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Accounts

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Accounts Accounts are set up for each item on the financial statements and are analyzed to provide details for financial reports. They each fall into one of the following categories: ‡ Balance Sheet Accounts - classified as assets, liabilities, or owner's equity ‡ Income Statement Accounts - classified as revenues or expenses. Each daily transaction of a business has an impact on the at least two accounts. For example paying $100 on an account in your payables would lower your cash level, but it would also lower your obligation. Simplest form Name of the Account Left side debit Right side credit Amounts entered on the left side of an account, regardless of the account title, are called debits to the account. Amounts entered on the right side of an account are credits. debit balance Asset Accounts Nature of the Account credit balance Liability Accounts Owner's Equity

Accounts Payable: When goods, services, or supplies are purchased on account, they become, to the purchaser, an account payable (to the supplier, they are an account receivable). For example, if Your Company purchases office supplies and agrees to pay the supplier at a later date, the amount due from that purchase is recorded in your books as an account payable. The journal entry below illustrates how an on-account purchase of $200 in office supplies would be recorded: General Journal Date 20XX 5 Jan Account Titles/Explanation Office Supplies Accounts Payable Bought office supplies on account. Ref Debit 200.00 200.00 Page: 1 Credit

When the account is paid, the following journal entry is made: General Journal Date Account Titles/Explanation Ref Debit 200.00 200.00 20XX 15 Accounts Payable Jan Cash Paid on account. Page: 1 Credit

Accounts Payable, like all asset and liability accounts, is a permanent account. That is, it is not closed at the end of the period as are income statement accounts; its balance carries over from one period to

the next. The account is also a balance sheet account. This means that it appears on the balance sheet along with all the other asset, liability, and equity accounts. An example of a balance sheet containing accounts payable is as following: Balance Sheet The Balance Sheet is a statement listing the total assets, liabilities and owner's equity indicating the net worth of the company at a certain point in time. In other words, a balance sheet dated June 30, 2008 contains account balances as of that day and is a snapshot of the business' finances at that point. Assets = Liabilities + Owner's Equity A balance sheet must balance. That is, assets must equal liabilities plus owner's equity. Assets represent resources (such as cash, inventory, and accounts receivable) that are owned by or owed to the company. Liabilities and owner's equity are claims to those assets. It can be broadly viewed like this - the value of everything owned minus the money owed to others leaves the value of the owner's rights to the business.

Balance sheets are usually formatted in one of two ways. The first is the account form which lists assets on the left and liabilities and owner's equity on the right. An example is shown below. Your Business Name Balance Sheet June 30, 20XX Assets Cash Inventory Land Total Assets $6,000.00 500.00 6,500.00 $13,000.00 Liabilities Accounts payable Owner's Equity Joe Smith, capital Total Liabilities and Owner's Equity 12,000.00 $13,000.00 $1,000.00

The other format used is the report form. It lists the assets first and the liabilities and owners equity next in vertical arrangement as in the example below. Your Business Name Balance Sheet June 30, 20XX Assets Cash Inventory $5,000.00 500.00

Land Total Assets Liabilities Accounts payable Owner's Equity Joe Smith, capital Total liabilities and Owner's Equity

5,500.00 $11,000.00

$1,000.00 $10,000.00 $11,000.00

Balance sheets are often more detailed than the basic examples shown above. In actual practice, many balance sheets separate assets and liabilities into long-term and short-term categories and include entries for accumulated depreciation and allowance for doubtful accounts. Accrual versus Cash-Basis Accounting There are two ways companies can keep their accounting books - Accrual- and Cash-Basis. The accrual basis is used by most companies; only very small businesses use cash-basis. Under the accrual method, expenses and revenue are recognized in the period they occur regardless of whether a cash transaction has occurred. For example, if a sale is made in January but payment is not expected until February, the revenue from the sale would be recognized in January (when it was earned) and the amount due to the company is recorded (accrued) in accounts receivable. Below are the Journal entries for the "sale on account" and the "payment on account". General Journal Date 20XX 5 Jan Feb 5 Account Titles/Explanation Accounts Receivable Sales Revenue Sale on Account Cash Accounts Receivable Payment on Account Ref Debit 450.00 450.00 450.00 450.00 Page: 1 Credit

Notice that the first entry above recognizes the sale in January, when it actually occurred. This method matches the revenue from the sale to the expenses incurred during the same period. On the other hand, under the cash-basis method, the revenue would not be recorded until February when the cash is actually received, as in the example journal entry below. General Journal Date Page: 1 Credit

Account Titles/Explanation

Ref

Debit

20XX 5 Feb

Cash Sales Revenue Received Cash from Sale

450.00 450.00

While this method is easier and requires fewer journal entries, the sale revenue would not be matched-up to the expenses the company incurred to make the sale possible. For example, consider the salesperson's salary who made the sale. Assume payroll expense is recorded in January. Since the revenue is not recognized until the next period (month), the accounting records do not portray a true picture of what actually occurred. Under the cash-basis method, this mismatching of expenses and revenues would also occur if payment was received right away (in January), but the salesperson's salaries where not paid until February. Generally Accepted Accounting Principles (GAAP) require that all public companies use accrual accounting. One reason for this is that a truer indication of a companies financial stability and income generating activities is reported giving investors and other interested parties better information to make informed decisions. End of Period Adjusting Entries Before end-of-period financial reports are prepared, adjustments to prepaid and accrued accounts are made. This process helps provide a true indication of where the company stands financially and it matches income and expenses to the period they effect. There are several types of accounts that require adjustments:
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Prepaid Expenses - items or services that are paid for up-front. They are classified as assets when purchased. Unearned Revenues - revenues received before they are earned. They are classified as liabilities when cash is received. Accrued Revenues - revenues that have been earned but cash has not yet been received and no transaction has been recorded. Accrued Expenses - expenses that have been incurred but not paid for yet and no transaction has been recorded.

y

y

y

Each of these adjustment types is described below along with examples and sample journal entries. Prepaid Expenses When an expense is prepaid (for example - prepayment of a 6-month insurance policy for $1,200) an asset is created. Think of it this way; the company is due something of value - the insurance coverage for a 6-month period in the future. To simply expense the $1,200 at the time cash is spent would inaccurately allocate the full amount to that period. Instead, accountants create a Prepaid Insurance account and subtract from it, each month, the amount that should be allocated to it ($1,200 ÷ 6 = $200). The first example entry below journalizes the prepayment of the 6-month policy; the second is the adjusting entry for the end of the first month.

General Journal Date 20XX 1 Jan Account Titles/Explanation Prepaid insurance Cash Paid insurance in advance Ref Debit 1200.00

Page: 1 Credit 1200.00 200.00 200.00

31 Insurance expense Prepaid insurance To record insurance expense.

After posting these transactions, the Prepaid Insurance account will have a balance of $1,000. At the end of each of the next 5 months an adjustment similar to the one above would be made. After the June 30th entry, the Prepaid Insurance account would have a zero balance and Insurance Expense would have a $1,200 balance. Unearned Revenues When revenue is received in advance (for example, receipt of a 6-month cleaning service fee of $600 up-front) a liability is created -- the company owes something of value (cleaning services) to another. If the $600 were posted directly to revenue on the date it was received, it would incorrectly allocate the entire revenue to one month rather than spread it over 6 months, when it is actually earned. The example entries below record receipt of the fee (which creates the liability) and the adjustment at the end of the first month to record the revenue earned during January ($600 ÷ 6 = $100). General Journal Date 20XX 1 Jan Account Titles/Explanation Cash Unearned revenue Received revenue in advance Ref Debit 600.00 600.00 100.00 100.00 Page: 1 Credit

31 Unearned revenue Service revenue To record revenue for services completed

At the end of each of the next 5 months, an adjustment similar to the one above would be made. After the June 30th entry, the revenue collected in advance would be correctly allocated to each of the months it was earned. Accrued Revenues When revenue has been earned but cash has not yet been received, accountants make an accrual adjusting entry. If an advertising company charges $1,500 for a month's services payable at the end of 30 days and begins working in the middle of the month (i.e. Jan. 15 - Feb. 15), an entry must be made at the end of January to record the revenue earned during the period ($1,500 ÷ 2 = $750) as follows: General Journal Date Page: 1 Credit

Account Titles/Explanation

Ref

Debit 750.00

20XX 31 Accounts receivable

Jan

Service revenue Paid insurance in advance

750.00

In February, when the customer makes payment of $1,500, Cash is debited $1,500, Accounts Receivable is credited $750 and Service Revenue is credited $750. Accrued Expenses Expenses are often incurred in one month or period and paid for in another. Examples include interest, rent, and salaries. Consider an employee who is paid $2,400 on February 5th for the work he/she completed in January. In order to reflect the expense in the correct month, an adjustment must be made at the end January. General Journal Date Page: 1 Credit 2400.00

Account Titles/Explanation

Ref

Debit 2400.00

20XX 31 Salary expense Jan Salary payable To accrue salary expense

On February 5th, when the employee is paid, Salary Payable is debited $2,400 and Cash is credited $2,400. Amortization Amortization, like depreciation, is the process of deducting, over a set period of time, the costs incurred in the procurement of assets. Whereas depreciation is used to expense out (over the useful life) the costs of tangible assets such as buildings, furniture, and machines; amortization is used to recover the cost of intangible assets such as: ‡ Going into Business Costs - start up expenditures, cost of incorporating, etc. ‡ Lease for Business Property ‡ Goodwill, patents, customer base, permits, etc. ‡ Reforestation Costs - direct costs of planting or seeding ‡ Pollution Control Facilities When the intangible asset is originally purchased the cost should be debited to an asset account. This cost is then "written off" or amortized, generally using the straight line method, over the legal useful life of the asset (see IRS Publication 535 Chapter 9 for amortization period guidelines). The straight line method is simply dividing the initial cost of the asset by its useful life. For example if a patent is purchased for $12,000 and amortized over 15 years (180 months) then the monthly write-off would be $66.67 (12,000/180). General Journal Date Page: 1 Credit 66.67

Account Titles/Explanation

Ref 55 14

Debit 66.67

20XX 31 Amortization Expense - Patents Jan Patents

Asset Accounts Anything owned, whether tangible (a physical item) or intangible (the right to something) is an asset. Assets are generally separated into two groups: Current Assets - Cash and other assets that will be used up, or sold, or converted to cash within the normal operation of business. Plant Assets - Permanent or fixed assets, such as land, buildings, equipment, etc. Common Asset Accounts: Current Assets: ‡ Cash - Includes the cash at the store & in the bank. ‡ Accounts Receivable - What others owe you. ‡ Notes Receivable - Loans made to others. ‡ Prepaid Insurance - Premiums that are paid in advance. ‡ Office Supplies - Are assets from purchase to use. ‡ Inventories - Ready to be sold and work in progress. Plant Assets: ‡ Equipment - Office, production, store equipment. ‡ Buildings - Your place of business - garage, plant, store. ‡ Land - Should have it's own account - doesn't depreciate.

Chart of Accounts: The complexity of a company's chart of accounts depends on a number of factors including: daily activity, type of business conducted, and to what detail records are needed for management decisions and tax authorities. Some businesses have very few accounts, others have thousands. It is common practice to assign a number to each account for indexing & coding transactions. Although simply numbering the accounts sequentially will work, it is more advisable to use a flexible system as is depicted here. Example Chart of Accounts Balance Sheet Accounts 1. Assets 11. Cash 12. Accounts Receivable 14. Supplies 15. Prepaid Rent 18. Equipment 2. Liabilities 21. Accounts Payable 22. Salaries Payable 3. Owner's Equity

31. Owner, Capital 32. Owner, Drawing 33. Income Summary Closing the Accounts At the end of the period, temporary or nominal accounts are closed; these include expense, revenue, and owner withdrawing accounts. This process zeros out the account balances so that the balance of the transactions in each account reflects only the transactions of a particular period. This is normally done only at the end of the year. To facilitate closing, a clearing account called Income Summary is used. The Income Summary account is used only momentarily; revenue and expensed are closed into it and then that balance is immediately closed out to Owner's Equity (or Retained Earnings). The four steps in closing the accounts are: 1. Close revenue accounts by debiting each for its credit balance and crediting Income Summary. 2. Close expense accounts by crediting each for its debit balance and debiting Income Summary. 3. Income Summary is closed into the Capital account by debiting (for a net income) or crediting (for a net loss) the balance. 4. Close the Withdrawals account by crediting it by its balance and debiting the Capital account. In the example of closing journal entries below, assume that revenue, expense, and owner equity accounts have the following balances. Account Expenses Rent Expense Salary Expense Office Supplies Expense Utilities Expense 1,400 400 320 Balance Revenue Sales Revenue Capital Account Withdrawals 6,000 9,000 1,000 Account Balance

1,200 Owner's Equity

The entries below depict a net income for the period. Read below how the entries differ for a net loss. General Journal Date Page: 1 Credit 6000 3320 1400 1200

Account Titles/Explanation

Ref

Debit 6000

20XX 31 Sales Revenue Jan (1) Income Summary To close revenue account 31 Income Summary (2) Rent Expense Salary Expense

Office Supplies Expense Utilities Expense To close expense accounts 31 Income Summary (3) Owner, Capital To close net income to Capital 31 Owner, Capital (4) Owner, Withdrawals To close drawing account to Capital 2680

400 320

2680 1000 1000

Here is how the transactions above effect the Income Summary and Capital accounts. The number in parenthesis indicates which of the transactions results in the account's entry:
 

ncome Summary (1) 6000

Owner's Equity (4) 1000 Bal 9000 (3) 2680

(2) 3320 (3) 2680

When the revenue and expense accounts are closed to Income Summary and a credit balance exists, a net income is the result. The opposite is true for a net loss; the Income Summary account has a debit balance. In the case of a net loss, the third entry above would contain a debit to Owner's Capital and a credit to Income Summary. Closing the Accounts At the end of the period, temporary or nominal accounts are closed; these include expense, revenue, and owner withdrawing accounts. This process zeros out the account balances so that the balance of the transactions in each account reflects only the transactions of a particular period. This is normally done only at the end of the year. To facilitate closing, a clearing account called Income Summary is used. The Income Summary account is used only momentarily; revenue and expensed are closed into it and then that balance is immediately closed out to Owner's Equity (or Retained Earnings). The four steps in closing the accounts are: 1. Close revenue accounts by debiting each for its credit balance and crediting Income Summary. 2. Close expense accounts by crediting each for its debit balance and debiting Income Summary. 3. Income Summary is closed into the Capital account by debiting (for a net income) or crediting (for a net loss) the balance. 4. Close the Withdrawals account by crediting it by its balance and debiting the Capital account. In the example of closing journal entries below, assume that revenue, expense, and owner equity accounts have the following balances. Account Balance Account Balance

Expenses Rent Expense Salary Expense Office Supplies Expense Utilities Expense 1,400 400 320

Revenue Sales Revenue Capital Account Withdrawals 6,000 9,000 1,000

1,200 Owner's Equity

The entries below depict a net income for the period. Read below how the entries differ for a net loss. General Journal Date Account Titles/Explanation Ref Debit 6000 6000 3320 1400 1200 400 320 2680 2680 1000 1000 20XX 31 Sales Revenue Jan (1) Income Summary To close revenue account 31 Income Summary (2) Rent Expense Salary Expense Office Supplies Expense Utilities Expense To close expense accounts 31 Income Summary (3) Owner, Capital To close net income to Capital 31 Owner, Capital (4) Owner, Withdrawals To close drawing account to Capital Page: 1 Credit

Here is how the transactions above effect the Income Summary and Capital accounts. The number in parenthesis indicates which of the transactions results in the account's entry:
¡

ncome Summary (1) 6000

Owner's Equity (4) 1000 Bal 9000 (3) 2680

(2) 3320 (3) 2680

When the revenue and expense accounts are closed to Income Summary and a credit balance exists, a net income is the result. The opposite is true for a net loss; the Income Summary account has a debit balance. In the case of a net loss, the third entry above would contain a debit to Owner's Capital and a credit to Income Summary. Income Statement The income statement reports a company's income or loss for a specific period. It lists revenues and subtracts from them the period's expenses. A positive balance results in an income and a negative

balance indicates a loss. In the example below revenues of $6,000 minus expenses of $3,000 results in a net income of $3,000. This figure is used on the Statement of Owner's Equity.

Your Business Name Income Statement For Month Ended June 30, 20XX Revenues Net sales Rental revenue Total revenues Expenses Wages expense Cost of goods sold Utilities expense Supplies expense Total operating expenses Net income/loss $1,500.00 1,000.00 250.00 250.00 3,000.00 $3,000.00 $5,000.00 1,000.00 $6,000.00

There are two formats commonly used to prepare income statements - the single-step and multiplestep. The example above is a single-step income statement. It consists of just two sections: revenues and expenses. Expenses are deducted from revenues in a single-step to find net income or loss. In a multiple-step income statement, the results of transactions are shown in sections separating operating activities from non-operating activities. In addition, it classifies expenses by function. For example, selling expenses are shown separate from administrative expenses. If the company experienced extraordinary items or discontinued a segment of operations, they are also shown in different sections. Inventory Systems - Perpetual and Periodic There are two systems companies use to maintain inventory records -- perpetual and periodic. The perpetual system is used by most companies especially now that computerized record-keeping systems that tie inventory and sales together are widely available. The periodic system is generally used by small businesses that have minimal inventories. As shown in the examples given later, the accounts used and the accounting entries made in each system differ slightly. The following table summarizes the differences: Transaction or Activity Perpetual Periodic

Inventory purchases are... Freight, purchase discounts, and returns and allowances are...

Debited to Inventory Debited to Inventory

Debited to Purchases Debited to individual accounts (Transportation In, Purchase Discounts, and Purchase Returns & Allowances At the end of the period (see example of entry below) At least once a year (more often for more current information) to determine inventory levels.

Cost of Goods is recorded...

At the time of each sale with a debit to Cost of Goods Sold At least once a year to account for breakage, errors, theft, etc.

Physical Inventory Count done...

The Perpetual System Under the perpetual inventory system, an up-to-date (really an up-to-transaction) running balance is kept of the inventory on hand and of the cost of goods sold. The example below shows the journal entries in a perpetual system for the following transactions:
y Purchase of 1,000 units on account at $7 each = $7,000 y Sale of 800 units on account at $13 each = $10,400

General Journal Date 20XX 5 Jul 6 Account Titles/Explanation Inventory Accounts Payable Purchase of 1000 units Accounts Receivable Sales Cost of Goods Sold (800 x $7) Inventory Sale of 800 units Ref Debit 7000

Page: 1 Credit 7000 10400 10400 5600 5600

Using this system, there is no need to make an entry at the end of the period in order to bring the Inventory and Cost of Goods Sold accounts up to date; they already show the correct balance. If a difference exists between the perpetual balance and the physical count balance then an adjustment should be made. In the case of a physical count that is lower than the perpetual inventory balance, a journal entry is made debiting an Inventory Over and Short account and crediting inventory. If the physical count shows more inventory on-hand that what the perpetual balance shows then Inventory is debited and Inventory Over and Short is credited.

The Periodic System Under the periodic inventory system, physical counts of inventory are periodically conducted and then the accounts are brought up to date. The example below uses the same transactions as were used in the perpetual system example above:
y Purchase of 1,000 units on account at $7 each = $7,000 y Sale of 800 units on account at $13 each = $10,400

General Journal Date 20XX 5 Jul 6

Account Titles/Explanation

Ref

Debit 7000

Page: 1 Credit 7000

Purchases Accounts Payable Purchase of 1000 units Accounts Receivable Sales Sale of 800 units

10400 10400 1400 5600 7000

31 Inventory (ending - 200 x $7) Cost of Goods Sold (800 x $7) Purchases End of period entry

As you can see, using the periodic system requires that an end-of-period entry be made to bring the Inventory and Cost of Goods accounts up to date. It should be noted that in the examples above it was assumed that there was no beginning inventory. To determine the value of Cost of Goods Sold when there is a beginning balance, the following formula is used (using the information from the examples above and a beginning inventory of 100 units at $7 = $700): Beginning Inventory Net purchases Cost of Goods Available for Sale Less: Ending Inventory (300 units x $7)* Cost of Goods Sold $700.00 7,000.00 7,700.00 2,100.00 $5,600.00

* Note that this quantity includes the 200 units purchased this month but that were not sold plus the beginning balance of 100 units. Journal: A journal is a chronological record of transactions and is the first place that transactions are recorded. It is often referred to as a book of original entry. Each entry records the date, the accounts effected and their reference number, an explanation of the transaction, and the debit/credit effect on the accounts named. Information from the Journal is later posted to each account.

General Journal Date 20XX 5 Jan Account Titles/Explanation Office Supplies Office Furniture Cash Bought office supplies & Furniture with cash. Cash Revenue Earned Collected fees for services rendered. Ref 14 18 11 11 41 Debit 15.00 300.00

Page: 1 Credit

315.00 425.00 425.00

6

Note: The page is numbered so that the transaction may be referenced when posting to accounts. Liability Accounts Anything that is owed to others is a liability. Liabilities are often referred to as "payables". Liabilities are generally separated into two groups: Current Liabilities Debts to others that are due in a short period of time and are paid with current assets. Long-term Liabilities Debts that are "fixed" or paid over a long period of time, often for plant assets. Common Liability Accounts: Current Liabilities: ‡ Notes Payable - Promissory notes to creditors. ‡ Accounts Payable - What you owe others on account. ‡ Unearned Revenue - You've been paid, but haven't delivered. ‡ Salaries Payable - Salaries you owe employees. ‡ Interest Payable - Interest you owe. ‡ Taxes Payable - Taxes you owe. Long-Term Liabilities: Liabilities that are carried over a number of years or at least more than one accounting cycle. Examples of long-term liabilities are mortgages payable, bonds payable, and long-term notes. LLC - Limited Liability Company Limited Liability Company LLC Books A Limited Liability Company (LLC) is sort of a cross between a partnership and a corporation. A small business formed as an LLC affords its owners the advantages of limited liability (little or no personal liability like corporate shareholders have) along with pass-through taxation (a tax saving benefit enjoyed by partnerships and sole proprietorships). Forming the LLC

Forming a LLC is a little more complicated than forming a partnership and less complicated than incorporating. There are several steps that will need to be taken to make it all legal. The company must be named, articles of organization need to be filed and fees paid, an LLC operating agreement must be created, and licenses and permits must be obtained where required. The book Nolo's Quick LLC: All You Need to Know About Limited Liability Companies explains forming an LLC in great detail. LLC Taxation Because a corporation is considered an entity separate from its owners, it is required to pay federal taxes. An LLC is different. It's more like a partnership or sole proprietorship in that; the profits and losses and associated tax responsibilities are divided up and passed through to the owners. Again, Nolo's Quick LLC is recommended. Other Things to Note LLC owners are also known as members. Single member LLCs are allowed in most states and there is no maximum number or type of members allowed. An attorney is not required - you can prepare the documents and complete the requirements yourself. Though not required by most States, an Operating Agreement is highly recommended. Prepaid and Accrued Revenue and Expenses Often in the day-to-day operation of a business, there are instances where revenue is earned but payment is not immediately received. Other times, payment is received up-front for services to be provided in the future. Expenses, too, can be incurred and then later be paid for -- or they can be paid for in advance of receiving good or services. These events require special handling in accounting so revenues and expenses are properly matched for a given period. Prepayments Prepaid expenses and unearned revenues are prepayments - money has exchanged hands but the expense or revenue is not recorded yet because the expense has not been incurred or the revenue has not been earned. Examples:
y

Prepaid Expense - A 6-month insurance policy costing $1,200 paid for up-front. Because something of value is due the company, the expense prepayment is recorded as an asset (debit Prepaid Insurance and credit Cash). Unearned Revenue - A 6-month cleaning service fee of $600 received in advance. Because the company owes something, the unearned revenue is recorded as a liability (debit Cash and credit Unearned Revenue).

y

Accruals Accruals occur when an accounting event happens but no money has yet exchanged hands. Accrued expenses are expenses that have been incurred but are not yet paid for. Accrued revenue is a revenue that has been earned but cash has not been received yet.

Examples:
y

Accrued Expense - Assume that an employee is paid a monthly salary on the 5th of each month for the previous month's work; the February 5th payment is for work the employee performed in January. To accurately account for this expense, the salary expense should be accrued at the end of January (debit Salary Expense and credit Salary Payable). When the pay check is cut on February 5th, Salary Payable is debited and cash is credited. Accrued Revenue - When services are completed and revenue has been earned during a period but payment for these services has not been received by the end of the period, the revenue should be accrued. For example, if a cleaning service begins working in the middle of January and bills the client $600 after a month of cleaning (in the middle of February), revenue of $300 has been earned at the end of January and should be accrued (debit Accounts Receivable and credit Revenue).

y

Accruals and prepaid accounts are kept current by making adjusting entries, generally at the end of the month or year. Sole Proprietorship Self-Employed Books A Sole Proprietorship is the easiest and least expensive way to form a business. All you basically have to do is get a local business license, a state sales tax permit, and go to work. States differ slightly on requirements for licensing and permits, but there are no special sole-proprietorship forms or anything you need to fill out for the IRS to get the business underway. Resource: Sole Proprietorship: Small Business Start-Up Kit provides everything necessary to set up a small business sole proprietorship in all fifty states. Amazon.com You & the Business are One A business set up and operated as a sole proprietorship does not exist apart from its owner. Though you are wise to keep separate records for the business, the bottom line profit or loss is yours and is reported to the IRS on your individual tax return. The business does not file a separate return (it is not its own entity). Records to Keep Accounting and recordkeeping for a sole proprietorship is just like that of any business structure, just a little less complicated. A separate bank account for the business is a good idea and you should, at minimum, keep track of your business related receipts and disbursements, maintain payroll records (if you have employees), and keep a list of business assets. The IRS doesn't care what system you use to account for income and expenses, just that you do it and that the records are available to them for auditing. You can use a paper-and-pencil method or choose to use accounting software which is widely available, easy to learn, and often times more accurate than a manual system. Resource: Tax Savvy for Small Business: Year-Round Tax Strategies to Save You Money covers recordkeeping with tax savings in mind. Amazon.com Other Things to Note

You will be responsible for paying self-employment taxes and you may be required to make Estimated Tax payments. Trial Balance The Trial Balance, which can be taken at any point in time, lists all ledger accounts and their balances and is used to prove the equality of debits and credits. Assets are listed first followed by liabilities and then owner's equity. Debit balances are listed in the left column and credit balances in the right column. The trial balance proves that the accounts balance, but it does ensure that all transactions were entered or entered into the proper accounts. Below is an example of a Trial Balance. Your Business Name Trial Balance June 31, 20XX Debit Cash Accounts Receivable Supplies Prepaid Rent Equipment Accounts Payable Owner, Capital Owner, Drawing Sales Salary Expense Misc. Expense 700.00 300.00 $15,000.00 $15,000.00 1,000.00 3,000.00 $800.00 400.00 600.00 1,200.00 10,000.00 $3,000.00 9,000.00 Credit

A trial balance is an internal document used only by company employees; it is not meant to be available to persons outside the company. Posting: Periodically, usually at the end of the day journal entries are posted to the effected accounts. The examples below show how to post 2 transactions from the general ledger - a owner deposit, and the purchase of office supplies and furniture with cash. General Journal Page: 1

Date 20XX 5 Jan 6

Account Titles/Explanation Cash You the Owner, Capital Owner Investment Office Supplies Office Furniture Cash Bought office supplies & Furniture with cash.

Ref 11 31 14 18 11

Debit 800.00

Credit 800.00

15.00 300.00 315.00

Account 11 - Cash Date Item Jan 5 6

Ref GJ1 GJ1

Debit 800.00

Credit 315.00

Balance 800.00 485.00

Account 31 - You the Owner, Capital Date Item Ref Jan 5 Account 14 - Office Supplies Date Item Jan 6 . Account 18 - Office Furniture Date Item Jan 6 .. Statement of Owner's Equity Ref GJ1 GJ1

Debit

Credit 800.00

Balance 800.00

Ref GJ1

Debit 15.00

Credit

Balance 15.00

Debit 300.00

Credit

Balance 300.00

The Statement of Owner's Equity shows the change in owner's equity during a given time period. It lists the owner equity balance at the beginning of the period, additions and subtractions to the balance, and the ending balance. Additions come from owner investments and income; subtractions from owner withdrawals and losses.

Your Company Name Statement of Owner's Equity For Month Ended June 30, 20XX Joe Smith, capital, June 1, 20XX Investment during the month Net income $10,000.00 1,000.00 3,000.00

14,000.00 Withdrawals during the month Joe Smith, capital, June 30, 20XX 2,000.00 $12,000.00

The net income figure contained on this statement comes from the Income Statement and the ending capital balance is used in the owner's equity section of the Balance Sheet. Owner Equity Accounts: There are several types of transactions that effect owner equity including: investments, withdrawals of cash by the owner, revenue earned, and expenses incurred. The accounts that collect data from these transactions are: Capital Account - The companies net worth. Initial and subsequent Investments are recorded here as well as changes in the equity of the owners; such as net income or loss. Capital stock represents the investment of stockholders for corporations, and retained earnings represents the net income/loss. Drawing Account - Also known as the Personal Account, this account is used to record withdrawals from the company by the owner or owners. Revenue Accounts - The gross increases to owner's equity. Sources include sales of merchandise or services, rental properties, lending money, commissions, and other income generating ventures. Expense Accounts - The costs incurred during the day to day operation of the business are expenses. Examples include, Salary Expense, Supplies Expense, Utilities Expense, and Rent Expense..

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