Accounting by George Hernandez

Intro
Ledgers and the Accounting Equation
Balance Sheets and Income Statements

Intro

I'm not an Accountant but I play one at work.

Here are some basic definitions of Accounting:

Accounting is a comprehensive system for collecting, analyzing, and communicating financial information.
Accounting provides quantitative numbers that help determine how well a business is run and its financial strength.
Accounting tracks transactions, inventory, and anything of financial worth.

With such definitions, it is not surprising that accounting folks are often linked to computer folks.

Ledgers and the Accounting Equation

The financial worth of a business is all of its assets after any of its debts have been paid off. That is the basic Accounting Equation:

Assets - Liabilities = Equity

The financial transactions that compromise each of the elements of the Accounting Equation (Assets, Liabilities, and Equity) are recorded in Ledgers (aka SubLedgers or Accounts). All of the ledgers added up (Assets + Liabilities + Equity) form the General Ledger (aka GL or G/L). The GL should balance, ie equal to zero if this convention is followed:

A transaction that increases Assets is done with addition (debits ). Decreases are done with subtraction (credits).
A transaction that increases Liabilities or Equity is done with subtraction (credits ). Decreases are done with addition (subtraction)

The Accounting Equation is often rewritten in this fashion to help remember those conventions:

Assets = Liabilities + Equity

Different ledgers will be used depending on the business. Here are typical names for typical ledgers used:

Assets (What is )		Liabilities (What is owed)		Equity (aka Fund Balance, Owners' Equity, Net Worth, Retained Earnings)
+Cash +Accounts Receivable (aka AR or A/R) +Inventory Raw Materials Works In Progress Finished Goods	EQUALS	-Accounts Payable (aka AP or A/P) -Deferred Revenue	PLUS	-Revenue (aka Income) Product A Product B Interest Consulting +Expenses Salaries and Wages Taxes Utilities Shipping Products Maintenance Depreciation* Amortization Interest Repairs Advertising Rent -Beginning Equity -Equity Additions +Equity Deductions
*Depreciation is usually (initial cost ÷ useful life), although accelerating depreciation is also used.

A large accounting system may provide separate sub ledgers for different departments.

EG: The Munster Garage Sale

Time	Transaction	Cash	Revenue	GL
1 AM	Initialize ledgers.	0	0	0
1-4 AM	Several sales.	40	-40	0

EG: The Addams Garage Sale

Time	Transaction	Cash	AR	Revenue	Beginning Equity
1 AM	nitialize ledgers.	20	0	0	-20
1-4 AM	Several sales.	70	0	-50	-20
5 AM	Sale to Munster who says he'll pay back later.	70	30	-80	-20
Next night	Munster pays back $30.	100	0	-80	-20

EG: Chaplin Sweeper

Time	Transaction	Cash	AR	AP	Revenue	Expenses
Monday	Initialize ledgers.	0	0	0		0
	Chaplin convinces Capone to give him a broom on $10 credit.	0	0	-10	0	10
	Chaplin sweeps Warbucks' mansion for $12, but on the condition that he'll pay on Wednesday.	0	12	-10	-12	10
Tuesday	Capone wants his money, but Chaplin can't pay, so Capone charges $2 more.	0	12	-12	-12	12
Wednesday	Warbucks pays the $12.	12	0	-12	-12	12
	Chaplin pay Capone his $12.	0	0	0	-12	12

EG: Sawyer Shoveler

Time	Transaction	Cash	Deferred Revenue	Revenue
12 PM	Initialize ledgers.	0	0	0
	Mom gives Sawyer $5 to shovel snow.	5	-5	0
12-7 PM	Mom nags Sawyer to shovel snow.	5	-5	0
7 PM	Dad comes home. Sawyer shovels snow.	5	0	-5

EG: Acme, Inc. Manufacturer

Time	Transaction	Cash	Raw Materials Inventory	Works In Progress Inventory	Finished Goods Inventory	AR	Revenue	Shipping Expenses	Beginning Equity
8:00:00	Initialize ledgers.	400	0	0	0	0	0	0	-400
	X1 Bird Feeder Trap ordered by Coyote.	400	0	0	0	0	0	0	-400
8:00:01	Raw Materials purchased.	0	400	0	0	0	0	0	-400
8:00:02	Begin manufacturing and assembling.	0	0	400	0	0	0	0	-400
8:00:03	X1 Bird Feeder Trap finished.	0	0	0	400	0	0	0	-400
8:00:04	X1 Bird Feeder Trap shipped to Coyote.	0	0	0	0	800	-300	-100	-400
8:00:05	X1 Bird Feeder Trap delivered to Coyote and paid for.	800	0	0	0	0	-300	-100	-400

EG: Loony University

Time	Transaction	Cash	Equity Additions	Equity Deductions
Jan	Initialize ledgers.	0	0	0
Feb	University receives grant.	20,000	-20,000	0
Mar	University returns grant money.	10,000	-20,000	10,000

Balance Sheets and Income Statements

Two of the most important kind of Financial Reports are Financial Statements that fall into two categories:

A Balance Sheet is a snapshot of the assets and liabilities of a company at a given point of time.
An Income Statement is a summation of the income and expenses of a company for a given time period.

Balance Sheet

Here is a typical Balance Sheet for a given date:

Assets
- Current Assets (ie liquid within a year, in order of decrease liquidity)
  - Cash
  - Marketable securities
  - Accounts receivable
    - Less: Allowance for doubtful accounts
  - Inventory. Usually calculated by one of 3 methods:
    - Weighted average: Total Cost of Goods ÷ Number of Goods
    - FIFO (First In First Out): n items @ the earliest price.
    - LIFO (Last In First Out): n item @ the latest price.
  - Prepaid expenses (eg supplies, rent)
- Fixed Assets (long-term use or value)
  - Land
  - Buildings
    - Less: Accumulated depreciation
  - Equipment (office, machinery, vehicles)
    - Less: Accumulated depreciation
- Imaginable Assets (good will assets)
  - Patents
  - Trademarks
  - Copyrights
  - Franchise fees
  - Less: Amortization of Imaginable Assets (like depreciation)
Liabilities
- Current Liabilities (must be paid within a year)
  - Accounts payable
  - Wages payable
  - Taxes payable
- Long-term Liabilities
  - Notes payable (mortgage, bank, vehicle payments)
  - Bonds payable
Equity
- Common stock (EG: The original 500 shares @ $20)
- Paid in capital (EG: New 500 shares @ $100)
- Retained earnings (profits for use by the company rather than paid as dividends)

Of course Assets = Liabilities + Equity

Some typical figures derived from a Balance Sheet:

Short-term solvency (liquidity)
- Current Ratio: Current Assets ÷ Current Liabilities. Higher values preferred.
- Working Capital: Current Assets - Current Liabilities. Positive values preferred.
Long-term solvency
- Debt to Equity Ratio: Total Liabilities ÷ Equity. Lower values preferred.

Income Statement

Here is a typical Income Statement covering a Calendar Year.

Revenues (aka Gross Sales, Sales)
Cost of Goods Sold
- Goods Available for Sale:
  - Inventory Jan 01.
  - Inventory purchased Jan 01-Dec 31.
  - Less: Inventory Dec 31
Gross Profit (aka Gross Margin) = Revenues - Cost of Goods Sold
Gross Profit Percentage = (Revenues ÷ Cost of Goods Sold) × 100
Operating Expenses (broken down by expense ledger)
Operating Income (before taxes) = Gross Profit - Operating Expenses
Income Taxes
Net Income = Operating Income - Income Taxes

Some typical figures derived from an Income Statement:

ROI (Return On Investment, aka ROE, Return On Equity) = Net Income × Equity (from Balance Sheet). Higher values preferred.
E/S (Earnings Per Share) = Net Income ÷ Outstanding Common Shares (i.e. m stocks). Higher values preferred.
Inventory Turnover = Cost of Goods Sold ÷ Average Inventory = Cost of Goods Sold ÷ ( (Inventory Jan 01 - Inventory Dec 31) ÷ 2). Preferred value dependent on industry.

Page Modified: (Hand noted: 2007-10-24 17:05:53Z) (Auto noted: 2010-12-24 22:58:53Z)