Adjusting Entries

In the accounting process, there may be economic events that do not immediately trigger the recording of the transaction. These are addressed via adjusting entries, which serve to match expenses to revenues in the accounting period in which they occur. There are two general classes of adjustments:

*      Accruals - revenues or expenses that have accrued but have not yet been recorded. An example of an accrual is interest revenue that has been earned in one period even though the actual cash payment will not be received until early in the next period. An adjusting entry is made to recognize the revenue in the period in which it was earned.
*      Deferrals - revenues or expenses that have been recorded but need to be deferred to a later date. An example of a deferral is an insurance premium that was paid at the end of one accounting period for insurance coverage in the next period. A deferred entry is made to show the insurance expense in the period in which the insurance coverage is in effect.

Like regular transactions, adjusting entries are recorded as journal entries. The following illustrates adjustments for accrued and deferred items.

How to Make Adjusting Entries

Like regular transactions, adjusting entries are recorded as journal entries. The following illustrates adjustments for accrued and deferred items.

Accrued Items

As an example of an accrued item, consider the accrual of interest revenue. The journal entry would be similar to the following:

Interest Recievable DR
Interest Revenue    CR

The adjusting entry is needed because the interest was accrued during that period but is not payable until sometime in the next period. The adjusting entry is posted to the general ledger in the same manner as other journal entries.

In the next period when the cash is actually received, one makes the following journal entry:

Cash                  DR
Interest Recievable   CR

Deferred Items

For deferrals, a journal entry already has been made in asset or liability accounts and an adjusting entry is needed to move the balances to expense or revenue accounts in the next accounting period. Consider the case in which the firm prepays insurance premiums in one period for insurance coverage in the next period. The journal entry made at the time of payment would be similar to the following:

Prepaid Insurance DR
Cash              CR

In the next period when the insurance coverage is in effect, one makes the following adjusting entry:

Insurance Expense DR
Prepaid Insurance CR

For a single deferred item, there may be several adjusting entries over subsequent accounting periods as the expense or revenue for the item is recognized over time.

Basic Accounting Terms Definitions

ACCOUNTING EQUATION: The Balance Sheet is based on the basic accounting equation. That is:

Assets = Equities.

Equity of the company can be held by someone other than the owner. That is called a liability. Because we usually have some liabilities, the accounting equation is usually written…

Assets = Liabilities + Owner’s Equity.

ACCOUNTS: Business activities cause increases and decreases in your assets, liabilities and equity. Your accounting system records these activities in accounts. A number of accounts are needed to summarize the increases and decreases in each asset, liability and owner’s equity account on the Balance Sheet and of each revenue and expense that appears on the Income Statement. You can have a few accounts or hundreds, depending on the kind of detailed information you need to run your business.

ACCOUNTS PAYABLE: Also called A/P. These are bills that your business owes to the government or your suppliers. If you have ‘bought’ it, but haven’t paid for it yet (like when you buy ‘on account’) you create an account payable. These are found in the liability section of the Balance Sheet.

ACCOUNTS RECEIVABLE: Also called A/R. When you sell something to someone, and they don’t pay you that minute, you create an account receivable. This is the amount of money your customers owe you for products and services that they bought from you…but haven’t paid for yet. Accounts receivable are found in the current assets section of the Balance Sheet.

ACCRUAL BASIS ACCOUNTING: With accrual basis accounting, you ‘account for’ expenses and sales at the time the transaction occurs. This is the most accurate way of accounting for your business activities. If you sell something to Mrs. Fernwicky today, you would record the sale as of today, even if she plans on paying you in two months. If you buy some paint today, you account for it today, even if you will pay for it next month when the supply house statement comes. Cash basis accounting records the sale when the cash is received and the expense when the check goes out. Not as accurate a picture of what is happening at you company.

ASSETS: The ’stuff’ the company owns. Anything of value - cash, accounts receivable, trucks, inventory, land. Current assets are those that could be converted into cash easily. (Officially, within a year’s time.) The most current of current assets is cash, of course. Accounts receivable will be converted to cash as soon as the customer pays, hopefully within a month. So, accounts receivable are current assets. So is inventory.

Fixed assets are those things that you wouldn’t want to convert into cash for operating money. For instance, you don’t want to sell your building to cover the supply house bill. Assets are listed, in order of liquidity (how close it is to cash) on the Balance Sheet.

BALANCE SHEET: The Balance Sheet reflects the financial condition of the company on a specific date. The basic accounting formula is the basis for the Balance Sheet:

Assets = Liabilities + Owner’s Equity

The Balance Sheet doesn’t start over. It is the cumulative score from day one of the business to the time the report is created.

CASH FLOW: The movement and timing of money, in and out of the business. In addition to the Balance Sheet and the Income Statement, you may want to report the flow of cash through your business. Your company could be profitable but ‘cash poor’ and unable to pay your bills. Not good!

A cash flow statement helps keep you aware of how much cash came and went for any period of time. A cash flow projection would be an educated guess at what the cash flow situation will be for the future.

Suppose you want to buy a new truck with cash. But that purchase will empty the bank account and leave you without any cash for payroll! For cash flow reasons, you might choose to buy a truck on payments instead.

CHART OF ACCOUNTS: A complete listing of every account in your accounting system. Every transaction in your business needs to be recorded, so that you can keep track of things. Think of the chart of accounts as the peg board on which you hang the business activities.

CREDIT: A credit is used in Double-Entry accounting to increase a liability or an equity account. A credit will decrease an asset account. For every credit there is a debit. These are the two balancing components of every journal entry. Credits and debits keep the basic accounting equation (Assets = Liabilities + Owner’s Equity) in balance as you record business activities.

DEBIT: A debit is used in Double-Entry accounting to increase an asset account. A debit will decrease a liability or an equity account. For every debit there is a credit.

DIRECT COSTS: Also called cost of goods sold, cost of sales or job site expenses. These are expenses that include labor costs and materials. These expenses can be directly tracked to a specific job. If the job didn’t happen, the direct costs wouldn’t have been incurred. (Compare direct cost with indirect costs to get a better understanding of the term.) Direct costs are found on the Income Statement, right below the income accounts.

Income - Direct Costs = Gross Margin.

DOUBLE-ENTRY ACCOUNTING: An accounting system used to keep track of business activities. Double-Entry accounting maintains the Balance Sheet: Assets = Liabilities + Owner’s Equity. When dollars are recorded in one account, they must be accounted for in another account in such a way that the activity is well documented and the Balance Sheet stays in balance.

You may not need to be an expert in Double-Entry accounting, but the person who is responsible for creating the financial statements better get pretty good at it. If that is you, go back through the book and focus on the ‘gray’ sheets. Study the examples and see how the Double-Entry method acts as a check and balance of your books.

Remember the law of the universe…what goes around, comes around. This is the essence of Double-Entry accounting.

EQUITY: Funds that have been supplied to the company to get the ’stuff’. Equities show ownership of the assets or claims against the assets. If someone other than the owner has claims on the assets, it is called a liability.

Total Assets - Total Liabilities = Net Equity

This is another way of stating the basic accounting equation that emphasizes how much of the assets you own. Net equity is also called net worth.

EXPENSE: Also called costs. Expenses are decreases in equity. These are dollars paid out to suppliers, vendors, Uncle Sam, employees, charities, etc. Remember to pay bills thankfully, because it takes money to make money. Expenses are listed on the Income Statement. They should be split into two categories, direct costs and indirect costs. The basic equation for the Income Statement is:

Revenues - Expenses = Profit

(You’ll see a profit if there are more revenues than expenses!…or a loss, if expenses are more than revenues.)

Remember, all costs need to be included in your selling price. The customer pays for everything. In exchange, you give the customer your services. What a deal!

FINANCIAL STATEMENTS: refer to the Balance Sheet and the Income Statement. The Balance Sheet is a report that shows the financial condition of the company. The Income Statement (also called the Profit and Loss statement or the ‘P&L’) is the profit performance summary.

Financial Statements can include the supporting documents like cash flow reports, accounts receivable reports, transaction register, etc. Any report that measures the movement of money in your company.

Financial Statements are what the bank wants to see before it loans you money. The IRS insists that you share the score with them, and asks for your Financial Statements every year.

GENERAL LEDGER: Once upon a time, accounting systems were kept in a book that listed the increases and decreases in all the accounts of the company. That book was called the general ledger. Today, you probably have a computerized accounting system. Still, the general ledger is a collection of all Balance Sheet and Income Statement accounts…all the assets, liabilities and equity. It is the report that shows ALL the activity in the company. Often this listing is called a detail trial balance on the report menu of your accounting program. The detail trial balance is my favorite report when I am trying to find a mistake, or make sure that we have entered information in the right accounts.

GROSS PROFIT: This is how much money you have left after you have subtracted the direct costs from the selling price.

Income - Direct Costs = Gross Profit. When this is expressed as a percentage, it is call Gross Margin.

This is a good number to scrutinize each month, and to track in terms of percentage to total sales over the course of time. The higher the better with gross margin! You need to have enough money left at this point to pay all your indirect costs and still end up with a profit.

INCOME STATEMENT: also called the Profit and Loss Statement, or P&L, or Statement of Operations. This is a report that shows the changes in the equity of the company as a result of business operations. It lists the income (or revenues, or sales), subtracts the expenses and shows you the profit J! (Or loss L.) This report covers a period of time and summarizes the money in and the money out.

The Income Statement is like a magnifying glass that shows the detail of activities that cause changes in the equity section of the Balance Sheet.

INDIRECT COST: Also called overhead or operating expenses. These expenses are indirectly related to the services you provide to customers. Indirect costs include office salaries, rent, advertising, telephone, utilities…costs to keep a ‘roof overhead’. Every cost that is not a direct cost is an indirect cost. Indirect costs do not go away when sales drop off.

INVENTORY: Also called stock. These are materials that you purchase with the intent to sell, but you haven’t sold them yet. Inventory is found on the balance sheet under assets. It is considered a current asset because you will convert it into cash as soon as you sell it. Beware of turning cash into inventory. You may run out of cash. Work with your suppliers to keep inventory SMALL.

JOURNAL: This is the diary of your business. It keeps track of business activities chronologically. Each business activity is recorded as a journal entry. The Double-Entry will list the debit account and the credit account for each transaction on the day that it occurred. In your reports menu in your accounting system, the journal entries are listed in the transaction register.

LIABILITIES: Like equities, these are sources of assets - how you got the ’stuff’. These are claims against assets by someone other than the owner. This is what the company owes! Notes payable, taxes payable and loans are liabilities. Liabilities are categorized as current liabilities (need to pay off within a year’s time, like payroll taxes) or long term liabilities (pay-back time is more than a year, like your building mortgage).

MONEY: Also called moola, scratch, gold, coins, cash, change, chicken feed, green stuff, BLING, etc. Money is the form we use to exchange energy, goods and services for other energy, goods and services. Used to buy things that you need or want. Beats trading for chickens in the global marketplace.

Money in and of itself is neither good or bad. I want you to make lots of it, and do great things with it!

NET INCOME: Also called net profit, net earnings, current earnings or bottom line. (No wonder accounting is confusing - look at all those words that mean the same thing!)

After you have subtracted ALL expenses (including taxes) from revenues, you are left with net income. The word net means basic, fundamental. This is a very important item on the income statement because it tells you how much money is left after business operations. Think of net income like the score of a single basketball game in a series. Net income tells you if you won or lost, and by how much, for a given period of time.

By the way, if net income is a negative number, it’s called a loss. You want to avoid those. The net income is reflected on the Balance Sheet in the equity section, under current earnings (or net profit). Net income results in an increase in owner’s equity. A loss results in a decrease in owner’s equity.

RETAINED EARNINGS: The amount of net income earned and retained by the business. If net income is like the score after a single basketball game, retained earnings is the lifetime statistic. Retained earnings is found in the equity section of the Balance Sheet. It keeps track of how much of the total owner’s equity was earned and retained by the business versus how much capital has been invested from the owners (paid-in capital).

Each month, the net profits are reflected in the Balance Sheet as current earnings. At the end of the year, current earnings are added to the retained earnings account.

Understanding General Ledger

Top Ten Accounting Software Programs

As an accountant, your job is to maintain your client’s accounts. And to add to that, computers and accounting software simply make your life great. Here is a review of the top 10 accounting software which will help you and your clients to manage their finances better.

Accounting software is a boon for so many of us - accountants included! These help us maintain our accounts - whether personal or for our business. However, with so many options available in the market, it sometimes becomes very difficult to choose the right accounting software package that will be perfect for the accountant as well as for the individuals. Hopefully, this review will help you narrow down your choices.

Peachtree

This software comes in different flavors depending on the number of users. Between Peachtree Pro, Peachtree Complete, Peachtree Premium and Peachtree Quantum buyers can choose from among several features, depending on what they specifically require. Of these, Peachtree Premium and Peachtree Quantum also have Accountants’ Editions, which can prove to be of great use for professional accountants. Added to these are several accounting and business management tools, reports customized for industry specific needs, and even payroll management solutions - you have a complete accounting software package that is just right for your pocket as well.

Quickbooks

A very popular choice of accounting software for personal and professional accounts management, Quickbooks offers something for everyone. Quickbooks is offered in versions Simple Start, Pro and Premier. There is also a free version of the software available for download from the website, and an online version of the software which you can access via the Internet. There is also a Premier version specifically for Accountants. Each of the versions offers a number of features - typically a simple and intuitive interface, access to several reports, payroll and even tax management.

MYOB

This is another popular choice across the board for individuals, small businesses and accountants. A cross-platform software package, MYOB offers the versions Premier Accounting and Business Essentials for Windows users, and AccountEdge, FirstEdge and Checkout for Mac users. Typically the features include invoicing, banking, contacts management, payroll management, inventory management, time billing, purchase management, and over 200 different reports.

Microsoft Accounting Express

Microsoft offers an accounting suite that integrates seamlessly with your other Microsoft products, while allowing you to manage your accounts, invoices, payrolls and even accept credit cards. You can also track your billable time, create quotes and invoices and custom create your reports from 50 available templates.

NetSuite

This is an online accounts management system. There is no software to download and install because it is web based. The website offers different roles for managing accounts, along with a variety of reports and tools for managing accounts receivables, accounts payable, payroll and inventory management along with time billing, costing and banking functions. A good option if you don’t want to install another software package on your computer and want to be able to access your accounts via the Internet.

FreshBooks

This is another web-based accounts management system. Freshbooks offers several features like invoicing, time tracking, estimate creation, tracking of expenses, and client and staff tracking among others. You can have either a free account with FreshBooks or a paid account depending on the number of contractors you want to add. FreshBooks also offers branding solutions helping you create an interface which is in line with your logo and company colors.

BookKeeper

This is a software package offering a complete suite of accounting features like integration with banking, expense tracking, payroll management, creating customized invoices, credit card payment processing, and over 125 custom reports. An additional purchase of Tax Table Updates enables you to automatically calculate your taxes and deductions.

DacEasy

DacEasy is a fairly good accounting software package which offers the typical features and sections like accounts receivable, accounts payable, payroll management, inventory tracking, banking and general ledger entries. A variety of reports from these different sections also allow you to review and manage your business more effectively.

CYMA

CYMA is also another preferred accounting package. Like several accounting software packages, this software also offers accounts payable and receivables, payroll management, banking integration, job costing and general ledger entries. However, it also offers two sections which are not offered by many other accounting software packages: Purchase Order management and Systems management. However, this software doesn’t offer features like inventory and time billing.

NolaPro

A web-based suite of accounts features, NolaPro offers a number of facilities like accounts payable and receivable, payroll management, order tracking, inventory control, point of sale management, and an e-commerce shopping cart. NolaPro also has a number of plugins which enhance the functionality of the accounts suite.

These accounting software packages should give you an idea of what is available out there in the market. Thus, depending on your requirement and the size of your business you can make the right choice.

Building Accounting Software Tips

* Use standard double entry accounting/bookkeeping (debits and credits) as the basis for your financial engine. You will find this will serve you well when it comes to not only storing data on transactions but also generating reports. Assets = Liabilies + Equity is a tried and true approach for tracking who owns what.
* Use decimal types for money.
* Use transactions.
* Keep the interface as simple as possible.
* You will need to have a method to allow the user to reconcile the bank records with their own records. Pulling in bank data would help this process but you will need to provide the user with a method to compare. You can use bank statements for this process.
* The bank is always considered to be right. If there is a discrepancy between the bank and the user records… the fault almost always is with the user records.
* Make sure you provide some sort of backup facility for the user
* Secure the users data
* Make sure you fully understand the process you are automating. Do not make assumptions. Run your ideas by an accountant who specializes in personal finance. Having this vetting will help quite a bit.
* Be prepared to write A LOT of code. Accounting software has been around for years, the list of “standard features” for a typical accounting package has grown, and there are quite a few players in the market. If you are planning on selling this product you will need to provide those standard features and then find some way of differentiating it from what is already available with additional features.
* Make sure there is an audit trail of all transactions within your system
* Make sure that every transaction within your system records the timestamp and username of a person who created it
* TEST TEST TEST and TEST again. You are keeping records of peoples personal financial transactions (their money). Errors are not taken lightly.

Books On Accounting Software Design Patterns

Patterns of Enterprise Application Architecture (Addison-Wesley Signature Series)

Patterns of Enterprise Application Architecture

Should Float or Decimal data type be used for dollar amounts?

The answer is easy. Never floats. NEVER !

Floats were according to IEEE 754 always binary, only the new standard IEEE 754R defined decimal formats. Many of the fractional binary parts can never equal the exact decimal representation. Any binary number can be written as m/2^n (m, n positive integers), any decimal number as m/(2^n*5^n). As binarys lack the prime factor 5, all binary numbers can be exactly represented by decimals, but not vice versa.

0.3 = 3/(2^1 * 5^1) = 0.3

0.3 = [0.25/0.5] [0.25/0.375] [0.25/3.125] [0.2825/3.125]

1/4       1/8     1/16       1/32

So you end up with a number either higher or lower than the given decimal number. Always.

Why does that matter ? Rounding. Normal rounding means 0..4 down, 5..9 up. So it does matter if the result is either 0.049999999999…. or 0.0500000000… You may know that it means 5 cent, but the the computer does not know that and rounds 0.4999… down (wrong) and 0.5000… up (right). Given that the result of floating point computations always contain small error terms, the decision is pure luck. It gets hopeless if you want decimal round-to-even handling with binary numbers.

Unconvinced ? You insist that in your account system everything is perfectly ok ? Assets and liabilities equal ? Ok, then take each of the given formatted numbers of each entry, parse them and sum them with an independent decimal system ! Compare that with the formatted sum. Oops, there is something wrong, isn’t it ?

SQL Server and .NET Framerwork use a different default algorithm for rounding

Just as an additional warning, SQL Server and the .Net framework use a different default algorithm for rounding. Make sure you check out the MidPointRounding parameter in Math.Round(). .Net framework uses Bankers algorithm by default and SQL Server uses Symmetric Algorithmic Rounding.

Nobody should ever have direct access to the database tables

Another thing you should be aware of in accounting systems is that no one should have direct access to the tables. This means all access to the accounting system must be through stored procs. This is prevent fraud not just SQL  injection attacks. An intenal user who wants to commit fraud should not have the ability to directly change data in the database tables, ever. This is a critcal internal control on your system. Do you really want some disgruntled employee to go to the backend of your database and have it start wrting them checks? Or hide that they approved an expense to an unauthorized vendor when they don’t have approval authority? Only two people in your whole organization should be able to directly access data in your financial database, your dba and his backup. If you have many dbas, only two of them should have this access.