Chapter 2 Basics of Record Keeping

1. Chapter 2Basics of Record Keeping Accounting and Finance for Entrepreneurs FINANCE 292 Dr. Echevarria

2. Basics of Record Keeping • Introduction • Keeping good business records are a must for every business • Accurate financial records help to monitor the progress of the business especially profitability • Accurate financial records also help in preparing accurate tax returns • IRS audits will require receipts, cancelled checks, and paid invoices Dr. Echevarria

3. Basics of Record Keeping • Bookkeeping • Bookkeeping describes how transactions are recorded in the books. • The books of the business reflect its economic structure • Transactions must be recorded in a complete, accurate, and timely manner. • Good bookkeeping practices also help to incorporate internal controls assuring the quality of the information contained. Dr. Echevarria

4. Basics of Record Keeping • Accounting • How the various transactions affecting the business are organized • Every transaction has an economic impact on the business • Internal controls, built into the system, help to deter fraud or other dishonest behavior • Just about all accounting systems are computerized using specialized software Dr. Echevarria

5. Basics of Record Keeping • General Journals and Ledgers • The basic document is the General Journal. The GJ is used to record all transactions The GJ is very similar to a check book register • Entries in the GJ are then distributed among the various specialized ledgers (accounts); • Sales Revenue • Cost of Goods Sold • Wages and Salaries • Accounts Receivable Dr. Echevarria

6. Basics of Record Keeping • General Journals and Ledgers • The ledgers are organized in accordance with the Chart of Accounts; each account has a number – typically 3 digits. • There are 5 major categories • Assets (100 – 299) • Liabilities (300 – 499) • Owner’s Equity (500 – 599) • Revenues (600-699) • Expenses (700-799) Dr. Echevarria

7. Basics of Record Keeping • General Journals and Ledgers • Let’s Take a look at a possible breakdown of the Current Asset Account Ledgers (100-199) • Cash (Acct # 100) • Accounts Receivable (Acct #110) • Inventory (Acct #120) • Prepaid Expenses (Account #130) Note: we leave some gaps so that we can create sub-categories as needs arise. For example – we may have more than one bank account. Dr. Echevarria

8. Basics of Record Keeping • Single Entry Accounting System • The simplest of all the bookkeeping methods • The single entry system is very similar to a checkbook register: each transaction is entered once. • The entries are then separated into revenues and expenses. The difference, Rev. – Exp. = Profit. • If your business does not carry inventories, you can use a single entry system. • If your business carries inventories, the IRS requires that you use double entry accounting. • The major drawback of a single entry system is that it works best in a cash only business. Dr. Echevarria

9. Basics of Record Keeping • Double Entry Accounting • Each transaction requires two entries; a Debit and a Credit • At the end of the accounting period (a month, a quarter or a year), the sum of all the debit entries must equal the sum of all the credit entries. • The double-entry system is self-balancing and is best suited for accrual basis accounting. Dr. Echevarria

10. Basics of Record Keeping • Double Entry Accounting • Each major category of the Balance Sheet accounts carries a distinct balance in terms of Debits or Credits • Asset accounts have DEBIT balances • Liability accounts have CREDIT balances • Owner’s Equity accounts have Credit balances. The Most important identity in Accounting is: ASSETS = LIABILITIES + OWNERS EQUITY DEBITS = CREDITS Dr. Echevarria

11. Basics of Record Keeping • Double Entry Accounting • Each category of the Income Statement accounts carries a distinct balance in terms of Debits or Credits • Revenues have CREDIT balances • Expenses have DEBIT balances Profits = Credits – Debits When we pay a bill – we credit cash, and debit an expense account. When we are paid cash; we debit the cash account, and credit the sales revenue account. See Exhibit 2.4 Dr. Echevarria

12. Basics of Record Keeping • Cash Basis vs Accrual Basis of Accounting • A cash-based business does not carry receivables or inventory. Very few businesses fit this operating style. • An accrual-based system is required by the IRS when the business carries inventories, unpaid bills, or uncollected receivables from one fiscal or calendar year to the next. Dr. Echevarria

13. Basics of Record Keeping • The Structure of Financial Accounts • There are two important financial statements • The Balance Sheet • The Income Statement • The Balance Sheet shows what the business owns (assets) and what it owes (liabilities). The difference between what it owns and what it owes is termed owners’ equity. A = L + OE See Exhibit 2.10 Dr. Echevarria

14. Exhibit 2.10Coastal Marine Supplies Dr. Echevarria

15. Basics of Record Keeping • The Structure of Financial Accounts • The Income Statement shows the total revenues of the business, the expenses incurred by the business related to those revenues and the net result = profit (loss) Revenues – Expenses = Profits (Loss) See Exhibit 2.11 Dr. Echevarria

16. Exhibit 2.11Coastal Marine Supplies Dr. Echevarria

17. Basics of Record Keeping • Statement of Owner’s Equity • The owners of the business uses a “draw” from the net revenues of the business to compensate them for their work • The draw may equal the total revenues or be less or more depending on the owner’s needs and expectations about future business. • Any amounts drawn that are less than the profits are assumed to be reinvested in the business. See Exhibit 2.12 Dr. Echevarria

18. Exhibit 2.12Owner’s Equity Dr. Echevarria

19. Basics of Record Keeping • Recording Business Transactions • Capitalizing a new business: Owner invests $50,000 Dr. Echevarria

20. Basics of Record Keeping • Recording Business Transactions • Paying Rent $600 (first month) Dr. Echevarria

21. Basics of Record Keeping • Recording Business Transactions • Buying Store Furnishings: $12,400 Dr. Echevarria

22. Basics of Record Keeping • Recording Business Transactions 4. Buying Inventory: $3500 in cash, $15,000 on 30 day invoice Dr. Echevarria

23. Basics of Record Keeping • Recording Business Transactions 5. Sale of Inventory $15,000 [@50%] markup for cash Dr. Echevarria

24. Basics of Record Keeping • Recording Business Transactions 6. Pay wages ($1536) to employees and $129 in payroll taxes Dr. Echevarria

25. Basics of Record Keeping • Recording Business Transactions 7. 1st Month Trial Balance Dr. Echevarria

26. Income Statement for Month Ending June 30, 1998 Dr. Echevarria

27. Balance Sheet for Month Ending June 30, 1998 Dr. Echevarria

28. Statement of Owner’s Equity Dr. Echevarria

29. Effect of Owner’s Draw • Owner Draws $2,000 from business. • Note: Owner must claim the $2,000 as income and pay the necessary taxes. Dr. Echevarria