100 Arbor Drive, Suite 108
Christiansburg, VA 24073
Voice: 540-381-9333
FAX: 540-381-8319
www.BEcpas.com
Providing Professional Business Advisory
& Consulting Services
Douglas L. Johnston, II
djohnston@becpas.com
SETTING UP YOUR
BUSINESS ACCOUNTING SYSTEM
BASIC ACCOUNTING FOR THE
NON-ACCOUNTANT
CONTENTS
The Balance Sheet
1
The Income Statement
4
The Cash Flow Statement
5
Accounting Concepts
6
Accounts Requiring Special Attention
8
Sample Financial Statements
9
THE BALANCE SHEET
PURPOSE:
The balance sheet is a summary of total assets and total liabilities of a given
business to portray its net worth at a given moment of time.
MAJOR COMPONENTS:
ASSETS
-
Economic resources owned by or available to the
business
LIABILITIES
-
Obligations due to others
OWNERS’ EQUITY
-
Residual interest in assets after deducting
liabilities
THE ACCOUTING “EQUATION”:
ASSETS = LIABILITIES + OWNERS’ EQUITY
1
THE BALANCE SHEET
CURRENT ASSETS:
Cash and other assets that are expected to be converted to cash or consumed
within one year. Examples:
Trade Accounts Receivable – Amounts owed by customers
Inventory – Raw materials and finished goods for sale to customers
Prepaid Expenses – Amounts paid for expenses attributable to subsequent
accounting periods
NON-CURRENT ASSETS:
Assets expected to be held for longer than one year. Examples:
Property and Equipment – Physical assets of a durable nature that will be
expended gradually in the operation of the
business
Intangible Assets – Assets that are not physical in nature such as
goodwill, non-compete agreements, patents, and
franchise licenses
OTHER ASSETS:
Example:
Investments – Real estate, securities, and other assets held for appreciation
or future development and not used in the operations of
the business
2
THE BALANCE SHEET
CURRENT LIABILITIES:
Obligations due to be paid within one year. Examples:
Trade Accounts Payable – Amounts owed to vendors
Accrued Expenses – Expenses incurred as of the balance sheet date that
will be paid in the subsequent accounting period
Current Maturities – The portion of long-term debt that will be paid
within one year
LONG-TERM LIABILITIES:
Obligations due in more than one year. Example:
Long-Term Debt – Amounts owed to lenders excluding the current
maturities
OWNERS’ EQUITY:
The residual value of assets over liabilities. Components:
Paid-In Capital – Amounts contributed by the business owners, whether
in cash or other property.
Retained Earnings – Cumulative net income of the business that has not
been distributed to owners
3
THE INCOME STATEMENT
PURPOSE:
The income statement is a summary of the revenue and expense transactions of
the business over a given period of time.
MAJOR COMPONENTS:
REVENUES
-
Amounts earned/received from sales to customers
COST OF SALES
-
The cost of goods bought or produced and sold to
customers
GROSS PROFIT
-
Profit on sales after deducting the cost of goods
sold and before the deduction of other expenses
OPERATING EXPENSES -
Expenses of marketing and operating the
business, including taxes
NET INCOME
Profit after deducting all expenses
-
THE “BOTTOM LINE”:
REVENUES – EXPENSES = NET INCOME
4
THE CASH FLOW STATEMENT
PURPOSE:
The cash flow statement is a summary of the increase or decrease in cash
generated from the business activities after adjusting for changes in other assets
and liabilities.
MAJOR COMPONENTS:
OPERATING ACTIVITIES
-
Cash generated or consumed by day to day
business activities
INVESTING ACTIVITIES
-
Cash provided by or consumed
by non-operating assets
FINANCING ACTIVITIES
-
Cash provided by or used in equity or debt
transactions
5
ACCOUNTING CONCEPTS
DOUBLE ENTRY:
Debit Accounts
Credit Accounts
Asset
Liabilities
Owners’ Equity
Expenses
Revenue
Each entry on one side of the “T-chart” must be accompanied by either: an
opposing entry on the same side of the chart or a parallel entry on the other side
of the chart.
HISTORICAL COST:
Transactions are generally based on the actual historical cost of assets used in the
business. While historical cost doesn’t reflect the true economic equity in the
business, it does eliminate the subjectivity inherent in the determination of market
value. There are exceptions to the historical cost method of accounting for
certain assets, such as worthless inventory and for readily marketable securities.
MATCHING:
Expenses should be recognized in the same accounting period as the revenue
which is generated from the use of those resources
6
ACCOUNTING CONCEPTS
CAPITAL EXPENDITURE VS. EXPENSE:
CAPITAL EXPENDITURE
-
Expected to benefit future periods and
must be expensed over time
EXPENSE
-
Consumed and expensed in the current
period and is therefore expensed currently
CASH VS ACCRUAL ACCOUNTING:
CASH METHOD
-
ACCRUAL METHOD -
Revenues are recorded when received
Expenses are recorded when paid
Exceptions for inventory and long-term assets
Revenues are recorded when earned
Expenses are recorded when incurred
7
ACCOUNTS REQUIRING SPECIAL ATTENTION
ACCOUNTS RECEIVABLE:
Accounts Receivable generally consists of numerous customer accounts. A “sub
ledger” is typically used to track each of these individual customer accounts and
reconcile back to the main (“general”) ledger. The individual customer accounts
receivable should be “aged” to indicate the time elapsed since the sale.
INVENTORY:
Inventory generally consists of an assortment of raw materials and/or finished
goods held for sale to customers. Inventory quantities can be determined upon
each sale using a “perpetual inventory” system, or inventory can be periodically
“counted” to determine the quantity on hand and compute the amount consumed.
There are several different techniques to determine a value for inventory
quantities, including specific pricing, first-in-first-out (FIFO), and last-in-first-out
(LIFO).
NON-CURRENT ASSETS:
It is desirable and necessary to match the consumption of assets with the revenue
that their consumption helps generate. Consequently, the cost of these assets is
expensed over time through “depreciation” (for tangible assets) or “amortization”
(for intangible assets.) Depreciation and amortization are required by generally
accepted accounting principles and income tax law. There are numerous
depreciation and amortization methods ranging from simple “straight-line” to
various accelerated methods.
ACCOUNTS PAYABLE:
Accounts Payable generally consists of numerous vendor accounts. A “sub
ledger” is typically used to track each of these individual vendor accounts and
reconcile back to the main (“general”) ledger. As a general rule, accounts
payable should be paid on the latest date possible to obtain discounts and/or avoid
penalties.
8
SAMPLE FINANCIAL STATEMENTS
9
ABC COMPANY
BALANCE SHEET
ASSETS
Year 2
CURRENT ASSETS
Cash
Accounts receivable
Inventory
Prepaid expenses
$
Total current assets
70,000
330,000
400,000
20,000
Year 1
$
40,000
410,000
400,000
15,000
820,000
865,000
175,000
75,000
175,000
75,000
250,000
80,000
250,000
45,000
170,000
205,000
10,000
12,000
$ 1,000,000
$ 1,082,000
CURRENT LIABILITIES
Accounts payable
Accrued expenses
Notes payable
Current maturities of long-term debt
Accrued income taxes
280,000
20,000
100,000
40,000
10,000
345,000
26,000
170,000
50,000
2,000
Total current liabilities
450,000
593,000
160,000
200,000
10,000
6,000
620,000
799,000
10,000
40,000
330,000
10,000
40,000
233,000
380,000
283,000
$ 1,000,000
$ 1,082,000
PROPERTY, PLANT, AND EQUIPMENT
Machinery and equipment
Furniture and fixtures
Less accumulated depreciation
OTHER ASSETS
Goodwill
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
LONG-TERM DEBT
DEFERRED INCOME TAXES
Total liabilities
STOCKHOLDERS’ EQUITY
Common stock
Additional paid-in capital
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
10
ABC COMPANY
INCOME STATEMENT
SALES
COST OF GOODS SALES
Gross profit
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
OTHER EXPENSES
Interest
Income before income taxes
INCOME TAX EXPENSE
Net income
RETAINED EARNINGS
Beginning of year
End of year
11
Year 2
Year 1
$4,325,000
$4,000,000
2,950,000
2,728,000
1,375,000
1,272,000
1,209,000
1,196,000
28,000
32,000
138,000
44,000
41,000
8,000
97,000
36,000
233,000
197,000
$ 330,000
$ 233,000
ABC COMPANY
CASH FLOW STATEMENT
Year 2
CASH FLOWS FROM OPERATING ACTIVITIES
Net income
Depreciation
Amortization
(Increase) Decrease in:
Accounts receivable
Inventory
Prepaid
Increase (Decrease) in:
Accounts payable
Accrued expenses
Accrued income taxes
Deferred income taxes
Cash Provided by Operations
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures
CASH FLOWS FROM FINANCING ACTIVITIES
Payments notes payable
Payments on long-term debt
Cash used in Financing Activities
$ 97,000
35,000
2,000
80,000
(5,000)
(65,000)
(6,000)
8,000
4,000
150,000
(70,000)
(50,000)
(120,000)
NET INCREASE IN CASH
30,000
BEGINNING CASH
40,000
ENDING CASH
$ 70,000
12