts. Costs are obligations that a business needs to pay, including rent, taxes, utilities,
salaries, wages, and dividends payable.
Owner's Equity
Owner's equity is also referred to as shareholder's equity for a corporation. This is the
value of money that the business owners can get after all liabilities are paid off if the
business shuts down. This may be in the form of shared capital or outstanding shares of
stocks. Examples of equity are capital and retained earnings. Retained earnings are the
sums of money that came from the company's profit that was not given back to the
shareholders.
The accounting equation formula helps in ledger balancing using double-entry accounting.
The ledger has debits on the left side and credits on the right side. The total amount of
debits and credits should always balance and equal. In bookkeeping and management of
ledgers, the basic accounting formula is extensive.
Assets Calculation
The basic accounting formula highlights the calculation of the assets and the relationship of
the three elements to each other. Total assets are total liabilities, and shareholder's equity is
added together. The main use of this equation is for the accurate recording of the balance
sheet. The double-entry practice ensures such accuracy by maintaining balance in each
transaction.
Purchase of equipment, for example, will increase assets. The accounting equation creates a
double entry to balance this transaction. If cash were used for the purchase, the increase in
the value of assets would be offset by a decrease in the same value of cash. If the
equipment were purchased using debt, the increase in assets would be balanced by
increasing the same amount in loans or accounts payable. This practice of double-entry
allows verification of transactions and the relationship between each liability and its source.
where:
The contributed capital (CC), beginning of retained earnings (BRE), and dividends (D) show
the company's transactions with the shareholders. It shows how the company shares profit
with its shareholders or keeps money in retained earnings. The revenue (R) less expenses (E)
show the net income on stockholder's equity.
Example 1:
Paul took $1000 from his savings to contribute to the starting business. He also took a soft
loan of $4000 from a credit union to buy office supplies. He received a $400 insurance bill
for his shop two days later. Calculate the total value of Paul's liabilities.
SOLUTION:
Liabilities are debts and expenses that a company needs to pay after some time. In this
example, Paul's soft loan of $4,000 and the $400 bill for insurance that he needs to pay
(considered expenses) are part of his total liabilities. Therefore, total liabilities = $4,000 +
$400 = $4,400.
Example 2:
On January 1st, 2020, Sherry took out the money from her savings for $100,000 to start her
skincare business. Determine the asset, liability, and equity value of her skin clinic as of
January 1st, 2020.
SOLUTION:
The basic accounting equation is balanced at any time. On January 1, 2020, the business had
$100,000 assets in terms of cash, $0 liabilities, and $100,000 owner's equity.
Example 3:
Company ABC wishes to purchase a $1,500 office machine using only cash. What is the
effect of this transaction on the basic accounting equation?
SOLUTION:
Purchasing the office machine with cash of $1,500 means an additional $1,500 on assets for
the purchased machine and a deduction of $1,500 for the assets in terms of cash going out.
This will cancel the values, and no change has happened on the right side of the equation.
Example 4:
Company ZZK plans to buy office equipment that is $500 but only has $250 cash to use for
the purchase. The remaining amount will be billed at a later time.
SOLUTION:
The purchased office equipment will increase Assets by $500 and decrease them by $250
(cash). On the left side of the basic accounting equation, an increase of $250 is balanced by
an increase of $250 on the right side of the equation for liabilities (accounts payable).
Lesson Summary
The basic accounting equation gives meaning to the balance sheet structure and is the
foundation of double-entry accounting. It has the following formula: Assets = Liabilities +
Owner's Equity. For every transaction in a business, there is a balance that is happening
between the three elements of the accounting equation. Assets will always equal the sum of
liabilities and owner's equity. Assets are everything that a company owns. Examples of
assets include cash, land, buildings, equipment, accounts receivable, and
supplies. Liabilities are what a company owes. Things such as utility bills, land payments,
employee salaries, and insurance are examples of liabilities.
Owner's equity is the amount of money that a company owner has personally invested in
the company. The residual value of assets is also what an owner can claim after all the
liabilities are paid off if the company has to shut down. The basic accounting equation is
very useful in analyzing transactions with the global practice of double entry in bookkeeping
and ledger organization. It is enough tool to balance everyday business exchanges. For a
more detailed analysis of the shareholder's equity, an expanded accounting formula may
also be used.
An accounting journal entry includes several important details of the transaction, such as
the date and description of the transaction and which accounts will be debited and/or
credited, depending on the nature of the transaction. If the journal entry is incorrect, it can
make the entire accounting record inaccurate and cause tremendous problems for the
business going forward. The examination of source documents, therefore, is a critical first
step to keeping accurate accounting records.
Source documents serve several purposes in accounting. First, original source documents
serve as evidence that a business transaction did occur. They also provide the details of the
transaction, including dollar amounts, the date of the transaction, the parties involved, and
information as to the purpose of the transaction. Accountants use source documents to
complete accounting journal entries about the transaction.
There are eight steps in what is known as the accounting cycleor, the basic steps to
thorough bookkeeping. These steps are:
Identifying the transaction- this includes examining the source documents to verify
the details of the transaction
Recording the transaction- once source documents are verified, the details of the
transaction are entered into the accounting journal
Posting- recording the transaction in the company's general ledger
Calculating the trial balance- this serves as a mathematical check of the records
Creating a worksheet- the worksheet is used to check that the records balance and
to look for discrepancies
Adjusting journal entries- this is as needed, based on the worksheet results
Creating financial statements- these statements include balance sheets, income
statements, and cash flow statements
Closing the books- a statement is generated that closes the records for the
accounting cycle
In addition to using source documents to begin the accounting cycle and journal entry
process, source documents can also serve as evidence should there ever be a question or
discrepancy regarding a particular transaction.
Sales receipts- these demonstrate that a purchase was made and usually include the
item(s) purchased, the name of the vendor, the date, the cost of each item and the
transaction total, and the payment method used
Banking documents- these documents show the movement of money into and out
of the company's bank accounts and include checks, deposit slips, and account
statements
Invoices- these can be either internal or external, depending on whether they are
invoices that the company has billed to clients for monies owed to the company or
invoices that have been billed to the company by vendors for payment
Payroll documents- these include records of hours worked, wages paid to the
employee, and taxes paid on behalf of the employee
Some other types of source documents include payroll records, accounting notes and
reports, leases, financial contracts, and credit memos.
The coffee shop must have their assets balance with their liabilities and
the amount of equity from the owner.
If the coffee shop owner makes the price for a cup of coffee too
expensive, they will not gain any revenue.
Expenses Formula
The expenses formula
is: TotalExpenses=Revenue−OperatingIncome−CostofGoodsandServicesSold�����
��������=�������−���������������−����
����������������������. Within the category of cost of
goods and services sold are labor costs, materials, and permits. Expenses can be fixed, as in
something that is paid on a regular basis regardless of production levels or variables. For
example, the coffee shop owner's rent is a fixed expense, because it doesn't change
depending on how much coffee is sold. Within the extended accounting equation, the
expenses equation is a part of the owner's equity.
Lesson Summary
The basic accounting equation is written as assets = liabilities + owner's equity. The basic
accounting equation forms the foundation for preparing a balance sheet and shows the
relationship that exists between assets, liabilities, and owner's equity. Assets are what
you own. Liabilities are what you owe. Owner's equity is the amount of money that a
business owner or owners have personally invested in the company.
The basic accounting equation can be extended by expanding the owner's equity. Owner's
equity equals the sum of expenses and dividends minus revenue. The expanded
accounting equation is written as assets = liabilities + (revenue - (expenses + dividends)),
where revenue is the amount of money earned in exchange for goods and services,
expenses are money paid to support a company's day-to-day operations, and dividends are
the money investors earn as a return on their investment. The revenue formula in
accounting is defined as price multiplied by quantity. The extended accounting equation can
be rewritten to show how to calculate revenue and expenses.
Account Meaning
There are many ways to define "account," as the term can apply to banking, online user
accounts, and businesses. The account meaning in business refers to a place to record
transactions that occur within the business. It is essentially a statement that consists of
transactions within a certain category. An account in business includes information about
transactions, funds, and available cash. Accounting methods make use of different types of
accounts, which can include transactions with both expenses and income. Businesses must
be sure to account for transactions accurately so that all financial statements are also
represented accurately.
What is a T-Account?
A T-account is a type of account that divides the debits and credit into two columns. It
provides a simplified way to compare money coming in and going out of the account. Debits
to the account are recorded on the left side, and credits are recorded on the right side. T-
accounts can be used for various types of accounts, such as accounts payable, cash, and
accounts receivable. T-accounts are meant to represent the shape of the letter T, with the
name of the account at the top and the debits and credits divided.
Account
Debit Credit
$100 $200
$50 $75
$20 $60
Asset accounts
Liabilities accounts
Equity accounts
Revenue accounts
Expense accounts
Assets are the things that bring value to a business; therefore, asset accounts include
things of value that are owned, such as equipment, inventory, and cash. Asset accounts
show what a company owns and include both current and noncurrent assets. Current assets
are the items that can be converted into cash in the current period, which is generally one
year. Noncurrent assets are the items that cannot be liquidated within the period, such as
land.
Liabilities are the things owed by the business. Liabilities accounts include the debts and
money owed, such as loan payments, bills, and orders owed to customers. Liabilities are
also classified as current or noncurrent. Current liabilities are those that are owed or due
within the current year, such as rent payments or utilities. Noncurrent liabilities are debts
that are not owed within the current period, such as deferred loan payments.
Equity accounts are the accounts which include owner's capital and shareholders' equity.
Owner's capital includes the investments made directly by the owner, while shareholders'
equity includes other investments and the sales of stocks. These accounts consist of the
money that is invested into the business, as well as the profits received from these
investments. Equity accounts may be referred to as owner's equity or just equity. Equity
accounts go hand-in-hand with assets accounts and liabilities accounts, as all are included
on the balance sheet. Equity is equal to assets minus liabilities.
Two other types of accounts which record the cost and income of a business are expense
accounts and revenue accounts. Expense accounts refer to the accounts which include
costs or expenses incurred by the business. Expense accounts may include costs such as the
bills that need to be paid or other businesses expenses that are accrued. Expense accounts
are similar to liabilities accounts in that they both deal with the debts and costs incurred by
the business. Revenue accounts are the opposite of expense accounts, as they include the
income that flows into the business. Revenue accounts consist of the cash that the business
brings in from things such as customer sales. Revenue accounts are similar to the assets
accounts, as they bring value to the business.
For example, if the business purchases new machinery for production, it would record this
purchase as an asset within the asset account. The equipment is classified as an asset
because it adds value to the business.
Another account that makes use of double-entry accounting is accounts payable. Items in
this account are owed to other businesses or individuals. These items are then added on to
other debts owed to make up the liabilities account. Essentially, double-entry accounting
shows how one transaction can impact other parts of the business financially.
Lesson Summary
The term "account" can be used for different things, including banking, online accounts, and
in business. In business accounting, an account is a place to record transactions that occur
within the business and typically consists of transactions. A T-account is an account that
divides the debits and credit into two columns, forming the shape of the letter T. Double-
entry accounting is a system where multiple accounts are affected by each transaction.
This means the funds recorded essentially impact other accounts when they are recorded
again in a larger account.
There are five types of accounts that are typically used in a business. These include assets
accounts, liabilities accounts, equity accounts, revenue accounts, and expense
accounts. Asset accounts show what a company owns and include both current and
noncurrent assets. Current assets can be liquidated within a year, while noncurrent cannot
be liquidated within that period. Liabilities accounts include the debts and money owed,
and they are also classified as current or noncurrent. Current liabilities are owed or due
within the current year, while noncurrent liabilities are debts that are not owed within the
current year, such as deferred loan payments. Equity accounts include investment-related
transactions that include owner's capital and shareholders' equity. Shareholders' equity
includes the sales of stocks. Expense accounts are the accounts that include the costs or
expenses incurred by the business, while revenue accounts include the income or revenue
that comes into the business.
The chart of accounts definition can be divided into two parts. The first part covers the
general ledger accounts. These are the accounts that are used to record all the financial
transactions that take place within a company. The second part covers the special ledger
accounts. These are the accounts that are used to track specific types of transactions, such
as inventory or customer accounts.
The chart of accounts is a vital part of a company's financial reporting system. It provides a
way to track all of the financial transactions that take place within a company and to provide
information for financial analysis. The chart of accounts is also an important tool for
managing a company's finances. By understanding the chart of accounts definition,
businesses can more effectively manage their financial resources.
There are many different ways to number the accounts in a chart of accounts. The most
common method is to use Arabic numerals (1, 2, 3, etc.). However, some companies prefer
to use Roman numerals (I, II, III, etc.), while others use a combination of both.
The numbering system for the chart of accounts is typically based on the structure of the
company's business. For example, a manufacturing company may have a separate account
for each type of product that it produces. A retail company, on the other hand, may have a
separate account for each type of merchandise that it sells.
A company's chart of accounts numbering system is a vital tool for monitoring financial
transactions. It aids in the preservation of accurate records and reports of all transactions.
Without a numbering system, it would be hard to know where each transaction belongs. As
such, businesses should thoroughly consider their alternatives when selecting a chart of
accounts numbering system.
Types of Ledgers
A chart of accounts and a general ledger are two important components of any accounting
system. The chart of accounts is a list of all the accounts that exist in an organization, while
the general ledger is a record of all transactions involving those accounts.
The chart of accounts contains information on all the different types of accounts that are
used in an organization, including asset, liability, revenue, and expense accounts. These
accounts form the basis for tracking financial data such as income, expenses, assets, and
liabilities over time.
There are two types of ledgers used in accounting: the general ledger and the subsidiary
ledger. The general ledger contains information on all of the accounts, while
the subsidiary ledger contains information for a specific general ledger account.
The subsidiary ledger contains detailed information about a specific account from the
general ledger. For example, the Accounts Receivable Subsidiary Ledger will contain detailed
information about each customer's outstanding balance. The Accounts Payable Subsidiary
Ledger will contain detailed information about each vendor's outstanding balance. It is
important to understand the difference between these two types of ledgers in order to
correctly record transactions and maintain financial records.
While the chart of accounts provides an overview of all the different types of accounts that
are used in an organization, the general ledger provides a more detailed view of the
financial transactions that have taken place within those accounts. This information can be
used to generate financial reports such as balance sheets and income statements.
Ultimately, the chart of accounts and general ledger are essential tools for tracking and
managing an organization's financial data.
Types of Accounts
The chart of accounts is a list of all the individual accounts that are used to keep track of a
company's financial transactions. These accounts are typically divided into five main
categories: assets, liabilities, owner's equity, revenue, and expenses. Each type of account
serves a specific purpose in tracking an organization's finances.
Asset accounts are used to record and track the value of items that a business owns or
controls. Examples include cash on hand, short-term investments, long-term investments,
inventory, and property. Liability accounts represent what the company owes to others -
for example, notes payable or accrued payroll taxes payable. Owner's equity records the
net worth of owners or shareholders in the company. Revenue accounts track income
generated by selling goods or services, while expense accounts record the costs associated
with running the business.
While each type of account provides valuable information about a company's financial
position, they all must be considered in relation to one another to get a complete picture.
For example, a high level of assets may be offset by a high level of liabilities, resulting in low
net worth. Likewise, high revenue can be offset by high expenses, leading to little or no
profit. By understanding how these accounts work together, you can get a clear
understanding of a company's financial health.
One way that the general ledger and the chart of accounts relate is through general ledger
entries. When recording transactions in the general ledger, businesses will typically also
need to create corresponding entries in their charts of accounts. For example, if a company
records a sale in their general ledger, they will also need to make a note of this in their chart
of accounts under the category of "sales." This helps businesses keep track of all their
financial information in one place and ensures that nothing is missed or forgotten.
Another way that the general ledger and chart of accounts relate is through financial
reporting. When businesses prepare their financial statements, they will often use data from
both the general ledger and the chart of accounts. The general ledger provides detailed
information about specific transactions, while the chart of accounts can help give a broad
overview of a company's financial picture. Combined, these two tools can give businesses a
complete understanding of their finances and help them make informed decisions about
where to allocate resources.
Lesson Summary
The financial management system of a firm is referred to as accounting. Ledgers are used
to keep track of final accounting entries. The chart of accounts lists all the company's
accounts. The numbering system is the order in which the account titles are presented in
the chart of accounts. The general ledger is used to keep track of all of the accounts, while
the subsidiary ledger is utilized to record transactions for one specific account in the
general ledger. The chart of accounts is a list of all the various accounts used to record a
company's financial transactions. These accounts are generally divided into five major
categories: assets, liabilities, owner's equity, revenue, and expenses. Each sort of
account has its own function in keeping track of a business's finances.
The general ledger and the chart of accounts are related because they both play an
essential function in keeping track of a company's financial information. The general ledger
is a record of all transactions that take place within a company, including income,
expenditures, assets, and liabilities. Businesses must first establish an organized chart of
accounts that lists all of the various accounts that will be used to record financial
information related to the general ledger. Together, these two financial management tools
can provide a comprehensive knowledge of a company's financial status and assist them in
making educated resource allocation decisions.
Two key elements in accounting are debits and credits. Understand these critical pieces of
notation by exploring the definitions and purposes of debits and credits and how they help
form the basics of double-entry accounting.
The Basics
Before we get too involved in the discussion of debits and credits, let's learn a few basics.
Every business has various transactions that occur each day. Each of these transactions are
examined by accountants and recorded in the accounts that they affect.
In the first steps of accounting, accounts are broken down into T-accounts. T-accounts are
simply visuals to help accounting professionals see the effects of transactions on accounts
individually. The accounting system that is used most often in this day and time is called
double-entry accounting. Double-entry accounting requires that every business
transaction be recorded in at least two accounts. One account will be debited, and one
account will credited.
Peggy owns a dress making shop. It's taken her two months, but she's just finished an
elegant wedding dress for a customer. The customer paid a $200.00 deposit on the dress
before Peggy made it. She comes in and picks up her dress and pays Peggy the $400.00 that
she still owes on the dress. The total cost of the dress is $600.00.
Using this example, you can see that Peggy was given $400.00 today for a balance due on a
dress. That $400.00 is a debit to the cash account. This debit increases the cash balance by
the $400.00. Cash is an asset account. Since a deposit was made on the dress, it was sold on
account, meaning that it is an accounts receivable. Since Peggy uses a double-entry
accounting system, she must have a credit that equals that debit. For this instance, the
credit, which is $400.00, will go to the accounts receivable.
Look at Peggy's dress shop. For one transaction, there were two entries made to accounts.
One entry added $400.00 to an account balance, and one entry subtracted $400.00 from an
account balance. In this example, $400.00 - $400.00 = 0. The transaction, once zeroed out, is
considered balanced.
Lesson Summary
Debits and credits are fundamental parts of the double-entry accounting system.
The double-entry accounting system requires that every business transaction be recorded
in at least two accounts. One account will have a debit entry, and one account will have a
credit entry. A debit is an entry that increases the asset and prepaid expense account
balances and decreases a liability, expense, or equity account balance. Just the opposite,
a credit is an entry that increases the balance in a liability, expense, or equity account
balance and decreases the balance in an asset or prepaid expense account.
The easiest way for accounting professionals to see the results of each transaction is to
create T-accounts. T-accounts are visuals that accounting professionals use to see how
accounts are affected by the debits and credits of business transactions. Debits are
recorded on the left side of the T-accounts, while credits are recorded on the right side of
the T-accounts. When the total debits of a transaction is added to the total credits of the
same transaction, the ending result should be zero. This means that the transaction is
balanced.
The best way to remember the purpose of debits and credits is to remember that age-old
saying that is accredited to Newton: 'For every action there is an equal and opposite
reaction.' Remembering that will help you to effectively use debits and credits to achieve the
one thing accounting is famous for: balance!
Learning Outcomes
Following this lesson, you should be able to:
Transaction analysis, the first step in the process, will be the subject of this lesson.
When analyzing a transaction, it is very important to make sure the accounting equation
remains in balance. If it is not in balance, there is an input error somewhere and it will not
be possible to close the firm's books at the end of the accounting period.
XYZ, Inc. purchases 10,000 widgets for $50,000 USD from a supplier, for resale to
their customers.
1. A transaction has taken place. Money has exchanged hands for the provision of goods.
2. The inventory asset account and the cash account will be affected by this transaction.
4. Both are asset accounts and will affect only the left side of the equation
Assets = Liabilities + Owner's Equity
+$50,000 = - + -
-$50,000 = - + -
$0.00 = - + -
5. The transaction has a net zero effect on the accounting equation, leaving it in balance.
1. A transaction has taken place. Money has exchanged hands for the provision of goods.
2. The sales revenue, cash, cost of goods sold and inventory accounts will be affected by the
transaction.
3. Sales revenue, cash and cost of goods sold will increase. Inventory will decrease.
4. Cash and inventory are asset accounts. Cost of goods sold is an expense account and
sales is a revenue account.
Sales transaction:
Lesson Summary
Transaction analysis is the act of examining a transaction to decide how it affects the
accounting equation. It is the first step in the accounting cycle. Whenever an exchange of
goods or services takes place, a transaction has occurred. The accounting cycle is a multi-
step process that begins with transactions and ends with the closing of the books and
reporting of financial information to regulatory agencies and/or interested parties.
When analyzing a transaction, it is very important to make sure the accounting equation
remains in balance. If it is not in balance, there is an input error somewhere and it will not
be possible to close the firm's books at the end of the accounting period. The accounting
equation is the tool used by most accountants to make sure the transaction is in balance.
The accounting equation states that Assets = Liabilities + Owner's equity. An asset is
something that a business owns. A liability is something that a business owes. Owner's
equity is the amount of money that a business owner personally invests in the business.
When using a double-entry bookkeeping system, the most important thing to remember
when analyzing business transactions is that all debits and credits must be equal. A debit is
an entry on the left side of a T-account that increases the balance for asset accounts and
decreases it for liability or owner's equity accounts. A credit is an entry on the right side of a
T-account that decreases asset account balances and increases liability or owner's equity
account balances. If, for example, company XYZ, Inc. purchases three workstations on
account for $15,000, this transaction would increase the company's assets by $15,000 with a
debit and increase the liability account by the same with a credit.
Most organizations will record the debit and credit side of the transaction in the general
journal with both sides offsetting each other. A good example that reflects this concept
would be a $60 cash transaction for office supplies. In this instance, one would record a $60
debit to office supplies and a $60 credit to cash. This record is detailed in the table below.
Office
$60
Supplies
Cash $60
Adjusting Entries: At the end of each accounting period, the organization completes
adjusting entries. This is to balance the general ledger and ensure that the financial
statements correctly reflect accounting balances. Most adjusting entries are completed for
items such as prepaid expenses, accrued expenses, accrued revenues, and unearned
revenues. However, adjustments may be needed for other accounts or to correct erroneous
entries or accrued expenses. An example of an adjusting entry would be prepaid rent.
Often, companies will pay for a 12-month-period lease agreement. Therefore, it is necessary
to record the full amount at the time payment is made and then reverse part of the expense
monthly.
For example, if rent is $900 per month, then for one period there would be a record of the
rental expense of $900 as a debit and then a credit to prepaid rent for the same amount.
Rent
$900
Expense
This table is an example of a compound entry with expenses recorded against petty cash.
Office
$35
Supplies
Postage $20
Account Debit Credit
Fuel-Travel $25
The journal entries are posted to the general journal which is the book of original record
that reflects and tracks accounts such as assets, liabilities, owner's capital, revenues, and
expenses. The balances of the journal entries are transferred to the general ledger, the
ledger being the foundation for the creation of financial statements. The general ledger can
also be considered a book of record reflecting the summaries of the journal entries. For
example, the balance of prepaid rent will be reflected in the general ledger. In the example
below, if prepaid rent had a balance of $1,200 in the previous period and $100 was utilized
this period, then the remaining balance of $1,100 will be reflected in the general ledger once
all adjusting entries are completed. The asset of prepaid rent will show a decrease, while the
rental expense will be increased.
Dat
Account Debit Credit
e
Debits record all of the money flowing into an account, while credits record the outflows
from the account. Whatever is done on one side should equal what is done on the other.
Here are some examples of journal entries.
Example 1: June 5th — The company sells $1200 worth of product to a customer on account.
No cash is received as the customer has Net 30 terms. In this instance: the Accounts
Receivable will increase, meaning this account will be debited. Sales will then be credited.
Sales $1200
Example 2: July 15th — The company receives cash on the customer's account to pay the
previous transaction in full. The company will decrease the Accounts Receivable, meaning
they will need to credit this account. Note that this account was previously debited.
Assets — Assets refer to the tangible or intangible items an organization owns that
add value to the company such as land, equipment, buildings, computers, prepaid
insurance policies, prepaid rent, and one of the most important would be accounts
receivable for companies that offer credit terms. Assets are generally recorded on
the left side of the balance sheet.
Liabilities — Liabilities are comprised of financial obligations of an organization
which may include loans, accounts payable, salaries payable, unearned revenue,
warranties, and accrued expenses. Basically, anything a company owes would be
considered a liability. Liabilities are generally recorded on the right side of the
balance sheet.
Owner's Equity or Shareholders' Equity — Shareholders' equity is the amount of
investment the stockholders have in a business and the amount of claim the owners
or stockholders have once the liabilities are subtracted from the assets.
The accounting equation for owner's or shareholders' equity is: Assets - Liabilities =
Owners Equity
One of the most important factors to why a trial balance is run is that it offers a sort of
check and balance system in that the debit side on the left should equal the credit side on
the right. If for any reason these amounts do not match, it shows that there is an issue
related to one of the journal entries for that accounting period. The accountant or
accounting team member will then have to trace the error back to the entry that caused the
issue. One should also note that even if the trial balance does actually balance, this is no
guarantee that the journal entries are error-free. The work should still be double-checked
for completeness and accuracy. The image below provides a good example of how a
balanced trial balance should look.
An example of how a trial balance should look
Dat
Account Debit Credit
e
Adjusting Entries: At the end of each accounting period, the organization completes
adjusting entries. This is to balance the general ledger and ensure that the financial
statements correctly reflect accounting balances.
Compounding Journal Entries: Compounding entries contain more than two lines
and are generally more complex.
Reversing Entries: Reversing entries are generally made on the first day of an
accounting period with the intent to reverse a previous accrual completed in the
previous month.
A trial balance is simply a list of all the general ledger accounts that an organization utilizes
and the corresponding balance. Creating a trial balance is an important step as it will allow a
company to verify that all journal entries have been entered correctly. The trial balance
consists of the three major account types: assets, liabilities, and shareholders' equity. One of
the most important factors related to why we run a trial balance is that it offers a sort of
check and balance system in that the debit side on the left should equal the credit side on
the right. If for any reason these amounts do not match, then there is an issue related to
one of the journal entries for that accounting period. The general ledger contains all the
details related to all the journal entries completed during an accounting period. In contrast,
the trial balance is only comprised of the ending balances for each account.
There are some problems with financial information, which is the information found on a
company's financial statements. Learn more about financial statements and typical
problems with financial information, including reporting errors, disagreements in judgment,
and fraudulent financial reporting.
Now that you know what it means, do you have any idea why financial information is
important? Financial information, as seen on the financial statements, gives users of this
information, which is usually creditors, investors, and potential creditors and investors, the
tools they need to make informed decisions about their interactions with the company.
Financial Statements
The financial statements provide all of a company's financial information. They are the
income statement, the statement of retained earnings, the balance sheet and the statement
of cash flows. Together, these reports tell the story of how well a company is operating and
how much of a risk investing in that company would be.
Disagreements in Judgment
Another problem that may occur when deciding what to include on the financial reports
involves disagreements in judgment. Now, this term should be pretty self-explanatory. In
simple terms, it means that what I believe and what you believe may not be the same. I bet
you're wondering how this can possibly have anything to do with financial information. Well,
let's look back at Henry and another situation he has run into when preparing the financial
statements.
Wasabi International has a decision to make on its inventory. There are three GAAP
approved methods they can choose from, FIFO or First In First Out, LIFO or Last In First Out,
or Weighted Average. The issue is that the methods each give a different valuation for the
remaining inventory and for Cost of Goods Sold. This leads to a different number for assets
and income, as well as taxes! While LIFO reduces income and Henry's tax bill, he chooses
FIFO because it is more realistic, and the increased income will look good at the bank when
he applies for a loan.
Most of the time, disagreements in judgment are related to the timing that the expenses are
reported.
Let's go back to Henry again. What would happen if Henry decided that he didn't want to
report the expense of purchasing the new machine at all? He knows that if he does report it,
then the company is going to have a lower net income in this accounting period compared
to the prior accounting period, and that's not what creditors and investors want to see.
However, not reporting the expense is definitely a fraudulent reporting practice.
Lesson Summary
Financial information refers to information found on the financial statements of a
company that tells how well or badly a company is performing. There are four reports,
called the financial statements that provide all of a company's financial information. They
are the income statement, the statement of retained earnings, the balance sheet, and the
statement of cash flows.
Three typical problems that occur when creating the financial statements are reporting
errors, disagreements in judgment, and fraudulent financial reporting. Reporting
errors are errors that are a result of such things as miscalculations or transposing numbers.
Disagreements in judgment simply means that what I believe and what you believe may not
be the same. Fraudulent financial reporting means to deliberately omit or misstate financial
information with the intent of deceiving investors and creditors. Each of these problems has
a major impact on the financial statements, which in turn has an effect on the financial
information that is used by potential and current creditors and investors that a company
may have.
Learning Outcomes
You should have the ability to do the following after watching this video lesson:
Describe what financial information refers to and identify the four reports of the
financial statements
Explain three common problems when creating the financial statements and their
effect on the financial information
What is internal control? Internal control definition can simply be stated as procedures put
in place within an organization to ensure a business is carried out in an orderly, effective
and accurate manner. Internal controls ensure that financial documents are accurate
because the financial documents will be used by the managers as well as investors and
bankers to get a picture of how well the company is doing. If they are not accurate, incorrect
decisions could be made.
Lesson Summary
Internal controls in accounting are policies and procedures in accounting that a company
or organization implements to guarantee that financial and accounting information is
accurate and reliable. Internal controls can be simply stated as procedures put in place
within an organization to ensure a business is carried out in an orderly, effective and
accurate manner. Internal controls ensure that financial documents are accurate because
the financial documents will be used by the managers as well as investors and bankers to
get a picture of how well the company is doing. If they are not accurate, incorrect decisions
could be made. In internal control, there exist five crucial components. They include Control
environment, Risk assessment, Control activities, Information and communication,
and Monitoring.
When the internal controls are in the right place, losses are hard to create, and they can be
easily and quickly detected and dealt with. Intentional losses may be a case of fraud, making
it paramount for the separation to occur. When intentional errors occur, the responsible
individual should be investigated and disciplined. Sometimes, the errors are accidental; that
is, they are honest mistakes by an individual. The Securities and Exchange Commission
founded the Financial Accounting Standards Board (FASB) to develop the guidelines that
all accounting professionals ought to follow. The FASB guidelines allow companies to
provide financial information in a transparent and useful manner, and this information can
be of use when auditing and to investors. Internal controls can easily be categorized into
three fundamental types, each serving its purpose. They include detective controls,
preventative controls, and corrective controls.
As institutions trusted with our money, banks must have strong safeguards and internal
controls in place to protect it. With this lesson, explore what safeguards and controls are,
the goals of safeguards, and how banks achieve these goals.
Safeguards are measures that are taken to prevent someone or something from an
undesirable outcome. Internal controls are rules and regulations that are put into place to
guard assets owned by a person or a company. These two terms seem to mean the same
thing, but in reality, they don't. You see, the rules and regulations that are put into place
(which are internal controls) are the measures that are taken to prevent someone or
something from an undesirable outcome (which are safeguards).
Goals of Safeguards
There are five goals for having effective safeguards in place in the banking industry. To
begin with, effective safeguards and internal controls provide reasonable assurance that
banks operate efficiently and effectively. They also ensure that each transaction that occurs
in the bank is recorded correctly. The third goal of effective safeguards is to make sure that
the information provided by banks is true and reliable information. Yet another goal of
banking safeguards is to make sure that the risk management system in place in the bank is
effective. And the final goal is to make sure that all the banking laws and regulations are
being complied to.
Example
Let's look at a banking scenario and see how the process flows. Jenny, Christie, Chelsea,
Faith, Jared and Blake all work at the First Bank of TyTy.
Jenny's a teller. At the beginning of her work day her bank protocol says that she needs to
count her drawer to ensure that it contains the correct amount of currency. The rest of her
day she spends taking customer deposits, customer loan payments, cashing checks and
making change. At the end of the day, again per bank protocol, she totals up the deposits
and loan payments that she's taken in and the checks she's cashed, and then balances her
drawer again. She turns all the cash and checks that she has received, along with all
associated paperwork, in to the head teller, Christie, at the end of the day.
Christie is the head teller. She's responsible for all the customer service duties of a regular
teller, as well as the direct supervision of the other tellers. She's also responsible for
retrieving money from the vault as needed to make change for the teller drawers, and
collecting all daily paperwork and reports that each teller generates. Christie turns all the
daily paperwork over to Chelsea.
Chelsea works in the bookkeeping department. It's her job to process all the documents
that Christie gives her at the end of the day, and check them against reports that are pulled
from the computer. Checks are then scanned and electronically dispersed to the Federal
Reserve. Once everything is verified, and copies are all scanned, the checks are then sent to
the document shredding department and shredded.
Faith works in the loan department of the bank. Faith does not take deposits or payments,
and she does not cash checks. Instead, she meets with bank customers who are seeking a
bank loan. She takes the application and submits it to the credit department at the bank.
Jared works in the credit department. He doesn't take deposits or payments. He doesn't
cash checks. He doesn't take loan applications. Jared runs the credit reports and does all the
legwork that needs to be done to verify whether a loan package can be offered to a
customer. He also writes the loan paperwork. The loan paperwork is then sent back to Faith
so that she can meet with the customer and have him sign the papers. She then gives him
something to take to Jenny so that she can deposit the loan proceeds to the customer's
account.
Blake is a compliance officer. He spends his day reviewing the work of Jenny, Christie,
Chelsea, Faith and Jared. He has to make sure that they're following the protocol that is
defined in the bank's procedures manual. If not, then he's responsible for letting the bank's
president know.
Do you see the separation of duties here? None of the six people that we talked about do
the same job. However, each of their jobs collectively fulfill the purpose of the bank, which is
to provide quality customer service. Having each of the employees do a different job is an
important safeguard. It allows for the internal control system to not only be followed, but to
be monitored closely.
Lesson Summary
Safeguards and internal controls are important concepts in the banking
industry. Safeguards are measures that are taken to prevent someone or something from
an undesirable outcome. Internal controls are rules and regulations that are put into place
to guard assets owned by a person or a company. The tie that binds the two concepts is
rather simple: internal controls are the safeguards that banks put into place to protect
customer assets.
There are five goals of having safeguards in the banking industry. They are to provide
assurance that banks are operating efficiently; to ensure that transactions are recorded
correctly; to make sure that information provided by the bank is true and reliable; to ensure
that risk management systems are effective; and to make sure that banking laws and
regulations are being complied to.
The best way to ensure that these goals are achieved is to have written policies and
procedures in place that consist of distinct separation of duties. Separation of
duties means to separate one big job into several smaller jobs, with a different individual
performing each. Having this system of safeguards and controls allows for customers in the
banking world to feel confident that their money is being protected.
Learning Outcomes
Following this lesson, you'll have the ability to:
Define safeguards and internal controls and describe how the two are interrelated
Identify the five goals of safeguards in the banking industry
Explain the importance of separation of duties in the banking industry
Cash Control
The term cash control has many facets. By definition, cash control is a way to monitor a
company's credit, collections, cash allocation, and disbursement policies, as well as its
invoicing function. In simple terms, cash control is the internal regulation of cash and cash-
related policies in a business. There are multiple components to cash. Cash includes
currency notes, coins, and bills. Cash can be defined as any money that takes the form of
currency. Cash equivalents can be defined as investment securities that mature within 90
days. Simply stated, cash equivalents are liquid assets that can be turned into cash within a
short period of time and are not affected by changing interest rates. An example of a highly-
liquid item would be a 90-day CD (Short-time Certificate of Deposit). Cash equivalents also
include bank certificates of deposit, money orders, banker's acceptances, treasury bills, and
commercial paper.
The relationship between value and its applicability lies in the concept of liquidity. Liquidity
can be defined as how quickly something can be turned into cash. This is important because
a business with few liquid assets can quickly encounter trouble that could derail business
activities. To understand liquidity, consider that a business might have $10,000 in the bank,
$25,000 in 90-day CDs, $15,000 in 1-year bonds, $5,000 in money orders, and $30,000 in real
estate. To understand how much cash and cash equivalents a business possesses,
remember that CDs and money orders are cash equivalents. Adding those $25,000 + 5,000
with the $10,000 in the bank equals $40,000 cash and cash equivalents.
First, cash allows a business to have more control over its activities. Having cash on hand is
important because it relieves a business of the pressures of being in debt. When a business
takes on a debt, specifically a sizable one, and is unable to repay in the short term, the
debtors tend to stake a claim as to how the business ought to be run. Debtors want their
debt repaid, so they may issue guidelines on how the business can recoup cash, or may
even offer ultimatums. This can derail the business, as what is necessary to do to cover a
debt may actually be unhealthy for the business in the long term. Having cash, then, allows
a business to run on its own terms and have a much wider scope of activities.
Second, cash allows a business to cover expenses effectively. The availability of cash makes
it possible for a business to pay employees, pay for utilities such as rent, power, and taxes,
and allows them to do so in a timely manner. Paying for expenses when they are due is
important because it avoids conflict with external parties and allows the business to focus
on itself, instead of worrying about factors such as reputation or litigation. One of the signs
that a business is not healthy is unpaid utilities, which rob the business of its reputation in
the eyes of the public and its investors. Having cash negates these possibilities.
Finally, cash allows businesses to pay investors and provide them with dividends. Cash in a
business can be used to acquire share buybacks within the context of investors, which is
beneficial to both the business and the investors. Paying out dividends keeps investors
happy and ensures that there is less internal friction to worry about. When investors are
happy, more investment is likely to be poured into the business, which allows it to grow and
thrive. Having cash provides the possibility for growth in this manner and negates internal
conflict.
It reduces the amount of idle cash in a business and ensures that the cash is being
put to productive use.
It ensures that transactions are recorded and balanced out to reduce the probability
of or to eliminate fraud in the business.
It keeps track of assets in such a way that going bankrupt or landing in debt becomes
very difficult. It is easy for a business to disintegrate without a cash management
control system.
Internal controls in cash management refer to the guidelines for managing a cash account.
Two necessary important components of an effective internal control system for cash
management are first, the separation of duties and second, a written protocol for cash
handling and disbursements. Internal controls can also include employee background
checks, training of staff, use of lockboxes for customer cash, reconciliation of statements,
and securing assets and cash in secure locations. They can be explained as follows:
Internal Control
Explanation
Measure
Written protocol for A written protocol provides a foundation for integrity, allows for
cash handling and later access to transactions, and serves as a deterrent for
disbursements deliberate illegal transactions.
Employee background These are important in verifying that an individual can be trusted
checks to partake in cash transactions.
For a cash management control system to be effective,
personnel must be trained on the time value of money, how to
Training of staff
detect transactions' inconsistencies, how to ensure integrity
during transactions, and the overall importance of cash.
Lesson Summary
Cash control is a way to monitor a company's credit, collections, cash allocation,
disbursement policies, and invoicing function. Cash is money that takes the form of
currency. Cash equivalents are liquid assets that can be turned into cash within a short
period and that are not affected by changing interest rates. An example of a cash equivalent
would be a 90-day CD (Short-term Certificate of Deposit), or a money order. Liquidity refers
to how quickly something can be turned into cash. It is important because a business with
few liquid assets can quickly encounter trouble that may derail its business activities. Cash
(whether currency or cash equivalents) is highly important to the ongoing function of
business.
Example:
2 Cash $500
An entry can also be made directly to the expense account. Expense accounts are income
statement accounts that are increased with a debit and decreased with a credit. For
example, a one-time purchase of door stoppers for the office might be placed in office
supplies. In this situation, expense went up, so it gets debited, and cash went down, so it
gets credited.
Debi
# Account Credit
t
2 Cash $125
Office supplies expenses like pens, pencils, and erasers for the accounting
department.
Employee payroll expenses like salaries and wages for management and laborers.
Rental cost for office or warehouse space.
Leasehold improvements expenses for any changes made to the building structure
being leased.
Utilities expenses like electricity and water.
Customer refunds for returned and refunded goods.
Part of the cash management process may include managing the timing of payments made
to vendors and other payees. Two ways a company can manage cash outflows are through
the use of controlled and delayed disbursements.
Banks offer these services to businesses with large account balances, where keeping the
funds in the account for a day might make a meaningful difference. An example would be a
Fortune 500 company with millions flowing through its bank accounts daily. The interest for
just one day is substantial enough to justify managing the outflows with delayed, controlled
disbursements.
To illustrate, in a company where the cash balance is $500,000 USD a day and the bank pays
3% interest on the balance, by maintaining this amount in the bank as much as possible, the
company would only earn $41.10 USD a day. Over the course of the year, that amounts to
about $15,000. It is not completely insignificant and is probably not worth actively
managing. Keeping the highest balance possible could have meaningful ramifications for a
company whose daily running balance ranges from $25,000,000 to $75,000,000, If the bank
pays this company 5% on its daily balance and the company strives to keep it at
$50,000,000, the daily earnings would amount to $6,849.31 USD. Over the course of the
year, this would turn into roughly $2.5 million dollars, certainly not insignificant. Part of that
could become a bonus for the accounting team that exercised such expert skill at managing
cash flows.
Example
Positive and negative disbursements are other examples of payments a firm might make.
Receiving a refund for a previous purchase can be recorded as a negative disbursement. It is
negative because the firm is receiving money back that had been disbursed for the
purchase of the returned product. Unlike most disbursements, this actually increases the
cash balance. Most items that increase the cash balance are cash receipts, not
disbursements.
A positive disbursement is any purchase made using cash. For example, buying office
supplies to replenish the diminishing stock is a positive disbursement. Normal
disbursements are positive, meaning they decrease the cash balance.
If the transaction is for the purchase of a good or service by the firm, then it keeps the
customer's receipt and places it in its accounting record files as proof of payment.
For transactions where there is no invoice, the cash receipt may be the only proof of its
occurrence.
Date
A unique receipt number
The name of the customer
The quantity of and list of items purchased
The cash value for each item
The total value for entire purchase
The payment method and amount
The change due back (for cash payments)
Customer signature (for credit transactions)
Not all receipts are the same, and some have more information than others. The above is an
example of a comprehensive receipt. A very basic receipt must include at least a unique
receipt number, the quantity of and list of items purchased, the cash value for each item,
and the total value of the purchase.
How To Account For Cash Receipts?
Cash receipts are accounted for by:
J. Jones
1 Quinoa Chickpea
8.00
Salad
2 Martinis 24.00
Sub-Total $146.35
Total $156.00
Received $200.00
Change $44.00
Separation of duties, as a mechanism of cash control, would mean having different people
responsible for different parts of the cash flow process. A good example of separation of
duties is to have one person responsible for cash withdrawals, another taking care of cash
deposits, another person writing checks, and yet another person filing receipts. Each person
takes on a minor job in order to complete a big one.
If back-up data was not required of employees and they were given free rein with the
expense account, it might encourage overspending and the charging of inappropriate items
to the company expense account. If no internal controls were in place to monitor the
expenses, no one would track them and no one would know what they were. The employee
could charge anything without repercussions. The policy outlined above is an example of
good internal controls because it applies segregation of duties, proper authorization,
adequate documents and records, and independent checks on activity.
Lesson Summary
Cash is the business asset most vulnerable to fraudulent activity. Whether cash is being
taken in or paid out, having several people play individual roles in the handling process will
allow for a system of checks and balances where mistakes or fraudulent activity have a
higher chance of being noticed. Internal Controls are rules and regulations that are put
into place to guard the assets owned by a person or a company.
Separation of duties, as a mechanism of cash control, would mean having different people
responsible for different parts of the cash flow process. A good example of separation of
duties is to have one person responsible for cash withdrawals, another taking care of cash
deposits, another person writing checks, and yet another person filing receipts. Each person
takes on a minor job in order to complete one big one. Part of cash management requires
the proper internal controls for cash disbursements and cash receipts. Cash
disbursements are monies paid out to individuals for the purchase of items that are needed
and used by a company. This can be anything from purchasing inventory, raw materials, or
even utilities. Cash receipts are money received from consumers for the sale of goods or
services.