#Accounting - What's a Balance Sheet? What's an Income Statement?

Question

What's a Balance Sheet? What's an Income Statement?

Answer

They are the two most basic accounting statements/reports. The Balance Sheet answers "Where are we right now?" and the Income Statement answers "How much did we earn over a given period of time?"

Analysis

 I've talked about T accounts and Debits and Credits in prior posts. The Balance Sheet and Income Statement arise directly from the activity recorded in the T accounts.

When preparing an Income Statement, we look at a period of time. For instance, a statement that is being done to show the activity for the year ending December 31, 2018 will be titled "Income Statement for the year, ending December 31, 2018). The report itself lists Sales and other Income related to the ordinary course of business (natural Credits) and subtracts from that Expenses and other costs related to the earning of that income (natural Debits).

When preparing a Balance Sheet, we pick a date that the statement will be of. For instance, a statement that is being done as of December 31, 2018 is titled "Balance Sheet as of December 31, 2018" (exciting stuff, right?). The report itself lists Assets on one side (the natural Debits) and the Liabilities and Equity on the other side (the natural Credits). The activity from the Income Statement is listed as a change in Equity.

Together, the two reports show a company's activity from ordinary activity and can be of tremendous help in guiding management and other decision makers on the health and activity of the business.

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Feel free to ask a question!

#Accounting - What are Assets? Liabilities? Equity? Income? Expenses?

Question

In accounting, what are Assets? Liabilities? Equity? Income? Expenses?

Answer

• The simple way to think of Assets is to think of them as things the company owns. If the company owns equipment, furniture, the building it's in, it's cash - these are all assets. Sometimes things that are assets are not held by the company - money owed it by customers is an asset (called a Receivable) - the company may not have the money in-house but the fact that it is owed money means that it owns the right to that money. Assets tend to be natural Debit accounts.

• Again, working within simple explanations, Liabilities are those things that the company owes. When the company buys things on credit or takes out a loan, these are amounts that are owed by the company to other entities. Liabilities tend to be natural Credit accounts.

• The difference between what the company owns and what it owes is what the company is worth. This is its Equity (oftentimes called Net Equity, Net Worth, Owner's Equity, and other similar names). When a company is incorporated, the shares of the company are part of the equity (there will be some mention as to the equity per share or a way given to calculate it). Equity tends to be natural Credit accounts. 

• The way a company brings in money or other assets through the ordinary course of affairs is called Income (note that this is different than when a company does things such as selling an investment or raises money by obtaining a loan. These activities, while it will bring in money, is classified under Investing and Financing activities). Sales tend to be natural Credit accounts.

• In like manner, when money or other assets are expended through the ordinary course of affairs, these are called Expenses. Expenses tend to be natural Debit accounts.

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Feel free to ask a question!

#Accounting - What's a Debit? What's a Credit?

Question

What's a Debit? What's a Credit?

Answer

 Debit is the Left Side of a T account. Credit is the Right Side.

Analysis

Remember the post about T accounts? Debits refer to the numbers on the left hand side of the vertical bar of the T and Credits refer to the numbers on the right hand side. It's as simple as that - different names for Left and Right.

When I was first learning the concept, at every opportunity I could find, I'd refer to things on my Debit side and on my Credit side. I'd turn Debit and Credit in a car. It was the only way to get the concept firmly planted in my head.

Accounts will hold what is sometimes termed "natural" balances. Assets and Income are typically natural debit balances (that is, to increase the account, we debit it) and Liabilities, Equity, and Expense accounts are typically natural credit balances (that is, to increase the account, we credit it).

At this point, you might be wondering why it is that when you are getting money back from a vendor (say like from the phone company), they say they're going to "credit your account". Or even when you deposit money into your bank account, it's called "crediting your account". Why is that?

The answer is that the customer service people are working from the viewpoint of the company. When they are giving you money, they are decreasing the company's money, or in other words, they are decreasing the company's assets, and that is a credit.

For a bank, it's a bit different. When someone makes a deposit into a bank, we are increasing the bank's assets, which is a debit. But what the bank is really interested in is the fact that they now owe you, the depositor, that same amount of money you just deposited in. In fact, when you, the depositor, get your bank statement saying that you have $1,000 in the bank, the bank has a liability for that amount (we'll talk more about liabilities in a future post) - they owe you that money at a time of your choosing. And so the teller, in working with your assets, is in actuality working with the bank's liabilities. When you had the teller money, you are increasing the bank's liabilities, which is a credit.

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As always, please feel free to ask a question!

#Accounting - What's a T account? Why use them?

Question

What's a T account? And why use them?

Answer

A T account is a simple but effective way to organize the activity in any given account.

Analysis

Let's first talk about accounts. An account is a way to gather similar activity in one place. For instance, over the course of a year, let's have Sample Co. have a number of sales throughout the year. We can sum up those sales to see the sales activity for the year. For an example, let's have Sample Co have sales of $100,000 for the year.

This $100,000 sales figure is made up of smaller sales throughout the year. We list them individually as they happen. A part of that list might look like this:

$500
$1000
$250
$300

and so on.

Some transactions will increase the balance of the account and some will decrease that balance. Take the account Cash for instance - as sales are made, cash comes into the company. As inventory is purchased, salaries are paid, and other outflows are accounted for, the balance of the account decreases.

One way to show this would be to list out all the transactions in a single list:

 $1,000
-$350
-$15
-$25
$300

and so on. Which can get messy.

Another way to look at the accounts is to put all the amounts that increase the account in one list and all the amounts that decrease the account in another list. To save space and to keep things organized, we can draw a T, put the account name above the crossbar of the T, and have amounts on one side of the T's vertical line increase the account and on the other side put those amounts that decrease it. It'll look something like this:


        Cash
------------------
$1000 |
           | $350
           | $15
           | $25
$300   |

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As always, if you have a question, please ask!

#Accounting - Accounting requires organization, not advanced math...

Question

I want to study accounting but I'm afraid to do it because I'm not good at math. What are your thoughts?

Answer

The good news is that accountancy rarely goes beyond basic arithmetic (adding, subtracting, multiplying, dividing). In fact, accountancy is far more about organizing and classifying information rather than manipulating it. 

Analysis

As a for instance, let's take a sample transaction and look at how an accountant would treat it.

Stan's Superheroes (a store specializing in superhero collectables) sold a Baitman figurine (it's a knockoff of Batman - this one is of a cowled fisherman who fights crime on the docks) for $10. The customer paid cash. Stan originally bought the figurine for $3. How do we book this transaction?

And now let's watch how an accountant works through this question.

• Cash has increased by $10, so the account Cash is increased (Debit)
• Sales have also increased by the same amount, and so the account Sales is also increased (Credit)
• The inventory has decreased by the amount originally paid for the figurine, and so it decreases by $3 (Credit).
• The last account, which is the Cost of Goods Sold, increases by $3 (Debit).

Accountancy also gets into reasonableness. For instance, would it be reasonable to conclude that Stan's Superheroes makes $1,000,000 per year from sales of Baitman? Probably not - and it's the role of the Auditor (a type of accountant) to examine those types of situations.

Bottom line, most accounting does not involve anything more than basic math. If however you are interested in stretching your math muscles within the accounting world, Cost Accounting might be for you (it's a type of managerial accounting that does it's best to examine a business from top to bottom, in all its processes, and put them into financial terms so that the management of a company can make better business decisions).

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Questions and comments welcome!