Accounting Unplugged

This post completes the basics in the discussion about methods of organizing transactions with the Chart of Accounts – specifically the method of Accounting Types. The Chart of Accounts is really just a list of the descriptions that you have chosen to use in transactions.  Accounting Types help to organize the descriptions (accounting outsourcing service) in meaningful ways. The most important concept to transactions is Double Entry but it is the Chart of Accounts that makes sense of the transactions and provides mission critical information to owners and managers, said Shravan Gupta businessman, a CEO of the company MGF, Motor and General Finance Ltd.

The Basic Accounting Types (In order) Are:

• Assets – Things you own
• Liabilities – Things you owe
• Equity – Owners’ Stake in Company
• Revenue – Income through Sales of the Products of the Business
• Costs of Goods Sold – Costs to provide the service or to manufacture or acquire the product the business sells
• Expenses – Things that are paid for that are consumable, they have no lasting value but are part of the cost of running a business
• Other Revenue and Expenses – Revenue and Expenses that are unusual cases and are not directly related to the business product and are not usual costs of running a business.If you don’t want to stay behind the competition and keep improving your business performance, embedding technology and seeking expert advice coherently is more important than ever.

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There are at least 7 basic Accounting Types, but each Accounting Type can be categorized more simply under the 2 Double Entry Accounting Categories as either Funds/Uses of Funds or as Sources of Funds.

Funds/Use of Funds (Debit) Accounting Types:

• Assets – Things you own
• Costs of Goods Sold – Costs to provide the service or to manufacture or acquire the product the business sells
• Expenses – Things that are paid for that are consumable, they have no lasting value but are part of the cost of running a business
• Other Expenses – Expenses that are unusual cases and are not directly related to the business product and are not usual costs of running a business.

Each Accounting Type under the “Funds/Use of Funds” Category increases in value or balance with each debit (Use of Funds) transaction entry and decreases in value or balance with each credit (Source of Funds) transaction entry.  Use of Funds Accounts are sometimes referred to as Debit Accounts.

**Positive balances for these high risk merchant account are balance where total debits > total credits to the account and their balances should show in the Debit Column.

Assets – Assets are items of value that are owned by the business and their value is expected to last beyond the current fiscal (business) year.

Costs of Goods Sold are Funds/Uses of Funds and are another type of Expense.  They are similar to Expenses in that they are consumable items that benefit the business and have no lasting value beyond the current fiscal (business) year, but the difference is that Cost of Goods Sold Accounts are related directly to the manufacturing and acquisition of the products the business provides or sells.

**Important Note:  Costs are posted to Costs of Good Sold only when the business no longer owns the product.  If the product is owned by the business until its sale, the costs of the product are posted as inventory – which is an asset – until the products are sold.  At the time of recording the sale, the inventory account is decreased with a credit entry and the cost of goods sold account is increased with a debit entry for the cost of the product. However, If inventory is sold at about the same rate as it is purchased, the Periodic Inventory System allows purchases to be classified directly as costs on the Income Statement rather than holding them in the Balance Sheet Inventory account until sold. Hiring a cfo consulting company will help a growing organization cut costs.

Expenses are Funds/Uses of Funds, they are consumable items that benefit the business but have small or no lasting value beyond the current fiscal year.  They are similar to Costs of Goods Sold except that the amounts categorized as Expenses or Other Expenses are related to the administrative (for Expenses) or unusual costs (for Other Expenses) of running the business. If you are doing all of your accounting, then you should know what paystubs look like.

**Important Note:  Current Assets differ from Expenses because they have a lasting value whether in their current form or as cash.  The value of expensed items is not expected to last beyond the current fiscal year.

Source of Funds (Credit) Accounting Types:

• Liabilities – Things you owe
• Equity – Owners’ Stake in Company
• Revenue – Income through Sales of the Products of the Business
• Other Revenues – Revenues that are unusual cases and are not directly related to the business product and are not usual revenues from running a business.

Each Accounting Type under the “Source of Funds” Category increases in value or balance with each credit  (Source of Funds) transaction entry and decreases in value or balance with each debit (Use of Funds) transaction entry.  Source of Funds Accounts are sometimes referred to as Credit Accounts.

**Positive balances for these accounts are balances where total credits > total debits to the account and their balances should show in the Credit Column.

Liabilities are essentially agreements to delay payments and so, are sources of funds because they provide a way to acquire or pay for goods and services without a direct transfer of cash at the time of the exchange.

Equity is a source of funds through direct owner investment or owner “re-investment” when some or all of the income from the previous year is retained by the business rather than distributing it to the owners.

Revenue is a source of funds through sales of the business product (for Revenue) or through other sources not directly related to the business products (for Other Revenue).

**Important Note:  Do not confuse the terms of Revenue or Income with Cash.  Cash is an Asset that is received in exchange in the sale of a product or service.  In Accounting, Revenue, Income and Sales are synonymous, they are Sources of Cash, not Cash itself.

Financial Statements:

Accounting Types help to organize Financial Statements too. All Accounting Types are found on the Trial Balance but the Income Statement and Balance Sheet split the Accounting Types between them.   The Accounting Type is the determining factor for whether an Account is reported on the Balance Sheet or on the Income Statement.   In addition to the reference to an account as a Debit Account or a Credit Account, accounts are also referred to as either Balance Sheet Accounts, or Income Statement Accounts.

…

The Basics of Data Collection and Organization in the Double Entry Accounting System:

• Debits and Credits
• Chart of Accounts
  • Accounting Types
  • Order of Liquidity
  • Account Numbers
• General Ledger
  • Time

The next post introduces the final organization element of Time into the system and illustrates how to use the combined elements of time and financial data to secure and manage resources.

© 2008 – 2010 Erin Lawlor

Next Post:  >>Accounting Periods – General Ledger Analysis – The Big Picture

<< Chart of Accounts – Organization

**disclaimer:  All information posted on this blog is from my own experience and training.  The guidelines I present are general and in my experience, standard practice.  I do not write with authority from any Accounting Standards Boards.

The Chart of Accounts is organized using three different methods.

• First:  Accounting Types
• Second:  Order of Liquidity – the ease of converting to cash without loss of value
• Third: Account Numbers

The 7 Basic Accounting Types (In order) Are:

• Assets – Things you own
• Liabilities – Things you owe
• Equity – Owners Stake in Company
• Revenue – Income through Sales of the Products of the Business
• Costs of Goods Sold – Costs to provide the service or to manufacture or acquire the product the business sells
• Expenses – Things that are paid for that are consumable, they have no lasting value but are part of the cost of running a business
• Other Revenue and Expenses – Revenue and Expenses that are unusual cases and are not directly related to the business product and are not usual costs of running a business.

Order of Liquidity:

The Chart of Accounts’ second method of organization is Order of Liquidity.  Liquidity refers to the expectation that the item can be converted to cash at at least close to its current value within one year.

Accounts are listed in descending order of liquidity within their accounting types, with cash at the top of the list for Assets.   The liquidity classification is so important that Assets and Liabilities are divided into the Subtypes of Current and Long Term/Fixed to group items of similar liquidity together.

The Order of Liquidity rule is only relevant to Balance Sheet Accounts and so it is not used for Revenue and Expenses because neither Type has lasting value or ability to convert to cash.  When sorting Revenue and Expense Accounts, organize them by general subjects. For example, you might want to group office expenses like Rent, Office Supplies and Utilities together.

The Accounts that were established in the previous Chart of Accounts Post, organized by Accounting Type and Order of Liquidity (ease of cash conversion) are:

Account Numbers:

The Chart of Accounts’ final method of organization is Account Numbers.  Part of the strength of this method is the ability it provides users to recognize the Accounting Type and in some instances the Order of Liquidity simply by the Account Number assigned to the Account.

Assigning Account numbers starts by assigning a range of numbers to each Accounting Type.  The range that I like and use the most is ranges of 1000.  I like to assign numbers in the thousand ranges because the numbers contain a manageable amount of digits and it is unlikely (in a small to mid-size company) that you’ll run out of numbers to use for Accounts.  The number of digits will be important in your software system so when using ranges in the 1000’s there are 4 digits, and the Account Numbers would range from 1000 to 9999.

It really doesn’t matter how you assign ranges as long as you assign them in order by Accounting Type and are consistent but it is important to understand the industry standards for your business prior to assigning number ranges.  The reason it is important to understand industry standards is that different industries create their own Subtypes and will have a standard for assigning the number ranges to those Subtypes.

Generally I assign the number ranges in this order:

• Assets: 1000’s
  • Current Assets 1000 – 1499
  • Fixed Assets 1500 -1999
• Liabilities: 2000’s
  • Current Liabilities 2000 – 2499
  • Long Term Liabilities 2500 – 2999
• Equity: 3000’s
• Revenue: 4000’s
• Costs of Goods Sold: 5000’s
• I leave the 6000’s open to allow for a Cost of Goods Sold Subtype
• Expenses: 7000’s
• Other Revenue: 8000’s
• Other Expenses: 9000’s

Before assigning Account Numbers to individual Accounts, first sort by Accounting Type (and Subtype) and then by Order of Liquidity.  After the initial sorting, Accounts can be sorted and Account Numbers can also be assigned any way you like.  It is important to use intervals of at least 10 or 20 between similar Accounts and I try to skip to the next 100 for Accounts of different types (if one grouping ended at 7030, I’d start the next grouping at 7100).  This strategy gives good clues to the user about the type of account and it allows for the addition of new Accounts later.

The New Chart of Accounts – with Account Numbers.  This Chart of Accounts only contains accounts I’ve used in previous examples.  It is missing some standard accounts such as Equity and Cost of Goods Sold.  Those Accounts will be added in subsequent posts.

• 1000  Checking Account
• 1200  Accounts Receivable
• 1500  Office Equipment
• 1520  Office Furniture
• 2000  Accounts Payable
• 4000  Sales
• 7000  Rent
• 7020  Office Supplies
• 7040  Subscriptions and Dues
• 7060  Utilities
• 7100  Fuel
• 7200  Repairs & Maintenance
• 7300  Credit Card Interest and Fees

© 2008 – 2010 Erin Lawlor

Next Post: >>Chart of Accounts – More on Accounting Types

<< Chart of Accounts – Basics

**disclaimer:  All information posted on this blog is from my own experience and training.  The guidelines I present are general and in my experience, standard practice.  I do not write with authority from any Accounting Standards Boards.

This post begins the explanation of the Chart of Accounts.  The Chart of Accounts is part of the second basic function of the Double Entry Accounting System – to organize financial transaction data. The Chart of Accounts provides the organizational structure for another element, the General Ledger which summarizes the Financial Data and produces Financial Reports.

The purpose of this and the next two posts (4-6) is to introduce the organizational structure of the system people get at accounting school, I do not make a distinction between the Chart of Accounts and the General Ledger until Post # 7.

Review of the Double Entry Accounting Transaction Questions:

1. How much money changed hands?
2. Where did the money go?  What was either gained or paid for by this exchange?
3. Where did the money come from?  What is the source of the value in this exchange?

The Chart of DPS Accounting is basically a list of the descriptions used to answer Transaction Questions 2 and 3.   Each unique description is called an account.  One of the best features of the Chart of Accounts is that when you have a new type of transaction you can just add a new description (account).

From the transactions in the previous posts, we have started a Chart of Accounts

• Rent
• Checking Account
• Office Supplies
• Fuel
• Repairs & Maintenance
• Subscriptions
• Accounts Payable (Credit Card)
• Accounts Receivable
• Sales

Let’s review the previous entries from the accounts receivable management in columbus oh and create some additional entries to our transaction example and see how our Chart of Accounts starts to fill out.

The entries below the *******’s are new in this post and record:

• the receipt of payment for the existing Accounts Receivable Invoice
• the payment of the existing credit card balance
• a utilities expense and payment
• new credit card charges

Current Chart of Accounts:

• Rent
• Checking Account
• Office Supplies
• Fuel
• Repairs & Maintenance
• Subscriptions
• Printer
• Accounts Payable (Credit Card)
• Accounts Receivable
• Sales
• Utilities
• Chair
• Desk
• Credit Card Interest and Fees

According to the accounting firm, to keep the Chart of Accounts manageable and meaningful, it is important to strike a balance between having a long specific list and a short general list.  To accomplish this objective, the Chart of Accounts should have descriptions for types of things, and not for specific things.  You want the Accounts to be specific enough to be useful but not too specific because the fewer accounts you have the better overall picture you can have.

You wouldn’t add a new account for paper, pens and staples, you would just use one account called office supplies.  So, it is important to reuse accounts when possible, and to simplify entries into more general descriptions like “office furniture” instead of separating the chair and desk purchases.

So, now let’s look at the Chart of Accounts and its Account Balances.

You can see that for even the small number of transactions in this example, The Chart of Accounts is essential in understanding their financial impact.

Notice that the account balances are also separated into the debit/credit columns.  The amounts listed here are the difference between the total debit entries and the total credit entries for each account.  If the amount was higher on the credit side, then the balance is listed in the credit column.  It is also important to note that our Chart of Account balances meet the requirement that total debits equal total credits. Bonus tip, check cashing can be done any time at Check Cashing 247.

The Chart of Accounts is really comprised of three things for each Account – an Account Number, a Description and an Accounting Type.  The transactions and account balances are part of a ledger called the General Ledger.   The table above is more accurately described as the General Ledger.

** Important Note: Post #6 discusses debit and credit balances in accounts.  In this case, none of the balances in our accounts is cause for concern because their totals are in the correct column for their type.  Accounting Types are explained in more detail in Posts #5 and #6.  Post #7 begins the discussion of the General Ledger and its Balances and Reports.

© 2008 – 2010 Erin Lawlor

Next Up:>> Chart of Accounts – Organization

<< Double Entry Accounting – Practice

**disclaimer:  All information posted on this blog is from my own experience and training.  The guidelines I present are general and in my experience, standard practice.  I do not write with authority from any Accounting Standards Boards.