Bean Counting 3101
This is a work in progress, I cannot guarantee that I will add to it on a regular basis but I will as I have time. I just found out that new entries are the first post and I have no choice with this blog, so when I do add something I am going to just add to the bottom of the current post, otherwise it will get out of order and make less sense than I usually do.
Note: When I wrote this I was not using tags, and in it I refer to the categories for specific topics, you might check the tags first since I have tagged most entries to make it easier to find things. Tags act as kind of an index.
Warning - to those accounting experts and wannabe experts, this is not meant to be an all inclusive tutorial. Hell it isn’t even going to follow acceptable anything - I tend to explain things the way it makes sense to me, and hopefully to others who are not professional bean counters but just want a basic understanding. So you professionals who accidentally read this, if there is some concept where I am just wrong - please let me know, if you are concerned about terminology, well …. let me know too, but I probably won’t change anything. That said ….
Ok so already I get an email asking how they will know I added to it - I’ll post an updated date right here
updated > 5/5/08
(click one to go to that subject area)
Business Thinking
Accounts & Accounting Standards
Buying
Depreciation
Depreciation Part 2
Purchase Orders
Getting ready to sell
Selling & Bad Debts
The very first thing you have to do, is to stop thinking in the first person. Stop thinking I do this and I do that, it makes things harder to understand, you have to think “the business does this or the business does that.” The business stands alone, you are not the business even if you are a sole proprietor.
Assets are what the business owns. They can be items in inventory, furniture, cash, accounts receivable, and other
things. An account receivable is a debt that is owed to you, it has value, you own it and you can sell it. Basically the
easiest way to decide if something is an asset or not is to ask the question, “Can you sell it?”, if the answer is yes then it is an asset.
Liabilities are what the business owes other people or other businesses. And guess what? You are an other person as far as the business is concerned.
Equity is also a business liability, the business owes you the owner some portion of what it owns. Because Equity is special in that it shows what the owner deserves, it is seperate from and not called a liability - but make no mistake, to the business that is what it is - a liability.
If you think of it this way, it makes the Debit Credit stuff easier to understand. Assets are things that add value, and a Debit is considered a plus, or an increase in the accounting world. A Credit then must be a minus - something that the business owes. So to follow that logic the normal amount in an asset account should be a plus (Debit) and the normal amount in a liability account should be a minus (Credit).
So logically if you add up all the debits and all the credits they should equal each other - that is what a balance sheet displays. While a balance sheet is typically set for a given period, the current year as an example, you have to understand that what it is really showing is the whole business history. And at this point the bean counters out there are taking exception to that statement. I feel this way simply because the balance sheet includes the asset carry forwards from the previous years, as well as the liabilities that were carried forward.
At this point someone always pops up and says, “Huh?” on my bank statement a deposit is a credit. Think of it from the banks point of view, you put money in there and they owe it to you - that makes it a credit, a business debt. Now you see why thinking of the business doing something makes things easier to understand?
Accounts & Accounting Standards
So we all know and love lawyers - right? Yea well, lawyers have screwed up the legal system simply because, at least in my view, they want to get around the standard set by the law. All I can figure is that accountants are wannabe lawyers because they have established more than one standard about how to track your money.
And then the IRS, who we all know so well, seems to have hired people who are both a lawyer and an accountant to write the IRS regs. That is the only reason I can figure as to why they are so screwy and do not always comply with any of the so called accounting standards.
If you are going public with your company, or you need to hit the bank loan officer for a large business loan, they like accounting standards; but, since I have no plans on doing that I follow the IRS way of thinking - after all who is going to audit you?
When I went to set up my accounts in QB I hit ebay and bought a year old version of TurboTax for Business (TT) for next to nothing. If you tell TT what form you will be using to report company taxes and then go through their interview, and poke around a little, you can see what accounts they use for tax filing. A little curiosity with the help file for each of their categories and things start to make sense. So that is what I do, I set up my accounts according to how they will be reported to the IRS, the line item name on the form I file in other words.
When a line item name can contain various kinds of expenses that I want to track individually, I create sub-accounts under that line item account. That way when I go to roll up the numbers for TT, the total in that line item is what it wants, yet I still have the level of detail I want by looking at the sub-accounts.
In the Miscellaneous Category in this blog I also talk about the section 179 deduction and how I set up the accounts for that, rather than repeat it you can just go read it.
One thing to be aware of is that QB does not adhere to the IRS regs in at least one area, inventory. The IRS allows a perpetual inventory, which is basically what QB does when it averages cost, but the IRS requires that the cost be averaged only for the fiscal year. QB does it for the life of the file. Not to worry though, this will never in my opinion cause an audit. Average cost is always less than actual cost, therefore you record more profit, which of course means more taxes paid - the IRS likes that.
So it makes sense that you look at inventory costs as your business goes from year to year, if your costs are drastically increasing and the average is not keeping pace, you might consider stocking the item under a new name to get the new cost on the books. Sell off the old item and then make it in-active. Or you might consider going to another program that handles FIFO, LIFO or specific cost, all of QB’s competitors do one or more of them.
I see no reason to use account numbers at all. As I understand them they are a hold over from the days of paper when each account had a paper ledger book, and the number system made putting them in order on the book shelves easier.
The business really only buys one of two kinds of things. And here you thought you were buying a whole bunch of stuff huh? You are either buying things to sell (or make to sell) or you are buying things that keep your business running.
Surprisingly enough, the things you buy to keep the business running are called operating expenses, normally these are things you use up and have to buy again. They include all the mundane things like utilities, insurance, paper clips, advertising, et al.
The other kind of thing you buy is also an asset but the accounting world treats it kind of special, inventory.
When you buy something you lower cash on hand and increase the expense (the amount of money you spent for that thing). So that is a credit to cash and a debit to the expense. Even if you charge the purchase on a credit card or some other line of credit, basically you are doing the same thing, since the credit card is a liability and it carries a credit balance showing what you owe. When you charge an item you are crediting the charge card and debiting the expense.
That is pretty straight forward.
When you buy inventory a couple of other things happen. Inventory Asset (the account that holds the total cost of all inventory) is debited (increased cause you have something on hand) and cash or credit is credited (cause you either spent money or owe money). In addition QB works behind the scenes to figure out and track how many of that item is on hand in the inventory asset account and what the average cost of the item is. QB does this for all inventory items - QB does NOT do this for any other kind of item, no cost data is kept for any item except inventory. (Well except fixed assets which I get to later.)
But, there is always a but huh, suppose you buy office supplies in bulk, what then? Well you are supposed to create an asset account for office supplies and post the purchase in that account (debit office supplies and credit cash or card). You use an asset account for this because you have the things on hand and are not using them. Then when you use some of the bulk office supplies, that you have in the asset account, you are supposed to do a journal entry to expense what you used (credit office supplies asset account and debit office supplies expense). The easiest way to track this kind of thing is to do an inventory of the office supplies that are on hand, and then do the journal entry for what is not there. The problem is figuring out the cost of the items used since QB does not keep cost data on anything but inventory. So to be technically correct you would have to go back and see what each box of paper clips cost on the purchase order, then compute what the boxes used cost so you can do the journal entry. Or you could just “guesstimate” the cost.
But you also buy things necessary to run the business that are not used up, and those things are either expensed in the year they are bought (See the Section 179 Deduction in the Miscellaneous category) or their value is held for many years in an asset account - those items are called equipment (office or shop or whatever). Anything the business owns is an asset. That purchase increases the equipment asset account and lowers cash or credit just like any other purchase. The difference here is that the asset is permanent, the amount you spent becomes part of the equity the owner has in the business.
But logic would tell you if something has a life expectancy, then obviously at some point it is useless, it dies. So since it has a life expectancy, it would seem reasonable to say it worth less each year as it ages. That is what depreciation does. Depreciation is a paper expense (you really do not spend any money). Accountants figured that if something has a life they would write off the annual cost of the item, then the IRS jumped in and said “Yea, BUT…” not everything lasts the same amount of time, so they created a depreciation mess. If the item can be expected to last longer than one year you can depreciate it, well except for some things. You have to get IRS publication 946 and find what items qualify and the depreciation tables, then figure out what table applies to your piece of equipment, and each year, at year end, you enter the approved amount of depreciation expense as a debit and credit the asset account (Well the Accumulated Depreciation asset account[see part 2].)
Now you would think that QB, as long as it has been around, would make this easy. I mean how hard can it be to include a table look up function and a button that identifies an asset as eligible for depreciation on the item screen, and then at year end enter the correct amount automatically? One reason QB can’t do this is because it does not hold the cost of the item purchased! Stupid!
Well let me back up a little, IF, (key word here is if) if you enter the item that has a long life as a fixed asset in the fixed asset list QB does keep the cost data. And for big ticket items like a 20K machine that makes sense, but a lot of lower cost items are also eligible for depreciation, and entering them as fixed assets make less sense to me - your choice. But even if you enter the fixed asset QB has no one click solution to depreciation.
So if you are in a situation where you have to deal with depreciation, you have to keep the depreciation table handy outside of QB and when you make your adjusting entries remember to credit the equipment asset Accumulated Depreciation account and debit the depreciation expense account. Make sure you enter in the memo block of the depreciation expense what particular item of equipment is being depreciated - if you ever get audited you will have to figure out a way to extract this information since QB does not keep cost!
Depreciation Part 2
Now all this paper expense sounds pretty good huh? So let’s see what do we need to do? Well if we are going to add an expense that is a debit, so something has to be credited. You could I suppose credit the fixed asset, but that is considered bad form for some reason even though it makes perfect sense to me. Of course in QB if you are depreciating something that is not a fixed asset and is part of the total in the equipment asset account that wouldn’t work anyway.
What you need to do is create an asset account called “Accumulated Depreciation”. And of course here we go with exceptions to policy, asset accounts are normally debits, this one is normally a credit because it lowers the value of an asset (I think but I am not sure that this kind of account is called a contra account - because it is opposite to what is normal in terms of the normal balance it holds). You could create Accumulated Depreciation sub accounts for each item you are depreciating if you wish, the level of detail is up to you.
And then you create the “Depreciation” expense account.
Once again QB does not make it easy. The depreciation expense has to be accumulated for each item that is being depreciated. If you don’t, how will you know when you have expensed it off the books? As part of your adjusting entries at the end of the year you do a journal entry and Debit “Depreciation” (Expense account), and Credit “Accumulated Depreciation” (Asset account).
At some point the asset is expensed off the books, the sum of Accumulated Depreciation and the cost is equal. That doesn’t mean you drop the two accounts from your business, if the item is still in use you should keep both accounts on the balance sheet. If and when you dispose of the item, then you make a journal entry that zeros out the amounts in the two accounts and the item goes away (the asset gets credited for the amount in the accumulated depreciation, and the accumulated depreciation gets debited for the same amount).
And if you sell or trade in a partially or fully depreciated asset, it gets even more fun with the journal entries - and I refuse to try to give examples of how to do it here.
Purchase Orders
Typically I think of a purchase order as something you actually send to a vendor. My business revolves around my receiving a paper purchase order, that could be why. But QB likes you to fill in a purchase order (even if you do not send it out) when you order inventory if nothing else. Well ok you can get around it by entering the bill when it comes in, but by filling out a purchase order you can see what you have on order, and the date it was ordered.
So any way from the on-line order screen I fill in the purchase order, then save and close.
What I also do, since I need to incorporate my paperless concept (I go into more detail on how I do paperless in the Misc category) with purchase orders and the bill too - is a little hard to follow I think. I order most everything on line, so when I get to the check out, before I click the submit or approve purchase button I print the screen to a pdf and instead of putting it in a sub-folder I put in in the top level folder for the paperless pdfs with the PO number as part of the name.
When the item comes in, I use the receive item with bill and when it asks me if I want to use the PO for that vendor I say yes and select it. With the PO on the screen here is where it gets dicey. If I have ordered supplies there is no problem I just compare the total and make sure it is right and click save.
But if the items ordered are inventory I need to make some adjustments to the Purchase Order. Shipping and any other costs that you pay to acquire an item for sale is part of the cost. Typically there is a shipping charge on the bill. I take this shipping charge and pro-rate it across all the inventory items, a best guess kind of thing. Instead of sitting there with a calculator and doing a bunch of math, click in the total block for that line item and add the amout of shipping to the total that is there. When I leave the total box, QB recalculates the cost per item and puts it in the rate column. As long as the final total is equal I am good to go.
Save it.
Now I have to pay for it, I try to do everything on credit card, it just makes it easier to me, so select pay bills and then the accounts payable if it is not already selected and then the bill to be paid. Down toward the lower left of the screen are two drop down arrows. For some reason they are backwards. The right one selects whether you are using a check or credit card, and the left one selects which account. Once I select the correct credit card and click save, the items are paid for. Then I move the PO from the top level paperless folder to the receipt folder.
QB really likes this sequence, the times I have short cutted the sequence I have ended up with problems that took more time to unravel than it would have taken to follow the sequence. Purchase order, receive items with bill, pay bills - pretty easy once you get the hang of it.
Ok great all that is being done, but do you know what is happening behind the scenes? Do you need to know? Probably not if all goes well, but if there is a problem you do.
When you tell QB that you bought something, QB does the journal entries that keep the books.
When you buy you incur a debt so that is the credit side of the entry - pretty easy. QB credits accounts payable. In QB all purchases are sent to accounts payable first, then when you pay the bill, you determine whether you pay with a check (cash) or a credit card. When you make that determination using the pay bills icon, QB debits accounts payable and credits the payment method (cash or credit card).
Since you bought something you added value somewhere, that is the debit side of the entry. Your value added could be inventory, supplies, equipment, something.
Getting ready to sell
So you have all the stuff on the books that make up the business, all the assets are entered (including bank accounts) and the liabilities (credit cards, business loans, etc), and you are ready to open your doors and start on your way to the first million.
Before you do, pull up a balance sheet and take a good look at it. The total of assets should equal the total of liabilities + equity. If it does not, this is the time to stop and find the problem. In QB when you move the cursor over a line, if it changes to a magnifying glass you can double click and get a detail report on what transactions are feeding that number. If the balance sheet is not in balance you have to find the problem now or things will get really wonky later.
If and when the balance sheet is correct then pull up a profit and loss statement. Profit should be zero or negative. It will be negative if you bought items that you considered expendables and entered them as an expense rather than an asset (like desks and things). If it is not zero or negative there is a problem, because at this point in time you have not sold anything so how could there be income - find the problem and fix it.
Customers have names - duh! But in QB your name list is limited to 14500 and while that sounds like a lot, it really isn’t. Names are anything, items, customers, vendors, employees, and other names (the owners and independant contractors as an example). So when ever possible use a generic name like gas, food, lodging, printing, usps, rather than the individual name of the place of business where you bought gas or whatever. In the memo line of the transaction you can enter the name of the place if you think you need it. I use lodging for all motel stays (we stay in motels a lot when visiting schools that are our clients) and in the memo line I enter the name and city (BestWestern-Abilene as an example).
In QB sales can be done in one of two ways. You sell something and you receive cash right away, across the counter in other words, a cash register kind of situation - when you do that use a sales receipt and a generic name like “Cash Sales.” Sales receipts post right away because you have the money right away. When you sell on time use an invoice. An invoice sends the amount of the sale to accounts receivable, the balance in that account shows what you are owed. Do not use a generic name for invoice sales, it makes it really hard to apply a payment to the correct invoice - especially if you have invoices that have the same amounts to several customers.
In QB you have the option to use or not to use an account called “Undeposited Funds” in company preferences, there are arguments on both sides of using this account, my view is - use it. All money received is sent to this account, sales receipts and invoice payments. It is a holding account so to speak. Basically if you think of it as a drawer where you are holding checks and cash until you manage to go to the bank, it will be easier to understand. When you manage to get to the bank to make deposits then use the icon make deposits, select the account and mark which ones you deposited.
I also use it to check my math on the deposit slip. I add up the deposits, and then bring up make deposits and check the items that I am going to deposit, if the computer total agrees with my finger and toe counting, I click clear and cancel and go to the bank. When I get back I do the deposit in QB for real.
If you have a cash register this comes in handy, move some of the receipts to the cash register account, and the rest to the bank using the deposit function. To QB any bank account, is just that a bank account and your cash register can be set up as that kind of account.
QB is funny on invoices, the total does not mean total due the business, it means total billed. Huh? If you receive a partial payment on an invoice, QB records it and keeps the correct balance due, but , key word here is but, it does NOT show that payment on the invoice itself. There is an entry in Sales & Customers category in this blog that tells you how to fix that.
Selling & Bad Debts
Selling is pretty cut and dried. You set a price, advertise, and the millions of people with money to spend beat feet to your doorway.
I don’t have a need for Point of Sale so I have no experience with it, similarly I don’t use Payroll either.
If you have all the items set up the right way in QB, selling is a no brainer. You select the item(s) to sell on the invoice/sales receipt and QB does the rest. The sale will go to the income account (and either cash or accounts receivable) and cost of items sold will go to the COGS account and be deducted from the inventory asset account.
Inevitably, this not being a perfect world, you will come across a dead beat who does not pay his debts. When that happens you will need to create an expense account called something like “Bad debt expense” and set up an “Other Charge” item called Bad-debt which points to the bad debt expense account. If you normally sell and collect sales tax make the Other Charge item taxable.
Bring up the customer center and use the drop down arrow by the button that says New Transactions and select Create Credit memos/refunds, that opens a window. Fill in all the fields, under item use the Bad-debt item. Remember that if the customer pays sales tax, you need to enter the amount less sales tax, then QB will calculate the sales tax on the amount.
Then save and close the credit memo, when you do that QB will ask you what you want to do - select apply to an invoice, then select the invoice it applies to. When you do the invoice will be marked closed, the amount will be removed from accounts receivable, the sales tax amount will be removed from the sales tax payable account, and the bad-debt expense account will show an increase.
Since you did not get whatever you sold back, there is no entry made to inventory or cost of goods sold.
