When you see these icons, you will find brief comments specifically useful for the:
And, to test your understanding of the concepts as you progress, there
are a number of Test Your Understanding sections,
complete with hypertext links to the answers to each question.
Traditionally there's just one ShoeBox for all your records.
That's where you throw all your bank statements, checkbooks, invoices, bills, parking receipts, dinner cheques, and the occasional business card and stale cookie (oops, how long has that been in there?). Then come tax time you dutifully tie the box up with an elastic band and cart it off to your accountant.
In ShoeBox Accounting we will create a cabinet for our accounting records called the General Ledger. Within the General Ledger we'll have seven shoeboxes to store all of our accounting information;
ShoeBox Accounting is designed as a series of eight lessons.
1) | Accounts | - defined, types, Income Statements, Balance Sheets |
Debits and Credits | - defined, double entry, application to accounts | |
Financial statement presentation | - objective, format | |
2) | General ledger | - purpose, general journal, posting |
3) | Accounts Receivable and Payable Subledgers | - purpose, cash receipts and cash payments journals, sales and purchases journals, control accounts, computerized versions |
4) | Bank Reconciliation | - objective, aspects, formats |
5) | Inventory; retail | - defined, purchase, inventory, cost of goods sold flow, accounts |
Inventory; manufactured | - Raw materials, work-in-process, finished goods, cost of goods sold flow, accounts | |
6) | Other Current Assets | - defined, types, valuation |
Fixed Assets | - defined, depreciation, depreciation; types, accumulated depreciation | |
7) | Payroll | - calculations, remittance accounts, taxable benefits |
8) | Financial statement analysis | - liquidity, ratio analysis |
Costing and product line analysis | - variable and fixed expenses, contribution margins, product mix analysis | |
Budgets | - purpose, variance analysis, design |
The Lite version of ShoeBox Accounting is free for personal educational
use, and includes lessons 1 to 4.
When you upgrade to the full version of ShoeBox Accounting is you will receive lessons 5 - 8.
You also receive the New County Grocery case study. The New County Grocery case study is an accounting practice business simulation which will allow you to apply what you learned in lessons 1 - 4 to a more life-like situation rather than just answering practice questions.
As a bonus when you register you will also receive the stand alone Accounting Dictionary, which lists and defines the accounting terms used in all of the modules, as well as terms beyond the scope of this program. The Accounting Dictionary can be a valuable resource for understanding the business pages or for reading financial statements.
ShoeBox Accounting is donation-ware, and the full registered version is
available by following the instructions located at http://members.shaw.ca/g-t-m/shoebox/index.htm
ShoeBox Accounting
copyright Glenn T. Mori
This HTML file and its associated graphic images of the Lite version of ShoeBox Accounting are the intellectual property of Glenn T. Mori (gTm Productions). The text and the graphics may not be altered nor copied into other programs, files or printed materials.
Only the unaltered compressed version of the complete ShoeBox Accounting zip file may be copied to shareware sites or on to other computers.
All rights reserved.
At its roots, accounting is just record keeping, numerically recording the activities and transactions of an entity whether that entity is an individual, a multinational corporation, a small business, or a non-profit community group.
Let's say your hobby is sewing clothes. You make a few items for yourself, then do a few for your family, and even try your hand at doing variations on storebought patterns.
One day a friend says that they like the dress that you made for yourself, and she would like one just like it in the same material but in a different colour, and how much would it cost. You figure that the material is $20.00, so you mark it up 75% and charge $35.00. You go one afternoon to pick out material, then spend half an hour modifying the pattern to her size, an hour and a half making the dress, and get paid $35.00.
Let's look at the cash transactions from an accounting perspective. First, you estimated your costs to be $20.00, so you marked it up 75% to get a $15.00 "profit". Then you spent 30 minutes or so of your time to get in your car, drive to the shop, pick up the materials and drive home. Then you spent 30 minutes to modify the pattern that you originally purchased for yourself to her size, then another hour and a half to draw upon your training and experience to sew the dress, then called your friend to say that the dress is ready, she picked up the dress, and gave you $35.00.
Your $20.00 material cost estimate turned out to be $19.50 _plus_ 7%
federal sales tax _plus_ 7% provincial sales tax, so your cash outlay turned
out to be
so your "profit" is down to $35.00 - $22.24 = $12.76.
In order to make that $12.76 you had to spend 30 minutes travel time to pick up the material as well as one and a half hours "production" time to make the arrangement for a total of two hours.
In other words, on an hourly basis you were paid $6.38 per hour to make this dress. In fact, if you were running a business this way and paid an employee $8.00 per hour to do the work, you would have incurred a business loss of $3.24. And we haven't included the cost of your thread that was used or the cost of the original pattern that you bought for yourself, or transportation costs, or costs for heating and lighting the area of the house while you are doing this work.
SOHO
Hint:
Obviously you could not continue to operate a business in this manner.
However, if you want to continue sewing only for friends, then you can
look at the $12.76 total as merely a cost recovery for your time, and the
real "profit" for you may be in the appreciation from your friend and your
enjoyment of the process of sewing.
For example, at this time of this writing this course is a test program and is free to the students and so has no cash return. At this point, I do not know whether the time that I am putting into developing the course will cause a cash return or profit in the future; I don't even know for certain whether I will complete writing all modules of this program, or to have the time or desire to teach and offer the course as an interactive internet course even if I find that there is a potential cash return. For now, the opportunity to explore the possibility of offering accounting via the Internet is sufficient reward for me to put in the time and effort required to do so.
Accounting can still help you to see what is happening in these situations. In the home sewing case, we can see that $12.76 is the cash above the direct new material costs for your efforts. You can also see that you cannot afford to hire an employee at this level of business activity or you will incur a business loss.
Accounts are categories of activities. For example, all wage costs can be accumulated in a Salary Expense account.
There are some standard types of accounts such as Salaries, Utilities, Equipment and so on. The exact name for the account and the number of accounts used will vary from organization to organization depending upon the type of activities and the level of activity.
For example, one company may call their account Wages instead of Salaries,
or it may have two, three, or more different types of wage accounts such
as Plant Salaries, Office Salaries, Sales Salaries, etc. All of this depends
upon the nature of the business of the organization, the manner in which
the owners or management prefer to have the information organized and presented,
and the accounting standards as set down by the Generally
Accepted Accounting Principles (GAAP) or by FASB.
There are various categories of accounts. The principle types are:
Revenues: | Monies that are earned. These can be sales of merchandise, services performed, or sponsorships due. |
Expenses: | These are the costs of earning the revenues. Typical expenses include wages, raw materials, merchandise purchased, delivery, utilities and rent. |
|
REVENUES - EXPENSES = PROFIT |
Asset: | Resources or possessions which are which are used to do what the person or organization seeks to do. Businesses use assets to make money, non-profit organizations use them to achieve their goals such as health care or providing recreational services. Typical assets are cash (or bank account), monies owed to the organization (accounts receivable), inventory, equipment, computer hardware, computer software, building and land. |
Liability: | Debts or responsibilities that the business has to parties outside the business itself. These typically include bills for goods or services received on credit (accounts payable), government remittances to be paid, wages earned but not yet paid (accrued payroll), bank overdraft, loans, mortgages, or bonds outstanding. |
Equity: | Equity is the investment that the owner or owners of the organization have in the business itself. Equity is a combination of dollars invested by the owner(s) and the cumulative profit or losses from previous years. Typical equity accounts are common shares issued, accumulated surplus, or simply owner's equity. |
|
ASSETS = LIABILITIES + EQUITY |
Another way of looking at it is to say that the assets of the business
are partly owned by the owners of the business, but the outside parties
that are owed monies also have a claim on these assets. Note:
1) Choose what type of account each of the following items would be. | |
1a) A term deposit? | Answer: |
1b) The money that you received for the dress? | Answer: |
1c) The material that you purchased for the dress? | Answer: |
1d) A car purchased for delivering garments? | Answer: |
1e) A car loan taken out to purchase the delivery car? | Answer: |
2) If you buy a bicycle at a garage sale for $25.00 and later sell it for $50.00, your profit is: | Answer: |
3) If you buy a house for $125,000.00 with a down payment of $35,000.00, your liability to the mortgage company is: | Answer: |
4a) Let's take another look at the last question. If your relationship to the mortgage company is a liability, then what type of account is your $35,000.00 down payment? | Answer: |
4b) What type of account is your $125,000.00 house? | Answer: |
Remember that in the balance sheet assets = liabilities + equity so that if you increase your assets, your liabilities and/or your equity increase by the same total amount, otherwise logically you have missed something and your balance sheet won't balance. In the last question you purchased a house for $125,000.00 with a down payment of $35,000.00 and incurred a liability of $90,000.00 to pay for the remainder of the house; 125,000 = 90,000 + 35,000.
However, you can just as easily decrease one asset to obtain a new asset. For example, you would have had at least $35,000.00 cash in the bank to make the down payment for the house. Your original equation may have been
You took the $35,000.00 out of the bank to make the down payment In doing so, you decreased the cash asset by $35,000.00, added a $90,000.00 liability, and added a new $125,000.00 asset.
the balance sheet still balances.
After the next Test Your Understanding section, we'll look at debits and credits, and then see how the income statement and the balance sheet relate to each other.
You decide to start your seamstress business by opening a separate bank account for all the cash transactions for your operations. You put $50.00 into your business account. | |
1a) What types of accounting accounts have you affected? | |
1b) How much have you changed them? | |
1c) How does the balance sheet read now? | |
2) Your favourite fabric shop is glad to see you going into business, so they offer you credit terms. You pick out a new fabric scissor. These scissors cost $23.00 (ignoring taxes), but you will pay for them in 30 days. | |
2a) What types of accounts have you affected? | |
2b) How much have you changed each affected account? | |
2c) When added to the transaction from question 1), how does the balance sheet read now? |
Debits and credits are simply labels for entries into the left (debit) or right (credit) side of an account.
Every account has a debit side and a credit side. The balance in the account is simply the net difference between the total debits and the total credits. If the total debits are greater than the total credits, the account has a debit balance. If the total credits are greater than the total debits, the account has a credit balance.
Accounting uses a system known as double entry bookkeeping. That means for each transaction, the total debit entries must equal the total credit entries. Therefore, if you debit an account $50, you must also credit one or more accounts a total of $50.
Increases in asset and in expense accounts are recorded as debits. Decreases in these accounts are credits. Conversely, increases in liability, equity, and revenue accounts are recorded as credits, and decreases in these accounts are debits.
This makes sense when we remember our entries into the balance sheet where assets = liabilities + equity. When we put $50.00 into a bank account as an investment into our company, we would debit bank $50.00 and credit equity $50.00. Now debits = credits and our balance sheet balances ($50.00 asset = $50.00 equity).
More than one account can be affected in one transaction, as long as the total debits still equal the total credits. Remember the house purchased for $125,000.00 with a $35,000.00 down payment and a $90,000.00 mortgage? How would you record the debits and credits in this transaction?
Decreases in the balance of an account work in the reverse direction. For example, if you sell and asset such as a computer, you credit the computer (asset) account. You would also debit the cash account for the funds received.
Or, if you pay an outstanding bill, you debit (or decrease)the liability account, and credit (or decrease) the cash account.
1a) Is an increase in an asset account a debit or a credit? | Answer: |
1b) Is an increase in a liability acccount a debit or a credit? | Answer: |
1c) Is an increase in an equity acccount a debit or a credit? | Answer: |
2a) Cash in the bank is what type of account? | Answer: |
2b) An increase to the cash account is a debit or a credit? | Answer: |
3a) A loan is what type of account? | Answer |
3b) An decrease or payment of the loan account is a debit or a credit? | Answer: |
4a) If you write a cheque for $75 to pay a last month's electricity bill, what two types of accounts have you affected? | Answer: |
4b) Which account do you debit and which do you credit? | Answer: |
We've already seen the two key financial statements, the balance sheet and the income statement; now we'll see how they're laid out. Before we get into detail, let's take a step back and think about what we are trying to accomplish when we present a financial statement.
We want to describe the financial situation of some organization or business person. Who is the financial information describing? Put the name of the organization at the top of the page.
Next, what type of financial information are we describing? Put the type of statement next; ie. balance sheet or income statement.
When is the next detail. The income statement describes revenues and related expenses that occur during a period of time. We need to describe that period of time, so we put "Year ended June 30, 1995", or "Month ended April 30, 1978", or even "Quarter ended September 30, 1999". Now we know the exact start and end of the period of time that will be covered.
The balance sheet describes assets, liabilities and equity that are accumulated or removed over a period of time, BUT, when we describe them, we are not describing a flow of assets like we described a flow of revenues in the income statement. Instead, the balance sheet describes the net assets, liabilities and equity at a specific moment in time. So, for the balance sheet date we instead write "as at June 30, 1995" to specify that moment in time when the assets, liabilities and equity totalled what we are about to describe.
Remember the equation; assets = liabilities + equity, so the logical
format is to list the assets, then list the total of the liabilities and
the equity to show how they match or balance. You can put the second list
beside or underneath the assets list; either form is accepted.
|
|||
|
|||
|
|||
Assets | Liabilities and Equity | ||
Cash |
$ 525.13
|
Liabilites | |
Accounts receivable |
1,789.03
|
Accounts payable |
$ 807.02
|
Sales taxes payable |
32.01
|
||
Bank loan |
550.00
|
||
---------
|
|||
Total liabilites |
$ 1,389.03
|
||
Equity | |||
James Doe, capital |
925.13
|
||
------------
|
------------
|
||
$ 2,314.16
|
$ 2,314.16
|
||
=======
|
=======
|
The other key concept is to sort the assets, liabilities and equity
in terms of liquidity
and then categorized and subtotaled into current and non-current.
Take a look at this next example of a company with many accounts. Many of the account names may be unfamiliar at this point, but I have included them here so that you have a single reference point in the future for proper balance sheet format.
Large organizations have a huge number of accounts, subaccounts, and departmental accounts so they consolidate these into just a few relevant categories.
Income statements (or Statement of Revenues and Expenditures for non-profit organizations) show revenues less expenses. Earlier we looked at the headings for the income statement; now let's look at the rest of the format. Again, there will account names in the examples that are unfamiliar to you at this point, but this is intended as a reference point for the entire program.
First we list all of the monies earned by the organization's normal operations. There may be a single revenue producer such as carpet cleaning, or there may be many, such as grocery sales, meat sales, tobacco sales, lottery sales and bus pass sales. These sales can be listed with subtotals, listed with just one total, or consolidated into one revenue amount.
Expenses normally grouped into direct costs of the revenues and indirect or administrative costs. A direct cost is anything purchased for resale such as cars, vegetables, cigarettes, or a direct cost can be a manufacturing cost such as shop labour, raw materials, fuel; anything that goes directly into the production of the finished product. The total of these expenses is called the Cost of Sales.
Immediately after the Cost of Sales the revenues are subtracted from
Cost of Sales, producing a Gross Profit or Gross Margin. This is what is
left after paying for the direct cost of producing the revenues. If you
divide the gross margin by the cost of sales, you get what is known as
the Gross
Profit percentage. Following the gross margin is the rest of the expenses
such as office salaries, stationary and advertising. This group of expenses
is then totalled, and the gross margin is subtracted from this total, leaving
the Net Income (or "Deficit" if total expenses are greater than total revenues)
Before Taxes and Extraordinary Items. This is the net operating income
from ordinary operations of the organization. After this number comes the
taxes, and the
extraordinary
items, if any.
If you've ever seen a bookkeeping note pad or a book for accounting records, you'll notice that it's made up of a column for dates, a wide column for descriptions, and two columns on the right-hand side that are made up of smaller columns.
Dates go in the date column, account names go in the description column and debits and credits go in the last two columns. In addition, a description of the reason for the entry usually follows the entry itself, followed by a blank line before the next entry.
Standard format is for all debit entries to be listed first, followed by all the credits and the account names of the credit entries to be indented slightly. It doesn't really matter though; conventions can fall by the wayside as long as all of the correct information is there.
These books are called "journals"; the process of recording information
in a journal can be referred to as "journalizing".
All we want to do at this point is to get a feel for how to record entries. Take a piece of lined paper and draw a few lines vertically to make it look something like this:
Or, window over and open up a spreadsheet.
Then, try writing journal entries for the following scenarios:
1) On July 3 you buy some notepaper, pens, and other stationary supplies. The total cost is $34.15. | Answer: |
The same applies to the bank account, which could be called "Cash" or
"Bank", but clearly is an asset account.
2) On May 9 you do some cleaning work for a customer, and you are paid in cash, $100.00 | Answer: |
3a) The computer that you want was on sale January 18, 1994. You borrow the $1,200.00 for the computer from your friend Sharkey to buy it for your home office. | Answer: |
3b) A month later Sharkey wanted $200.00 of the loan repaid, but your company account didn't have enough money. Instead, you took money out of your personal account to pay Sharkey back. | Answer: |
Note: The computer account is not affected by this transaction at all since this is a loan repayment and does not change the balance in your computer account.
You could also record this into a "Loan from owner" account instead of increasing the equity account, but unless you specifically designated it as a loan with repayment terms, it's easier to treat it as an increased investment in the company by you, the owner.
After writing down a transaction in a journal, the entries are transferred to a ledger. A ledger is where the accounts are listed, and where the accounting activities are stored summarized by account. The core ledger in which all transactions eventually end up in is the general ledger. The general ledger lists all of the accounts and show all of the entries from the general journal and the balance in each account.
The only detail that does not show up in the general ledger are the entries made in the sub-journals, such as the sales and purchases journals. Entries in these sub-journals end up in the accounts receivable and accounts payable subledgers respectively. However, the general journal does show the net balance in both of the subledgers.
Before we go on to other journals or to subledgers, lets see how entries
are recorded or posted
to the general ledger.
Manual ledgers can be set up in two ways. One is to have one page in a book for each account. In this case each part of each entry is recorded in the appropriate page of the book, and the subtotals or totals of each page will tell you the balance in the account.
The second way is to use a wide page of accounting columns. Here each account is a given a column, and each part of each entry is posted on one line of the page in the appropriate column. In this case the balance in each account is simply the total of the column of the page. When you get to the bottom of one page, it is standard procedure to total up each column and then start the next page listing the starting total of each column so you can carry on.
The second method wastes a lot of paper (if your using paper rather than spreadsheets) and is only useful for small businesses with few transactions. The advantage is that all of the activity is easy to see and your can easily total up your columns to check that everything still balances.
Use a spreadsheet, or take a wide piece of paper and draw columns to make up a worksheet.
Label the columns from left to right as below.
Now, take the answers from the previous Test Your Understanding section on general journals and enter each on your worksheet. Each question should take one row or line, and each line should balance; that is, the total debits should equal the total credits on each line.
Assume that the opening balances in each account are as below:
Date | Description | Cash | Computer | Loan | Owners equity | Revenue | Office supplies |
Opening balances |
50.00
|
|
|
(50.00)
|
|
|
Next: Other Types of Journals
In a small operation the general journal may be the only journal used, and all journal entries will be written up here. However, at a certain level of accounting activity or business size some accounts have so much activity going on that it makes sense to use separate journals for these busy accounts.
Typical sub-journals include:
a cash receipts journal,
a cash payments journal,
a sales journal, and
a purchases journal.
Both the cash receipts journal and the cash payments journal record transactions affecting the cash account. Remember that cash is an asset account, so increases to the cash account are recorded as debits and decreases to the cash account are recorded as credits.
Therefore the debit side of every entry in the cash receipts journal is to the cash account, and the credit side of every entry in the cash payments journal is to the cash account.
Through these two journals virtually all entries to the cash account are recorded (except for such things as bank charges or automatic loan payments).
Maintaining cash control is very important to any operation. For a retailer,
it is crucial for recording sales and preventing theft. If you are a retailer,
please see this section on cash
sheets
1) Cash Sheets: If you have cash sales, go back to the example
cash sheet
2) Cash Payments: At the end of the month you review your cheque book and find the following cheques:
Cheque # 58 for $91.50 to Andy's Electric for repair to your cash register
Cheque # 59 for $105.52 to pay for electricity
Cheque # 60 which was voided
Cheque # 61 for $385.95 to Lee's Wholesale as payment on account for supplies
Prepare journal entries to record these cheques into your general ledger.
The cash receipts and the cash payments journal record cash transactions; the sales journal and the purchases journal record credit transactions.
The sales journal records sales on credit, so each entries affect the
sales and the accounts receivable accounts. For each sale, credit
(increase) the appropriate sales (a revenue) account, and debit
(increase) the accounts
receivable
The term accounts receivable is also used to refer to any specific customers' account.
(an asset) account.
The purchases journal records purchases purchased on credit, so each
entry affects the accounts payable account. Normally the purchases journal
is reserved exclusively for purchases of inventory items, so for each purchase,
debit (increase) the inventory (an asset) account
and credit (increase) the accounts
payable
(a liability) account.
Obviously, if your business has no credit sales, you do not need a sales journal to record credit sales. You may also opt to record all payments in the cash payments journal and not have a purchases journal.
Journals are simply books for writing down the transactions. Ledgers are where the accounts are listed, so this is where the activities are stored, sorted by account.
The general ledger holds the bulk of the accounts, but the busiest accounts have their own subledger. After a Test Your Understanding we'll look at two sublegers; the accounts payable subledger, and the accounts receivable subledger.
In a business that has credit sales or credit purchases, the accounts receivable and accounts payable accounts are very active. In this case it can be difficult to follow exactly what is happening, even though it is very important to know what exactly is happening. For example, you can't call to collect on your customers if you don't know which of your customers owe which amounts.
For this reason the accounts receivable and accounts payable accounts have sub-ledgers. Subledgers are essentially the same as the general ledger. Instead of tracking the asset, liability, equity, revenue and expense accounts, accounts receivable and accounts payable subledgers track:
1) the total balance in each customer or supplier's account, and
2) the individual activity in each customer or supplier's account (so
that you know specifically which invoices are outstanding),
3) the aging
You must pay particular attention to the aging of your receivables. If you don't, your bank will do so for you because the bank knows that when your customers don't pay their bills on time, you don't have money in the bank to pay your own bills which will put you out of business.
When your customers are slow paying you, it could mean that they are in financial trouble and are at risk of defaulting, or, it could just be that they are using you to finance their operations. For example, if your customer buys product from you on January 1 for $1,000 and sells the goods for $1,250, then receives payment from their customer on February 10, but does not pay you until March 15, they have had $1,000 of your money to use for over a month. During February 10 to March 15 you have had to pay interest to the bank for your extra overdraft of $1,000, or you have missed out on collecting interest from the bank for that same $1,000.
And don't let your customers take you down with them. If they are having trouble collecting from their customers, consider requiring post-dated cheques from them, or partial payments on receipt of goods. If your customer goes bankrupt because their customers don't pay, you won't collect either.
of each individual invoice in each customer or supplier's account, and
4) the total balance of the accounts receivable and accounts payable.
Physically these subledgers can be set up in the same manner as your general ledger. You can have a book with a page dedicated to each customer or supplier, or you can have a spreadsheet or worksheet with a column dedicated to each customer or supplier account, or if you use a database, you can have it summarize information by customer or supplier.
You computer installation company has done the following work during the month of May:
- Sold computer with software and installation to Asmir Co. on May10 for $2,500.00 and sales taxes of $125.00.
- Sold printer to Asmir Co. on May 15 for $350.00, sales tax of $17.50.
- Sold software and installation to Konrad Construction Ltd. on May 21 for $1,100.00, sales tax of $55.00
All sale were on credit.
Set up a piece of paper with five colums for Date, Sold to, Sale Amount, Sales Tax, and Total Sale. Enter the sales for the month of May into this sales register..
Your grocery store has made the following purchases on account during the month of January:
- Lee's Wholsale, January 3, $1,568.00, tax of $109.76, total of $1,677.76
Note:
Canada, Australia and many European countries use a value added tax system where you can recover sales taxes paid if you are a business. In these countries you should keep track of sales taxes paid in a separate account so that you can recover the tax paid.
- Frank's Bakery, January 7, $325.25, tax of $ 22.77, total of $ 348.02.
- Lee's Wholesale, January 11, $985.24, tax of 68.97, total of $ 1,054.21.
Set up a piece of paper with five colums for Date, Purchased From, Purchase Amount, Sales Tax, and Total Purchase. Enter the sales for the month of May into this purchases register..
Recall that in the sales journal, each transaction affects the sales account and the accounts receivable. The accounts receivable subledger slips in between the sales journal and the general ledger by tracking the invoice amount by customer. Each sale is recorded as an additional amount to the customer's individual account and as an increase in the balance in the accounts receivable account in the general ledger.
Say you do a special flower arrangement for a wedding. The Ms. Smith, the bride's mother agrees to pay you the $50 next month after the wedding. To record the sale, you credit (increase) sales $50 and debit (increase) accounts receivable $50. In the accounts receivable subledger, you record the $50 increase to accounts receivable and record it as an increase to Ms. Smith's account.
When you receive the money from Ms. Smith, you record the cash received in the cash receipts journal by debiting (increasing) cash and crediting (decreasing) accounts receivable. In the accounts receivable subledger you record the $50 payment as a decrease in Ms. Smith's account and a decrease in the accounts receivable balance.
Exactly the reverse applies to the purchases journal and the accounts payable subledger. For your wedding floral arrangement you purchase dried flowers from your florist for $15. In the purchases journal you debit (increase) dried flowers expense for $15 and credit (increase) accounts payable for $15. In the accounts payable subledger you record the $15 increase to accounts payable by increasing the floral shop's account. When you subsequently pay the bill for the dried flowers, you credit (decrease) cash in you cash payments register and debit (decrease) the accounts payable. In the subledger you record the decrease to accounts payable by decreasing the florist's account and the net accounts payable.
Recognize, then, that the accounts receivable and accounts payable subledgers are simply a way of keeping track of your credit sales and credit purchases.
So, if you got all standard journals and ledgers for you books, the flow goes like this:
Bank reconciliations are pretty straight forward. They only become complicated when there's a lot of activity, or when you have to reconcile amounts that someone else has taken out or put into your account, such as automatic payroll deductions or unreconciled cash sales deposits. In these cases you first have to do reconciliations of these amounts before you can reconcile the bank account.
Your objective in a bank reconciliation is to figure out how the bank
balance relates to the amount that you have recorded in your accounting
records of the bank account. What you need to find are the amounts that
are in your accounting records that the bank doesn't know about yet
such as outstanding
cheques
and outstanding
deposits,
and amounts that the bank has recorded that you don't have recorded
yet, such as bank charges or automatic loan payments. These differences
between your records and the bank statement are called reconciling items.
Note on the example:
1) The adjusted records and bank balance are equal, meaning the bank is reconciled,
2) All additions and subtractions to the bank and to our records are grouped and subtotaled,
3) Account numbers are listed for each reconciling item for our records. Later we will post these adjustment to these accounts to make our bank records match the $884.40. Remember that the account numbers are used by database programs. If you have a small operation and/or if you use a spreadsheet type of ledger, account numbers are not needed.
4) The subtraction of the NSF
cheque,
NSF cheques are a pain, even if you do eventually collect the money. First, bank may charge you a fee for returning the cheque. Then, even if you do collect the money, the customer may refuse to pay the NSF charge, and you're out $5.00 or whatever the bank charged you. Even if they do pay you the NSF charge, you still have the hassle of having to collect the payment the second time. No wonder many grocery stores, other retailers, even libraries post signs saying that there is a $20.00 charge for NSF cheques. Not because their bank charges them $20.00, but because of all the extra work involved in recollecting the funds.
Whenever you accept a cheque as a payment, make sure that you confirm the person's name, address and telephone number from another piece of identification, preferably picture identification. This way at least you have some confirmation that the person is who they claim to be as well as a number and address for tracking the person down.
If you have repeated NSF problems from a regular customer, consider requiring cash or a bank certified cheque.
5) The correction of the deposit error.
Whenever things don't add up when they should, check the difference that you are out. If the amount is evenly divisable by 9 (ie. $18.00, $0.27, $5.40) it could be a transposition error.
6) The write off of the stale dated cheque. The same accounting entry is applied to cancelled cheques. You simply reverse the entry by debiting (increasing) the bank (asset) account and decreasing (crediting) the expense account.
Given the following information, do the bank reconciliation using the format of the example from the previous section. Use a regular sheet of lined paper, or try one of the spreadsheet templates included with ShoeBox Accounting to do the reconciliation.
- The month just ended is August, 1996.
- The bank balance per the bank statement is $12,609.29
- The bank balance per your accounting records is $32,45.75
- Your payroll service has automatical withdrawal approval, and has withdrawn $9,485.72 on August 15th and $9,165.72 on August 31 from your account.
- Bank charges for the month are $35.25
- Your night deposit on August 31 of $2,455.85 does not show on your bank statement.
- The bank statement shows the NSF cheque from J. Stern for $185.60 on August 8th.
- As you compare your cheque register to the bank statement, you find that the following cheques were written before the end of August but have not yet shown up on the bank statement:
Cheque # 198 for $52.25
Cheque # 199 for $524.58
Cheque # 202 for $985.42, and
Cheque # 204 for $20.52.
- In your bank shoe box you find a note to yourself stating "Issued cheque # 186 on August 23 for $514.85 Patsy Co. to replace cheque # 174 for $541.85. Nice of her to return the cheque since the error was in her favour. Must rememeber to send her a Christmas card."
To get a better grasp of how things flow in the bank reconciliation, consider the following after you've completed the exercise above.
1) The bank statement shows a deposit on August 1 of $1,984.58, which is not in your accounting records for the month of August. After some puzzlement, you remember that this was the outstanding deposit on the July bank reconciliation. How does this affect the reconciliation?
2) Cheque # 198 for $52.25 is not an August cheque, but was written July 30, 1996 and was outstanding in the July bank reconciliation. How does this affect the August reconciliation?
3) You discover that cheque # 199 for $524.58 was never mailed because the next day you returned the goods because they were the wrong size. How does this affect the reconciliation?
At the beginning of this module we looked at general journal entries and used them to record transactions. Now you know that if you have cash receipts, cash payments, sales and purchases journals, most of the transactions will be recorded in the appropriate subjournal and either be recorded into the general ledger ShoeBox or into the accounts receivable or accounts payable subledger ShoeBox.
Even if you use these subjournals, the general journal is still used for other entries. Entries from the bank reconciliation, for example, do not flow through any subjournal, and are recorded in the general journal and posted directly into the general ledger.
Other types of entries that are posted directly via the general journal are
1) Corrections; for example if a cheque is posted to the incorrect expense account,
2) Depreciation and amortization (See module III, Fixed Assets for more detail),
4) Any accrued revenues or expenses (next section)
1) Take the adjustments from the bank reconciliation in the last Test Your Understanding section and write up the journal entries from the bank reconciliation.
Use the standard general ledger format used before.
In addition, try the following.
2a) On March 2, you pay your insurance agent $1,020.00 for insurance to cover the period from March 1 of the current year until February 28 of next year. At first you posted the cheque to your Insurance expense account, but now you realize that it should be in the Prepaid insurance account. Prepared the adjusting journal entry to correct the posting
2b) Now, what is the entry that you make each month to record the "usage" of your insurance?
At the end of your accounting period, be it a month, a quarter, or a full year, there are often times that you get goods or services during the period, but don't receive the bill until later. In order to make the financial statements really represent what happened during the period, you need to account for these late arriving bills because you have already received the goods or services.
For example, if you get a major shipment of inventory on February 28, have a big sale on February 29, but don't get the bill for the inventory until March 7, your income statement for the month of February will look unrealistically good and your income statement for March will look really bad unless you account for the goods received in February. To account for these differentials, you do accruals.
Most accruals are for expenses. To record them is easy, you simply collect up all the bills for goods and services received during the month of February that weren't recorded until March, debit the appropriate expense accounts for each item, and record one total credit to the Accrued Expenses Payable (liability) account.
Note that the date for the journal entry is the last day of February. It is very likely that you actually determine the entry in the following month (March in this case), but you must date the entry within the month that the entry applies to. Usually there are a large number of journal entries such as accruals and bank reconciliation entries that are made after the end of the month but which refer to the previous month's activities. These are often referred to under the general name of "month end entires" and are usually dated as of the last day of the month.
During the month of March, you record and pay the bills as usual. At the end of March, you reverse the accrual entry that you made for February.
So, in February you would show a advertising expense of $345.83. In March you pay the bill debiting the advertising expense $345.83 again, but at the end of March you reverse the February accrual and credit the advertising expense, so there is no advertising expense showing in March. Instead, it showed up in February, which is where it belonged because you received the service in February.
If you do construction or long term services you may also have unrecorded
revenues.
Next period, after you finish, bill for, and record the job, you reverse the accrued revenue entry similar to the way you reverse accrued expenses.
- On May 2, an invoice dated April 29 for $53.15 for office supplies
received April 26.
- On May 4, an invoice dated April 30 for $180.95 for electricity for
April.
- On May 5, an invoice dated May 1 for $200.00 for janitorial services
for the month of May.
Prepare separate journal entries or one compound journal entry to the accruals for February.
1b) Because your payroll is bi-weekly you last paid your employees up to and including the last Friday before the end of April, April 26. The two employees worked 8 hours each on Monday the 29 and Tuesday the 30, at a rate of $10.00 per hour.
Prepare a journal entry to accrue payroll for February. Ignore income tax and other payroll deductions.
1c) After preparing your financial statements you realize that you haven't received a bill for computer repair that your friend did for you on April 27. He said he would charge you $100.00, but you call him and he's gone on holiday. What do you do now?
That's the basics of the basics of accounting.
When you register ShoeBox Accounting, you will receive a second HTML file containing the remaining modules. These modules will cover in more detail the aspects of accounting for inventory, fixed assets and depreciation, payroll, and financial analysis.
Even now, after completing the basic modules, you have the ability to understand the fundamental terms and concepts of accounting, and are equiped to set up and use a simple set of accounting records for a small business. Use these modules as resource material as you put into practice your new understanding.
If you are running a small business, don't neglect to see a public accountant for tax advice and for specific suggestions about accounting systems for your particular business. I've mentioned this before, but income tax laws vary from locale to locale and are in a constant state of change, so see a professional to at least get you started, and after that, you may be able to do all of your accounting yourself. In the process, you can save a lot of time, frustration and money and better understand what the accounting numbers are telling you about your business's well-being.
And don't forget other business and tax sources of information. Federal governments publish summaries of tax laws, business and tax advice are available from newspapers and from the internet, computer programs such as accounting programs and tax programs are available from stores and in shareware and freeware versions on the internet.
Upgrade to the full version of ShoeBox Accounting to receive lessons 5 - 8!
You also receive the New County Grocery case study. The New County Grocery case study is an accounting practice business simulation which will allow you to apply what you learned in lessons 1 - 4 to a more life-like situation rather than just answering practice questions.
As a bonus when you register you will also receive the stand alone Accounting Dictionary, which lists and defines the accounting terms used in all of the modules, as well as terms beyond the scope of this program. The Accounting Dictionary can be a valuable resource for understanding the business pages or for reading financial statements.
ShoeBox Accounting is donation-ware, and the full registered version is
available by following the instructions located at http://members.shaw.ca/g-t-m/shoebox/index.htm
3b) | ![]() |
3a) | ![]() |
2) | ![]() |
1) | ![]() |
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![]() Note that it is possible to group the entry as above, or to do each entry separately. Again the exact account names are not important. |
Purchases Register
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1) | An outstanding deposit of the previous month does not affect the current reconciliation at all, unless it does not appear in the current bank statement (ie. the bank still has not received or recorded the deposit; then you better find out what happened at the bank's end of things). Listing a deposit as outstanding in July simply allows you to reconcile the bank's balance to your records of the bank balance at the end of July. Once the deposit clears the bank on August 1, it is no longer an item of difference between your records and the bank's records, so you no longer list it on your August bank reconciliation. |
2) | Just because the cheque was written two months ago and was
outstanding last month does not matter at all. Simply list the cheque as
still outstanding in the August reconciliation.
If the cheque takes more than a month or so to clear for no apparent
reason (ie. you haven't delayed mailing it), you might want to look further.
The cheque may have been lost in the mail, or the intended recipient may
have closed up or otherwise have no forwarding address. If the cheque seems
to have simply disappeared, you may want to get the bank to stop payment
on the cheque and and then re-issue the cheque. The stop payment is a safety
measure and will prevent anyone from trying to deposit the cheque if it
reappears after you have issued a replacement cheque.
|
3) | When an outstanding cheque is discovered to be never mailed
and the goods returned, remove cheque # 199 from the list of outstanding
cheques, then reverse the entry that records the issuance of the cheque.
For example, if the cheque was
Debit Office supplies 524.58 Credit Bank 524.58, reverse the entry by doing a general journal entry as Debit Bank 524.58 Credit Office supplies 524.58 Now the balance in both the bank account and the office supplies account is as if you had never made the purchase |
1) | ![]() |
2a) | When you first posted the cheque you debited (increased)
the Insurance expense account. To correct the posting you must credit the
Insurance expense account $1,020.00 and debit the Prepaid insurance account.
Prepaid insurance 1,020.00 Insurance expense 1,020.00 to correct posting of payment for insurance
|
2b) | 7Your monthly usage of your year's worth of insurance is $1,020.00
divided by 12 months, or $85.00. Therefore you need to record $85.00 worth
of usage of your prepaid insurance each month.
Insurance expense 85.00 Prepaid insurance 85.00 to record insurance for the month After 12 months, the balance in your Prepaid insurance account is down
to nil.
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1a) | ![]() Note that the invoice for janitorial service is for May services and therefore is not accrued as an April expense. |
1b) | ![]() Calculated as $10.00 per hour times 8 hours times 2 days times 2 employees. Note that often payroll is accrued to its own accrual account (Accrued payroll payable). |
1c) | You know that the repairs were done in April, and you know the amount that you expect to pay for the repairs. Therefore, accrue $100.00 to Computer repairs expense. |
![]() Don't forget these "home" costs in your accounting records. Whatever portion of your home that is used for business purposes can be legitimately recorded as a business expense. For example, if you have a home office that uses 1/10 of your house's floor space, you could record 1/10 of your heating and electricity bills as a business expense. |
![]() Computer accounting programs are usually databases with accounts as records and descriptive information and amounts as fields for those records. Posting information to the accounts usually means transferring the information from a temporary working database to a permanent archive. These permanent archives are usually encrypted or passworded internally so that information can only changed through the interface provided in order to protect the integrity of the accounting records. Anyone who has tried to recover corrupted data files in an accounting program can attest to the difficulty of trying to manipulate this data. |
GAAP
GAAP is established by the Accounting Research Committee of the Canadian Institute of Chartered Accountants. |
Note:
However, that the value of the assets as recorded is rarely exactly the same as the current value of the asset. We will explore this further in Module 3) Assets. In addition, the market value of a company is never the sum of the equity accounts, even if the accounting value of the assets and liabilities happen to be close the current value. What are not represented in the accounting records are the intangibles. These are things such as the quality of the management and the employees, the distribution channels, market strength, the customer base, and other key success factors which must be given a dollar value when a company is be sold. These elements are what the investors in the stock market use to try to determine the value of a stock since the stock is equity in the company. |
(House purchased for $125,000.00
with a $35,000.00 down payment and a $90,000.00 mortgage)
Debit the building (asset) account $125,000.00. Credit the mortgage (liability) account $90,000.00 Credit the equity account $35,000.00. Total debits = 125,000; total credits = 125,000 Assets of 125,000 = Liabilities of 90,000 + equity of 35,000 |
Note:
There are some tricky aspects involved here which will be covered in later sections. For example, if your business buys and sells computers, instead of debiting the cash account you must debit the Cost of Goods Sold account, credit the sales account, then debit the cash account. Or, if the computer is considered equipment for the company's use it is considered a fixed asset, and accumulated depreciation must be debited, gain or loss on sale of assets must be credited, and cash debited. These aspects are covered in the Inventory and the Asset modules, respectively. |
Liquidity
Liquidity is a relative term which refers to the ease with which something is converted into cash. Cash itself is obviously the most liquid asset. A term deposit is liquid but you have to pay a penalty for early redemption, so it is less liquid than cash. Inventory is more liquid than production equipment since inventory is made to be sold, but inventory is less liquid than a term deposit because a buyer must be found first. |
Sample Company, Ltd. | |
Chart of accounts | |
Account | Description |
1000 | Petty cash |
1010 | Bank, operating |
1020 | Bank, payroll |
1100 | Accounts receivable, trade |
1110 | Accounts receivable, other |
1190 | Allowance for doubtful accounts |
1200 | Investments, short term |
1300 | Inventory, raw material |
1310 | Inventory, work in process |
1320 | Inventory, finished goods |
1400 | Prepaid insurance |
1410 | Prepaid taxes |
1420 | Prepaid rent |
1430 | Deposits |
1500 | Furniture and fixtures |
1510 | Equipment |
1520 | Computer hardware |
1530 | Computer software |
1540 | Leasehold improvements |
1550 | Building |
1560 | Land |
1600 | Accumulated depreciation, furniture and fixtures |
1610 | Accumulated depreciation, equipment |
1620 | Accumulated depreciation, computer hardware |
1630 | Accumulated depreciation, computer software |
1640 | Accumulated depreciation, building |
1650 | Accumulated amortization, leasehold improvements |
2010 | Bank loan, operating |
2100 | Accounts payable, trade |
2110 | Accounts payable, other |
2120 | Dividends payable |
2200 | Wages payable |
2210 | Payroll deductions payable |
2300 | Federal sales taxes payable |
2310 | Provincial/State sales taxes payable |
2400 | Corporate income taxes payable |
2500 | Long term debt |
2600 | Shareholders' loans |
2610 | Deferred income taxes |
3000 | Common stock |
3010 | Preferred stock |
3020 | Retained earnings |
3040 | Dividends |
4000 | Sales |
4010 | Sales returns and allowances |
4020 | Sales discounts |
4030 | Delivery recovered |
4040 | Interest income |
4050 | Miscellaneous income |
5000 | Cost of goods sold |
5010 | Delivery |
5020 | Employee benefits, direct |
5030 | Rent, direct |
5040 | Repairs and maintenance |
5050 | Salaries, direct |
5060 | Shop supplies |
5070 | Utilities, direct |
6000 | Accounting and legal fees |
6010 | Advertising |
6020 | Automotive |
6030 | Bad debts |
6040 | Bank charges |
6050 | Donations |
6060 | Dues and licences |
6070 | Employee benefits, indirect |
6080 | Insurance |
6090 | Interest, long term debt |
6100 | Interest, other |
6110 | Miscellaneous |
6120 | Office supplies |
6130 | Promotion and entertainment |
6140 | Rent, office |
6150 | Salaries, management |
6160 | Salaries, office |
6170 | Sales commissions |
6180 | Telephone |
6190 | Travel |
6200 | Utilities |
7000 | Gain/loss on disposal of assets |
8000 | Corporate income taxes |
8010 | Corporate income taxes, deferred |
Types of accounts grouped by 1000s and100s | |
1000 | Assets |
2000 | Liabilities |
3000 | Equity |
4000 | Sales |
5000 | Cost of Sales |
6000 | Administrative expenses |
7000 | Unusual items |
8000 | Corporate income tax |
Gaps in account numbers for additions | |
Exact account names/number of accounts depends on company |
Gross Profit
Percentage
The gross profit percentage can tell you whether your sales are increasing or decreasing relative to your direct costs. In order to remain profitable, most business need to maintain their gross profit percentage within a certain range. If the gross profit percentage goes too low, you won't generate enough profit from your sales to cover your administrative and other expenses. If you try to push it too high, (getting a higher markup on your sales), you may drive away customers which will decrease your volume. The gross profit percentage is a useful tool for bankers and investors because it allows you to compare one company's performance to others in the same industry, regardless of size. We'll look at more analysis tools in Module VIII, Ratios and costing. |
Extraordinary
items
Extraordinary items are those outside of normal business operations and which are not expected to occur on a regular basis. Examples might include sales of parts of the business or government legislation which significantly affects the business operations. |
![]() Spreadsheet programs are very good for producing this type of output. You can produce blank pages with lines just like a store bought journal, or you can set up a template spreadsheet and type in the information and print it out. |
![]() Computerized accounting programs are often database programs, and have a chart of accounts, a list of all of your accounts sorted into groups. The standard format is to first list assets, then liabilities, equity, revenue, and expenses accounts. The accounts are usually given a numerical code in order to give the
listing of accounts a pre-determined order for printing out and to make
it easy for the computer to match journal entries to the appropriate account
in the database.
|
Posted
"Posted" just means that the entry is now official and has been or is being recorded in a ledger. |
![]() ![]() In this format, credits are entered as negatives so that you can easily count debits against credits. Note, however, that credits or negative balances in accounts are not necessarily bad. Revenues, for example, are recorded as credits or as negative numbers, so you want to have a negative number or credit balance at the end of your revenue account. |
![]() Credit notes are issued for refunds or returns are not credits to sales, they are credits to the customer's account or to the cash account, and are debits to the sales accounts. |
![]() Computer accounting programs use database files for ledgers. When you post an entry, the record is added to the database. When you print out the activity in an account, the software searches the database for matching records, collects the information in a temporary (in RAM) file, totals up the numerical information, and prints it out. |
Cash Sheets:
For a retailer, or for the retail portion of an operation (ie. a maufacturer may set up a pormotional booth at a trade show; the booth may operate as a retail operation even though the main portion of the business is credit sales to distributors) daily cash sheets are necessary to track sales and cash deposits. Below is a sample of a cash sheet for any retail operation. Note the:
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![]() Essentially your business's deposit book and/or receipt book will act as a cash receipts journal and your cheque register will serve as a basic cash payments journal. (The cheque register is the part of your cheque book where you record all of your cheques as you write them; you do record them as you write them, don't you? If you don't, you make it more difficult for you and/or your accountant to figure out what has been happening, especially if you don't get your cancelled cheques back at the end of the month. Or else, get one of those cheque books with NCR paper so you automatically get a duplicate of the cheques that you write.) The important thing is to record every transaction as they happen, and to keep copies of bills to and from you so you know what each transaction is for (all you need to do is to throw them into a designated shoe box, or better yet, file them sequentially with the cheque numbers written on them). One of the most time consuming things for your tax accountant is having to go through your bank statement and canceled cheques trying to piece together the activities, call you up and ask questions, then wait for you to call back with the missing information before they can finish their work. The better organized your own record keeping is, the faster you can track your business's successes and failures as you proceed, and the lower your accounting bill will be. |
Accounts Payable
Accounts payable , like accounts receivable, refers to both the specific liability account, and the term can be used to refer to any specific supplier or vendors' account. |
Aging
Aging means to take the individual invoices and determine how old each invoice is. This is done to see whether there are overdue amounts and how much is overdue by how many days. Again, you need to know this kind of detail because you can't allow customer's to take advantage of you. Conversely, you don't want your hydro cut off because you forgot to pay your hydro bill. |
Outstanding cheques
Outstanding cheques are cheques written before the bank statement date that have not yet been cashed. Because you have written the cheque, the amount(s) are recorded in your accounting records. Because the cheque has not been cashed, the bank hasn't recorded the cheque in its records yet. |
Outstanding deposits:
Outstanding deposits, like outstanding cheques, are deposits that were not recorded by the bank at the month end date. Sometimes this happens because the bank processed the deposit on the following working day instead of the day you made the deposit, such as a night deposit. Or, it may be that you had the deposit in your office but didn't take it to the bank that day because it was a small deposit. Or, your month end may be the last day of the month, but the bank issues its statements on the 27th of each month, so you need to account for the last 3 or 4 days of activity every month to match dates. |
Outstanding:
Outstanding means not paid or not cleared up. Accountants sometimes abbreviate this in written form as simply "O/S" |
Accounts receivable:
Accounts receivable is two things; it is the specific name for an asset account which represents all of the monies owed to the organization for sales on credit. |
NSF:
NSF, or Not Sufficient Funds, cheques are those that are returned by the bank because the person who wrote the cheque hasn't enough money in the bank to cover the cheque amount. Accounting-wise, subtract (credit) the amount from the bank (asset) account and reverse (debit) the amount to the NSF or Bad Cheques (expense or contra-sales) account. If and when you eventually collect on the amount, post (credit) the re-deposited cheque to the NSF account, thereby making the NSF account a zero balance again. |
Note:
Note the amount of the error; $18.00. This is what is called a transposition error; the 5 and the 3 were "transposed" when writing up the deposit slip. |
An easy way to do bank reconciliations is to use a spreadsheet like in the example. (See the BANKREC.WK1 file included with Shoe Box Accounting). Simply clear all the data entry cells, enter the current information, and add any additional rows where you need them. Keep working with the spreadsheet until the difference between the adjusted bank balance and the general ledger balance is zero. |
A common prepaid expenses is insurance. You pay once a year for a service that you "use up" month by month. Instead of recording a $1,200 insurance expense as soon as you pay and nothing during the rest of the year, you record the $1,200 as a debit (increase) to prepaid expenses (asset) account. Then, each month, you debit (increase) the insurance expense account $100 and credit (decrease) the prepaid insurance account $100. By the end of the year, the prepaid insurance account is down to nil. |
You may have unrecorded revenues if you don't bill until you have completed a project or service. For example, if you do computer systems installation and at the end of the month the installation is only partially complete, you need to record the portion of the installation that is complete as a revenue. To do this, you can simply take the percentage of the installation that is complete and multiply by the total anticipated billing. For example, if the installation is 30% complete and you plan to bill $1,000 for the complete installation, you record $300 as a credit (increase) to your sales and $300 debit (increase) to Unrecorded Revenue, an asset account. |