Double Entry Types of Balance Sheet
Theme:
Double
Entry
Types of Balance Sheet
Prepared:
Almaty 2009y.
Plan
The Essence of Double Entry Principle
The Accounting Equation
Double Entry Bookkeeping
Ledger Accounts
Balance Sheet
Trial Balance
Interpreting Balance Sheet
Glossary
The Essence of Double Entry Principle
In accounting, the journal should has two ledger that
is called double entry accounting. This method was introduce by Mediecci in
12th century at Italy. The father of accounting, Luca Paccioli is the first
publisher of double entry accounting system.
Double entry accounting is a method in which each
transaction is recorded in two separate accounts, i.e. in one account as a
debit and in the other account as a credit. In other words, in double entry
principle each transaction that has a value added to the assets account also has
a value subtracted from the liabilities account - these transactions are called
credits. Conversely, each transaction that has a value added to the liabilities
account has a value subtracted from the assets account - these transactions are
called debits.
Double entry accounting principle is used more often
than the single entry principle, in which each transaction is recorded in only
one account. It is used more often since it prevents many errors and promptly
alerts the business to possible errors so that they can be corrected on a
timely basis. Since credits and debits should always be equal, i.e. according
to the essence of accounting basics there must be an equation between debits
and credits, if there is ever a discrepancy between the value of the credits
and debits, it is an alert to the business that an error has occurred while
recording the transaction in the books of the business. Thus, with the double
entry accounting principle it is quick and easy to ensure that the accounts are
always balanced. Also this principle is useful to record transactions
separately and present proper and accurate data to its users for the purpose of
decision making relating the entity.
Example 1
Consider the following example of the double entry
principle. Cut to the Chase, a hair salon, buys hair brushes in bulk once every
quarter, purchase is made on credit, i.e. cash for the purchase made is paid
later on after the purchase. The bulk of brushes costs $250. So, every quarter
the accountant for Cut to the Chase makes $250 entry in the liabilities account
(adding to the value of the liabilities) and a $250 entry in the assets account
(adding to the value of the assets). Below you can see how the entries look
like;
D Inventory (Assets) $250
Accounts payable (Liabilities) $250
Example 2
The next example is the usage of the acquired brushes
in the activities of the Cut to the Chase hair salon. Assume that during the
next quarter the company used all the acquired brushes in its activities, i.e.
$250 expenses were incurred and assets decreased by $250. The accountant will
record a $250 entry in the assets account as a credit and a $250 entry in the
equity account as a debit, i.e. expenses as a decrease in equity. Below you can
see how the entries look like;
D Expenses (Equity) $250
C Inventory (Assets) $250
As these examples show, the bottom line of double
entry principle is that for each entry made in one account (i.e. liabilities or
equity), an opposite entry in the same amount of the original entry must be
made in the other account (i.e. assets).
The Accounting Equation
All accounting entries in the books of account for an organisation have a
relationship based on the 'accounting equation':
Assets = Liabilities + Owner's equity
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Assets
Assets are tangible and intangible items of value which the business owns.
Examples of assets are:
• Cash
• Cars
• Buildings
• Machinery
• Furniture
• Debtors (money owed from
customers)
• Stock/Inventory
Liabilities
Liabilities are those items which are owed by the business to bodies
outside of the business. Examples of liabilities are:
• Loans to banks
• Creditors (money owed to
suppliers)
• Bank overdrafts
Owner's Equity
The simplest way to understand the accounting equation is to understand
what makes up “owner's equity”.
By rearranging the accounting equation you can see that Owner's Equity is
made up of Assets and Liabilities.
Owner's Equity = Total Assets less Total Liabilities
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Owner's Equity can also be expressed as:
Owner's
Equity = Capital invested by owner + Profits (Losses) to date
(also known
as 'Retained Earnings')
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Rearranging the equation again, therefore:
Total Assets - Total Liabilities = Capital + Retained Earnings
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The accounting equation establishes the basis of Double Entry
Bookkeeping
Double Entry Bookkeeping
All accounting transactions are made up of 2 entries in the accounts: adebit
and a credit.
For example, if you purchased a book, your value of books would increase,
but your value of cash would decrease by the same value, at the same time. This
is double entry bookkeeping.
Ledger Accounts
A ledger account is an item in either the Profit & Loss
account (which we'll discuss shortly) or the balance sheet. A Ledger account is
either a:
• Asset
• Liability
• Equity
• Income
• Expense
The example of purchasing a book, mentioned above, can be shown in the
form of ledger "T" accounts as follows:
“Dr” is short form “Cr” is short form for Debit for Credit
Purchases-Books
Dr Cash Cr
$20
Cash
Dr Cr
Books $20
If all transactions are entered into the books in this way, then the sum
of all of the debits would equal the sum of all of the credits.
Balance Sheet
Balance Sheet is one of the three main Financial Statements.
It reflects structure of the company's assets and financing sources used to
finance these assets as of particular date (i.e. as of year end).
Referring
to the Accounting Equation, where:
Assets
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=
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Liabilities
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+
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Equity
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Balance
Sheet reflects the same principle, i.e. one side of the Balance Sheet
represents Assets and the other side - Liabilities
and Equity. The must be a balance between the total value of
the Assets and the total value of Liabilities and Equity.
Assets are properties (can be material, immaterial, monetary) owned
by the entity, i.e. any physical thing (tangible) or right (intangible) that has
a monetary value. Assets usually are divided into Current Assets (cash
and other assets that may reasonably be expected to realized in cash or sold or
used within period less or equal to one year. Examples: inventory, cash,
accounts receivable, prepaid expenses) and Long-term Assets
(used by the entity for a period longer that one year. Examples: long-term
investments, fixed assets, intangible long-term assets).
Liabilities are debts owned to outsiders, i.e. creditors. Divided into Current
Liabilities, which are due within one year (accounts payable, salaries
payable, taxes payable, interest payable) and Long-term Liabilities
which are due after one year
Equity includes amounts invested in a business by owners, special
kind of liability residual claim against assets of business after total
liabilities are deducted. Includes Share Capital (financial
means invested by the shareholders), Retained Earnings – net
income retained in the business.
Below there is
an example of the Balance Sheet:
You
can see that total value of the Assets ($50650) equals to the
total value of Liabilities ($17900) and Equity
($32750).
Trial Balance
A trial balance is a list of all of the ledger accounts of a business and
the balance of each. Debits are shown as positive numbers and credits as
negative numbers. The trial balance should therefore always equal zero.
If the journal entries are error-free and were posted properly to the
general ledger, the total of all of the debit balances should equal the total
of all of the credit balances. If the debits do not equal the credits, then an
error has occurred somewhere in the process. The total of the accounts on the
debit and credit side is referred to as the trial balance.
The more often that the trial balance is calculated during the accounting
cycle, the easier it is to isolate any errors; more frequent trial balance
calculations narrow the time frame in which an error might have occurred,
resulting in fewer transactions through which to search.
Interpreting Balance Sheet
1. ASSETS DEBIT balance = positive amount. CREDIT balance =
negative amount
Cash Always review the status of your cash. A cash deficit should rarely
occur. Cash represents the liquidity of your fund and its ability to pay
its expenses. It is very important to make sure your cash remains
positive.
Petty Cash Periodically review the level of your petty cash fund.
Remember that
petty cash is quite vulnerable to loss through fraud or error. Can you
reduce the size of the fund without affecting efficiency?
Receivables When you review your receivables balance, make sure your
receivables are realistically valued. If you have anything more than a
negligible amount in receivables, you should have an allowance for
uncollectibles. It should have a credit balance, offsetting the debits to
receivables. If you do not have an allowance for uncollectibles. your
receivables are probably not worth what your balance sheet shows. Receivables
should show a realistic expectation of future cash.
If your receivables balance is growing it could mean the following:
1.
Your
business is growing in size. Check if the other numbers, such as supplies
expense, are growing also.
2.
Receivables
are increasing in relation to your other assets. Perhaps your customer types
are changing. Be careful not to let receivables get out of proportion. You
can't pay vendors or staff with receivables!
3.
Your
customers are paying more slowly and your receivables are staying on the books
longer than before. You might need to speed up collection or you might need to
extend credit less readily.
If your receivables balance is getting smaller, it could mean the
following:
1.. Business is falling off. You have fewer customers and thus fewer
people asking to be invoiced. Check your customer base. Has your customer mix
changed? Is your product or service still needed?
2. The amount of business you are doing is staying the same. But more
customers are paying in cash.
4.
You
are collecting your receivables quickly. This is good!
Inventory Inventory consists of items that you will sell, or the raw
materials for making those items. Because you are going to sell it, it
represents future cash for your organization. Inventory items are very
vulnerable to "shrinkage" - meaning deterioration, becoming outdated,
and theft. You should have a tracking method and periodically you should
physically count the inventory items. The value of your inventory should appear
on your balance sheet and you should be able to document that the value shown
on the balance sheet is correct.
Prepaid Items Prepaid items such as maintenance agreements are important
assets because they represent something you have already paid for. You need to
check that you are receiving the appropriate value. For example, if you have a
maintenance agreement as an asset on your balance sheet, you should check if
you really are receiving the service you paid for.
Amounts in prepaid expense balances are generally transferred to expense
over the term of the related maintenance agreement, insurance policy, etc.
There should be zero balances in the prepaid accounts once the agreements have
expired.
2. LIABILITIES A CREDIT balance shows there is a liability. A DEBIT
balance shows a liability is negative (often meaning it has been overpaid).
Sales Tax If you sell items that are subject to state sales tax, the
sales tax should be paid monthly. The Office of the Treasurer processes the
payments and remits sales tax to the state of Ohio, based on the amounts you
tell them are owed. You should review the balance sheet each month to make sure
the payment is being made. Otherwise you might be misled into thinking that all
the cash on the balance sheet is yours to use, whereas in reality some of it
belongs to the state.
Salaries In the OSU General Ledger, Salaries Payable or "Accrued
Salaries
Payable Payable" occur only at year-end and only for bi-weekly Classified
Civil Service employees and Nine-month Faculty (faculty who work three of
the four quarters of the year, but are paid over 12 months).
Since Nine-month Faculty are usually paid from general funds only bi-weekly
employees are discussed here.
At the end of the fiscal year, bi-weekly classified employees have almost
always worked a portion of a pay period. The university owes these employees
money for their work, but of course payment does not occur at the end of the year.
Instead it occurs at the next appropriate paycheck run. Nevertheless the fact
that the money is owed must be recorded in the university's books as a
liability.
Although this liability is only a "paper entry" and is reversed
at the beginning of the next fiscal year, you should verify that the amount
recorded as a liability to your fund is the appropriate amount.
Deferred Deferred revenue represents prepayments received from your
Revenue customers. Since you owe your customers the goods or services
that you will provide in the future, you cannot claim to fully "own"
the cash they have paid to you. The liability "deferred revenue"
shows a record of the cash you have received but for which you have not yet
provided the corresponding goods or services.
When you provide the goods or services to the customer, amounts in
deferred revenue should be transferred to revenues. There should be zero
dollars in deferred revenue once all the goods or services have been provided.
You should track your deferred revenue for the following reasons:
1.
To see
how much of your cash is potentially refundable to others.
2.
To
ensure that all balances are "current" (represent only amounts for
goods or services not yet provided to customers).
3. EQUITY CREDIT balance shows positive equity. DEBIT balance
shows negative equity.
Equity The equity, net worth or fund balance of your fund represents the assets
the fund owns, less any liabilities owed to others.
Equity also represents the cumulative effect of all revenues, expenses
and transfers posted to the fund since its inception.
It is an important measure of the value of your fund. Equity should
always be positive.
Equity "with" Because the cash on your balance sheet does not take
into Encumbrances account any encumbrances, your equity (assets
minus liabilities) does not take them into account either. Consequently, the
balance sheet gives you an additional figure labeled "equity with
encumbrances," meaning "equity with encumbrances subtracted."
When this figure is positive it shows a credit balance, following the same
pattern as equity.
The balance sheet gives you this view of your equity so that you can see
what equity would be if all the cash that is currently committed were already
spent. As you review this figure, bear in mind the following:
1.
Some
commitments are firmer than others. For example, a salary commitment for a
Classified Civil Service employee will certainly be used, unless the person
leaves or reduces work hours. On the other hand, if you have a blanket purchase
order, you might have established it for a maximum amount, planning to spend
that amount only if absolutely necessary. The first encumbrance is
"firm," the second less so. Consequently, you must know your
operation well in order to interpret "equity with encumbrances."
2.
Depending
on the type of fund, monies are received at different points during the year.
For example, Endowment Income and Expense funds receive the major portion of
their funding in July. Earnings funds, on the other hand, usually receive
revenues at regular intervals during the year. Thus an Endowment Income and
Expense fund that has negative "equity with encumbrances" in the
early part of the fiscal year is probably of concern, whereas an Earnings fund
can begin the year with negative "equity less encumbrances" because
it will earn money during the year to offset the commitment
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