Term
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Definition
Owner’s equity is one of the three main components of a sole proprietorship’s balance sheet and accounting equation. Owner’s equity represents the owner’s investment in the business minus the owner’s draws or withdrawals from the business plus the net income (or minus the net loss) since the business began.
Mathematically, the amount of owner’s equity is the amount of assets minus the amount of liabilities. Since the amounts must follow the cost principle (and others) the amount of owner’s equity does not represent the current fair market value of the business.
Owner’s equity is viewed as a residual claim on the business assets because liabilities have a higher claim. Owner’s equity can also be viewed (along with liabilities) as a source of the business assets. |
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Term
| Are estimates allowed in bookkeeping? |
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Definition
While bookkeeping involves mostly precise amounts from sales and purchase invoices, cash receipts and checks written, etc. there are situations when estimates need to be entered. This is especially true when monthly financial statements are prepared under the accrual method of accounting. For instance, the monthly bookkeeping entries for depreciation, property taxes, utilities, fringe benefits and more will need to be estimates.
Even the end-of-year financial statements will require some estimated amounts. For example, a company’s liability for warranties on its products and its allowance for noncollectable accounts receivable will need to be estimates. Providing an estimated amount is better than ignoring reality and reporting a zero amount.
I recommend that the company’s accountant review the estimated amounts that will be entered in the bookkeeping or accounting system. |
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Term
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Definition
The account Sales is credited because a corporation’s sales of products will cause its stockholders’ equity to increase. A sole proprietorship’s sales will cause the owner’s equity to increase.
The Sales account is used in order to keep a tally of the sales made during an accounting year. However, when the accounting year is completed, the credit balance will be moved via closing entries to the corporation’s Retained Earnings account or to the sole proprietorship’s Owner’s Capital account.
Recall that asset accounts will likely have debit balances and the liability and stockholders’ equity accounts will likely have credit balances. To confirm that crediting the Sales account is logical, think of a cash sale. The asset account Cash is debited and therefore the Sales account will have to be credited. Also the accounting equation will remain in balance because the asset Cash is increased with a debit, and through the closing entries an owner’s or stockholders’ equity account will be increased with a credit. |
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Term
| What is a general ledger account? |
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Definition
A general ledger account is an account or record used to sort and store balance sheet and income statement transactions. Examples of general ledger accounts include the asset accounts such as Cash, Accounts Receivable, Inventory, Investments, Land, and Equipment. Examples of the general ledger liability accounts include Notes Payable, Accounts Payable, Accrued Expenses Payable, and Customer Deposits. Examples of income statement accounts found in the general ledger include Sales, Service Fee Revenues, Salaries Expense, Rent Expense, Advertising Expense, Interest Expense, and Loss on Disposal of Assets.
Some general ledger accounts are summary records which are referred to as control accounts. The detail that supports each of the control accounts will be found outside of the general ledger in what is known as a subsidiary ledger. For example, Accounts Receivable could be a control account in the general ledger, and there will be a subsidiary ledger which contains each customer’s credit activity. The general ledger accounts Inventory, Equipment, and Accounts Payable could also be control accounts and for each there will be a subsidiary ledger containing the supporting detail. |
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Term
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Definition
Budgeting is a process. This means budgeting is a number of activities performed in order to prepare a budget. A budget is a quantitative plan used as a tool for deciding which activities will be chosen for a future time period.
In a business, the budgeting for operations will include the following:
- preparing estimates of future sales
- preparing estimates of future cash collections and disbursements
- preparing estimates of the future day-to-day activities of the organization
- summarizing these estimates into an income statement and balance sheet
The budgeted income statement and balance sheet are also known as pro-forma financial statements. Once prepared and approved, the budgeted income statement and balance sheet are used to control the future activities of the business. |
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Term
| What are inventoriable costs? |
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Definition
Inventoriable costs are 1) the costs to purchase or manufacture products which will be resold, plus 2) the costs to get those products in place and ready for sale. Inventoriable costs are also known as product costs.
To illustrate, let’s assume that a retailer purchases an item for resale by paying $20 to the supplier. The item is purchased FOB shipping point, which means that the retailer must pay the freight from the supplier to its location. If that freight cost is $1, then the retailer’s inventoriable cost is $21. Assuming this is the only item in the retailer’s inventory, the retailer’s balance sheet will report inventory at a cost of $21. When the item is sold, the retailer’s inventory will decrease by $21 and the $21 will be reported on the income statement as the cost of goods sold.
In the case of a manufacturer, a product’s inventoriable costs are the costs of the direct materials, direct labor and manufacturing overhead incurred in manufacturing the product. |
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Term
| What is the proper use of the words lend and borrow? |
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Definition
If a company is granted a loan from its bank, the company is borrowing money from its bank, and the bank is lending money to one of its customers. In other words, the bank is the lender and the loan customer is the borrower.
To use your friend’s car, you might ask “May I borrow you car? or “Will you lend me your car?” If your friend agrees, you are borrowing your friend’s car and your friend is lending his or her car. |
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Term
| Does the accrual method apply to the purchase of equipment? |
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Definition
The accrual method does apply to the purchase of equipment (as well as applying to revenues and expenses).
To illustrate, let’s assume that on December 29 a company ordered and received some equipment to be used in its operations. The payment for the equipment is to be made on February 10. Under the accrual method, on December 29 the company should debit the asset account Equipment and credit the liability account Accounts Payable. (When the supplier or vendor is paid on February 10, the company’s asset Cash will be credited and its liability account Accounts Payable will be debited.) |
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Term
| What is the statement of activities? |
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Definition
The statement of activities is one of the main financial statements of a nonprofit or not-for-profit organization.
A nonprofit’s statement of activities is issued instead of the income statement which is issued by a for-profit business.
The statement of activities focuses on the total organization (as opposed to focusing on funds within the organization) and reports the following:
1. Revenues such as contributions, program fees, membership dues, grants, investment income, and amounts released from restrictions.
2. Expenses reported in categories such as major programs, fundraising, and management and general.
3. The change in net assets resulting from items 1 and 2.
The statement of activities will have multiple columns in order to report the amounts for each of the following classes of net assets: unrestricted, temporarily restricted, permanently restricted, and total. |
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Term
| What is the difference between the cash basis and the accrual basis of accounting? |
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Definition
1. Revenues are reported on the income statement in the period in which the cash is received from customers.
2. Expenses are reported on the income statement when the cash is paid out.
Under the accrual basis of accounting…
1. Revenues are reported on the income statement when they are earned—which often occurs before the cash is received from the customers.
2. Expenses are reported on the income statement in the period when they occur or when they expire—which is often in a period different from when the payment is made.
The accrual basis of accounting provides a better picture of a company’s profits during an accounting period. The reason is that the income statement prepared under the accrual basis will report all of the revenues actually earned during the period and all of the expenses incurred in order to earn the revenues.
The accrual basis of accounting also provides a better picture of a company’s financial position at a moment or point in time. The reason is that all assets that were earned are reported and all liabilities that were incurred will be reported.
The accrual basis of accounting is required because of the matching principle. |
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Term
| What is the difference between an implicit cost and an explicit cost? |
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Definition
An implicit cost is a cost that has occurred but it is not initially shown or reported as a separate cost. On the other hand, an explicit cost is one that has occurred and is clearly reported as a separate cost. Below are some examples to illustrate the difference between an implicit cost and an explicit cost.
Let’s assume that a company gives a promissory note for $10,000 to someone in exchange for a unique used machine for which the fair value is not known. The note will come due in three years and it does not specify any interest. Due to the company’s weak financial position it will have to pay a high interest rate if it were to borrow money. In this example, there is no explicit interest cost. However, due to the issuer’s financial difficulty and the seller having to wait three years to collect the money, there has to be some interest cost. In other words, there is some interest and it is implicit. To properly record the note and the machine, the accountant must determine the amount of the interest, which is known as imputing the interest. In effect the accountant must convert the implicit interest to explicit interest. This is done by discounting the $10,000 by using the interest rate that the issuer of the note would have to pay to another lender. If the rate is 12% per year, the interest that was implicit in the note is $2,880 and the principal portion of the note is the remaining $7,120.
If another company with the same financial condition purchased this unique machine by issuing a $7,120 note with a stated interest rate of 12% per year, the interest cost of $2,880 would be explicit. In this situation, there is no need to impute the interest.
Another example of an implicit cost is the opportunity cost of a sole proprietor working in her own business. For example, Gina works as a sole proprietor and her business reported a net income of $30,000 for the year. Since a sole proprietor does not receive a salary or wages, there is no explicit cost reported for Gina’s work in her business. However, if Gina is foregoing a salary of $40,000 from another company, that is an implicit cost for her business. After considering this implicit cost, Gina is losing $10,000 by working in her proprietorship.
If Gina operates her business as a corporation, Gina will be an employee of the corporation. If her annual salary is $40,000 the corporation’s income statement would report the $40,000 salary as an explicit cost for Gina’s work. |
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Term
| What is a financial statement? |
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Definition
We use the term financial statement to mean one of the general-purpose, external financial statements such as the income statement, balance sheet, statement of cash flows, and the statement of stockholders’ equity.
These financial statements for a U.S. company must be prepared in accordance with U.S. generally accepted accounting principles—also referred to as US GAAP. |
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Term
| What is the difference between information and data? |
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Definition
I was taught that information is useful data. The point is there are lots of data (plural of datum) everywhere, and most of the data will not be useful to a decision maker. Only after the data have been sorted and the relevant portions presented to a decision maker will the data become information.
While that is the distinction that I learned many years ago, I believe that most people use the terms information and data interchangeably. In other words, one person might say data processing and another might say information processing, and both could be referring to the same thing. |
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Term
| What is a contra asset account? |
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Definition
A contra asset account is an asset account where the balance will be either a credit balance or a zero balance. (A debit balance in a contra asset account will violate the cost principle.) Since a credit balance in an asset account is contrary to the normal or expected debit balance the account is referred to as a contra asset account.
The most common contra asset account is Accumulated Depreciation. Accumulated Depreciation is associated with property, plant and equipment and it is credited when Depreciation Expense is recorded. Recording the credits in the Accumulated Depreciation means that the cost of the property, plant and equipment will continue to be reported. Reporting the accumulated depreciation separately allows the readers of the balance sheet to see how much of the cost has been depreciated and how much has not yet been depreciated.
Another contra asset account is Allowance for Doubtful Accounts. This account appears next to the current asset Accounts Receivable. The account Allowance for Doubtful Account is credited when a company enters estimated amounts as debits to Bad Debts Expense under the allowance method. The use of Allowance for Doubtful Accounts permits a reader to see the documented amounts in Accounts Receivable that the company has a right to collect from its credit customers. The separate credit balance in the account Allowance for Doubtful Accounts tells the reader how much of the debit balance in Accounts Receivable is unlikely to be collected.
A less common example of a contra asset account is Discount on Notes Receivable. The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable |
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Term
| Where are accruals reflected on the balance sheet? |
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Definition
Accrued expenses are reported in the current liabilities section of the balance sheet. Accrued expenses reported as current liabilities are the expenses that a company has incurred as of the balance sheet date, but have not yet been recorded or paid. Typical accrued expenses include wages, interest, utilities, repairs, bonuses, and taxes.
Accrued revenues are reported in the current assets section of the balance sheet. The accrued revenues reported on the balance sheet are the amounts earned by the company as of the balance sheet date that have not yet been recorded and the customers have not yet paid the company.
Accrued expenses and accrued revenues are also reflected in the income statement and in the statement of cash flows prepared under the indirect method. However, these financial statements reflect a time period instead of a point in time. |
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Term
| How are period costs reported in the financial statements? |
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Definition
Under the accrual method of accounting, period costs such as selling, general and administrative expenses are reported on the income statement in the accounting period in which they are used up or expire. They are referred to as period costs because they are not assigned to products, and therefore cannot be included in the cost of items held in inventory.
If a selling, general and administrative (SG&A) expense is prepaid, the prepaid portion will be reported as a current asset. When the prepaid expense expires, it will move to the income statement and become part of that period’s SG&A expenses.
Interest expense is also a period cost unless it is determined to be a necessary cost of a self-constructed, long-lived asset. |
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Term
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Definition
Petty cash is a small amount of cash on hand that is used for paying small amounts owed, rather than writing a check. Petty cash is also referred to as a petty cash fund. The person responsible for the petty cash is known as the petty cash custodian.
Some examples for using petty cash include the following: paying the postal carrier the 17 cents due on a letter being delivered, reimbursing an employee $9 for supplies purchased, or paying $14 for bakery goods delivered for a company’s early morning meeting.
The amount in a petty cash fund will vary by organization. For some, $50 is adequate. For others, the amount in the petty cash fund will need to be $200.
When the cash in the petty cash fund is low, the petty cash custodian requests a check to be cashed in order to replenish the cash that has been paid out. |
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Term
| What is the difference between fixed assets and noncurrent assets? |
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Definition
Fixed assets are one of several categories of noncurrent assets. Fixed assets are usually reported on the balance sheet as property, plant and equipment.
In addition to property, plant and equipment, the other categories of noncurrent assets include long-term investments, intangible assets, deferred charges, and other noncurrent assets. |
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Term
| Is it a requirement for a small business to have a CPA? |
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Definition
Generally, a small business is not required to have a CPA or certified public accountant. A CPA would be needed if the small business must have its financial statements audited or reviewed in order to obtain a bank loan, to apply for a grant, to bid on a job, or some other unique requirement.
Although most small businesses are not required to have a CPA involved, a small business may engage a CPA to review its internal controls, evaluate accounting software, obtain tax advice, and so on.
Some businesses utilize accountants who are not certified, but are very experienced and effective. You could ask your banker to recommend an accountant who works well with clients such as yourself. |
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Term
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Definition
In accounting, ERP is the acronym for enterprise resource planning. ERP could be described as a database software package that supports all of a business’s processes and operations including manufacturing, marketing, financial, human resources, and so on. In other words, the goal of ERP is to have one integrated system for the entire company.
The integration of all of a company’s information from all departments, processes, operations, etc. requires that an ERP system be very sophisticated. This in turn requires a company to commit considerable resources for planning, training, and implementing an ERP system.
Two of the suppliers or vendors of major ERP systems are SAP and Oracle. |
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Term
| What is the cost of sales? |
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Definition
Cost of sales is the caption commonly used on a manufacturer’s or retailer’s income statement instead of the caption cost of goods sold or cost of products sold.
The cost of sales for a manufacturer is the cost of finished goods in its beginning inventory plus the cost of goods manufactured minus the cost of finished goods in ending inventory.
The cost of sales for a retailer is the cost of merchandise in its beginning inventory plus the net cost of merchandise purchased minus the cost of merchandise in its ending inventory.
The cost of sales does not include selling expenses or general and administrative expenses, which are commonly referred to as SG&A. |
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