Accrual | Adjusting Entry | Asset | Balance Sheet | Budget | Client Portal | COGS | Cost Principle | Credit | Debit | Depreciation | Double Entry | Engagement Letter | Entity | Equity | Expense | Fiscal Year | Fixed Asset | Forcast | GAAP | General Ledger | Going Concern | Journal Entry | Liabilities | Matching | Net Income | Realization | Retained Earnings | Revenue | Reversing Entry | Trial Balance test
There are two ways to keep books on recording items: the cash and accrual methods. Let’s invoke Popeye the Sailor Man’s friend Wimpy who always says, “I’ll gladly pay you Tuesday for a hamburger today.” Let’s say today is the Friday before this famous Tuesday.
- If you use the cash basis method, you will record the entire transaction on Tuesday when you get the cold hard cash.
- If you use the accrual basis, you will have two entries: On Friday, record the sale to accounts receivable. On Tuesday, you will zero out the receivable and increase cash.
It’s the same net effect; the only difference is in the timing. Most small businesses that extend credit keep their books on an accrual basis so they can keep track of everything. However, most taxes are paid on cash-basis books, requiring adjusting entries at year-end that reverse at the beginning of the year.
Make an adjusting journal entry when account balances need to be corrected. An example is depreciation expense, which typically associates with an adjusting entry. Accountants will make several adjusting entries like this at year-end.
Essentially, assets are what you own. These include your bank accounts, business equipment, and even the amounts that customers owe you.
A balance sheet is a standard report of all of the business’s account balances as of a specific date, such as December 31. These accounts include cash, receivables, fixed assets, liabilities, equity, and others.
Most companies sit down once a year and plan what they intend to spend. This set of numbers is a budget. Prepared in income statement format, including planned revenue and expenses, and span a year, monthly, or both.
A standard report that compares budget to actual figures is the Income Statement Comparison to Budget, which includes columns for the month and year-to-date actual, budget, and variance (the difference).
A client portal is a software application where client files can be stored and retrieved securely. Both the accountant and the client have access to the portal.
COGS stands for Cost of Goods Sold. It’s a form of expense that directly relates to the selling of a product or service. For example, your business sells shoes, the cost of purchasing those shoes is considered COGS. At the same time, something like rent or insurance is simply an expense. COGS is mainly essential in manufacturing, retail, and distribution companies.
The cost principle is a foundational accounting principle. When booking a transaction, it is at cost and not market or current value. So even though an asset may have gained in value after you bought it, your books will still reflect the cost of the item, not the current value.
A credit is a term that tells you whether money is being increased or decreased. The hard part is that it’s opposite depending on the account and the company. Here are some examples:
- A credit to cash decreases it, as in writing a check to someone.
- A credit to a loan you owe increases it, so you owe more money.
- When you talk to a bank teller and want to credit your account, it means they are putting money in because your account is a liability. So it’s the opposite.
A debit is a term that tells you whether money is being increased or decreased. The hard part is that it’s opposite depending on the account and the company. Here are some examples:
- A debit to cash increases it, so that’s good.
- A debit to a loan you owe decreases it, so that’s good because you are paying it off.
- When you talk to a bank teller and want to debit your account, it means they are taking money away because your account is a liability. So it’s the opposite.
Most fixed assets except land depreciate over time. For example, when you drive a new car out of the lot, no one will give you what you just paid for it. Recognize this reduction in value over time in your accounting books by recording depreciation. Since recognizing assets need to be at market value, depreciation is an estimate of this adjustment. Thus, depreciation becomes an expense and reduces the value of the fixed asset. Unlike most other transactions, cash is not affected when recording depreciation.
A double-entry bookkeeping system means that when a transaction occurs, two accounts are impacted. For example, when an invoice is generated, entries are made to the accounts receivable account and the accounts receivable. It was invented in the 1400s and is widely used in modern accounting today.
An engagement letter is a contract that defines the relationship between the client and the accountant. It is typically signed before the work starts and can be renewed once a year. It can also be changed if the scope of the work varies.
Entity is a generic term for a company or organization. There are many types of entities: nonprofit, corporation, partnership, and sole proprietor.
In mathematical terms, equity is the net of your assets, less your liabilities. In more philosophical terms, it’s the net amount invested in your business and adjusted by the years of net income you’ve made less than what you’ve taken out of the company.
An expense is what you spend in your business on items that are not expected to benefit you in the long term. Expenses include credit card fees, office supplies, insurance, rent, payroll expense, and similar items that you need to incur to keep your business running.
Most companies report their results on a calendar year, from January 1 through December 3. Some companies use a different year for reporting, and that’s called a fiscal year. For example, Intuit’s fiscal year runs from August 1 to July 3.
A nonprofit commonly runs from July 1 to June 3. The word fiscal alone refers to government or public revenues and expenditures. However, a fiscal year can also be considered when companies report their financial results to the public.
A fixed asset is a particular type of asset that includes items such as land, vehicles, furniture, buildings, office equipment, plants, and machinery. Fixed assets cannot easily be converted into cash (cash equivalents are termed current assets). They must last longer than one year. They are physical or tangible (as opposed to intangibles such as patents and trademarks).
While a budget is a longer-term plan, a forecast is an attempt to predict the short-term future. Forecasts can be made for cash flow, predicting your bank account balance, or can be focused on potential profit for a period. A forecast is created by enumerating current and expected short-term cash commitments.
GAAP stands for Generally Accepted Accounting Principles. It refers to the set of standards that accountants must follow when creating accounting reports for people like bankers and investors who rely on them.
A general ledger is a fancy word for your accounting books. It’s also a particular report that lists each account within the chart of accounts, beginning balances, the activity of each account for a specific period, and ending balances. In addition, it includes balance sheet accounts, such as cash, accounts receivable, accounts payable, and income statement accounts, such as revenue and expenses.
Going concern is an accounting principle. For example, an entity is a going concern if it’s expected to continue operations soon.
A journal entry is usually an adjustment that is made to the accounting books. The result is that some accounts increase and others decrease. In theory, every transaction made to a company’s books is a journal entry. When you write a check, and it’s cashed, cash goes down, and an expense is increased. When you receive a payment, cash goes up, and revenue goes up. Each of these transactions is a journal entry.
Liabilities are what you owe. If you have loans taken out for your business or owe vendors money for invoices of purchases they sent you, those are liabilities. Typical liabilities include:
- Collected unpaid sales tax.
- Outstanding vendors’ invoices.
- Credit cards that are not paid off each month.
- Mortgages on buildings.
- Bank loans.
The matching principle is another basic accounting principle. It says that for any particular transaction, all aspects should be booked in the same accounting period. For example, let’s say you incurred expenses from an order in November. However, the order wasn’t delivered or invoiced until December. So to meet the matching principle, expenses should be deferred until December where they can be matched with the revenue that relates to the expenses.
Another word for net income is profit. It’s calculated by subtracting expenses from revenue. If what’s leftover is a positive number, it’s net income, and if it’s negative, it’s a net loss. Besides your salary, it’s the amount of money you can either keep or reinvest into your business.
A business transaction has many stages. It starts with an idea, may progress to a promise, then it happens. Accountants need to figure out when it becomes “real” when to record it on the books. This is the concept of realization. A transaction is realized and recorded when there is a contract, legal obligation, exchange of products or services, or cash exchange. There are many complicated principles and rules to help accountants determine this timing.
Retained earnings are an account in the equity section of the balance sheet. It’s the amount of earnings that is reinvested in the company after dividends are paid out. It’s computed by taking the retained earnings beginning balance, adding income or subtracting loss for the period, and subtracting any dividends paid.
Revenue is what you make. Another word for it is Sales. You generate revenue in your business when you make a sale to a customer. The amount of the sale is included in revenue.
A reversing entry is a form of adjusting entry made in the period following an adjusting entry. It reverses the adjusting entry. One example of this is a cash basis taxpayer that is tracking accounts receivable. The accounts receivable balance is adjusted to zero before year-end and reversed on January 1.
A trial balance is an accounting report that lists the current balances of your accounts in your chart of accounts as of a specific date. It can also be called working trial balance. Another way to look at the trial balance is that it’s a very informal version of a balance sheet.