AccountsQ&a 2010

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Q&A from 2010

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Accounting Term Questions from 2010 (Click a question below) Pg. #

A/C What is a/c? 15

Accrual What is the difference between an accrual and a deferral? 9

Accruals Where are accruals reflected on the balance sheet? 19

Aging of Accounts Receivable

How does the aging of accounts receivable determine bad debts expense?

32

Allowance For Doubtful Accounts

What to do with the balance in Allowance for Doubtful Accounts? 28

Asset What is a toxic asset? 26

Asset Is the deposit for a booth at a future trade show an asset? 28

Asset, Sale of If we dispose of an asset, will there be a change in the owner’s equity?

27

Assets What is the difference between fixed assets and noncurrent assets?

22

Balance Sheet Why doesn’t the balance sheet equal the post-closing trial balance?

15

Balance Sheet What does a balance sheet tell us? 28

Balance Sheet Nonprofit vs. For-Profit

What is the difference between a balance sheet of a nonprofit organization and a for-profit business?

35

Balance Sheet, Comparative

What is a comparative balance sheet? 31

Bank Reconcilement How do you balance a checkbook? 8

Benchmarking What is benchmarking? 10

Bonds Why do bonds rarely sell for their maturity value? 31

Bonds Payable Are bonds payable reported as a current liability if they mature in six months?

7

Byproducts What are byproducts? 14

Careers Is it a requirement for a small business to have a CPA? 22

Cash What is cash from operating activities? 19

Cash What is included in cash and cash equivalents? 25

Cash Basis of Accounting

What is the difference between the cash basis and the accrual basis of accounting?

9

Cash Flow Statement Where is interest on a note payable reported on the cash flow statement?

22

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Cash Flow Statement What is the purpose of the cash flow statement? 24

Chart of Accounts Why would a business change its chart of accounts? 13

Commitment and Contingencies

Why does commitment and contingencies appear on the balance sheet without an amount?

12

Compilation What is a compilation? 11

Consistency Principle What is the consistency principle? 16

Contra Asset Account What is a contra asset account? 18

Contra Liability Account What is a contra liability account? 18

Controller’s Cushion What is a controller’s cushion? 12

Conversion Costs What are conversion costs? 16

Correlation vs. Cause and Effect

What is the difference between correlation and cause and effect? 31

Cost Can a cost be both a direct cost and an indirect cost? 6

Cost What is the difference between an implicit cost and an explicit cost?

9

Cost Allocations What is the weakness of traditional cost allocations? 17

Cost Driver What is a cost driver? 33

Cost of Sales What is the cost of sales? 23

Costs What are the methods for separating mixed costs into fixed and variable?

17

Credit What is a credit? 28

Death Spiral What is the death spiral? 13

Debit What is the meaning of debit? 25

Deferred Asset What is a deferred asset? 14

Deferred Expense What is the difference between a deferred expense and a prepaid expense?

11

Depreciation What are the accounting entries for a fully depreciated car? 15

Depreciation What is the entry to remove equipment that is sold before it is fully depreciated?

16

Depreciation Can a fully depreciated asset be revalued? 30

Depreciation Is the depreciation of delivery trucks a period cost or is it manufacturing overhead?

34

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Discount on Asset Purchase

Where is the discount on the purchase of office furniture recorded?

6

Discount, Cash What is a cash discount? 33

Dividend What is a dividend and why is it needed? 6

Drawing Account Is the drawing account a capital account? 32

Elastic Demand What is elastic demand? 12

Equity Financing What is the difference between equity financing and debt financing?

6

ERP What is ERP? 23

Escrow Payment What is an escrow payment? 30

Expense Is there a difference between an expense and an expenditure? 27

Expenses What does it mean to report expenses by function? 11

Federal Payroll Taxes Where can I get official information for federal payroll taxes? 32

Financial Statement What is a financial statement? 15

Fringe Benefit Rate What is a fringe benefit rate? 7

GAAP Is AccountingCoach.com based on GAAP or IFRS? 26

Goods in Transit What are goods in transit? 20

Historical Cost What is the advantage of using historical cost on the balance sheet for property, plant and equipment?

24

Impairment What is an impairment? 11

Income What is accrued income? 24

Income Statement, Comparative

What is a comparative income statement? 32

Income Statement, Condensed

What is a condensed income statement? 11

Information What is the difference between information and data? 16

Interest How do you record the interest that is unpaid on a note payable? 27

Internal Rate of Return Why does the internal rate of return equate to a net present value of zero?

25

Inventory How do you calculate the cost of carrying inventory? 21

Inventory What are the disclosures for a manufacturer’s inventory? 23

Inventory Shrinkage What is inventory shrinkage? 22

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Inventory Valuation What is inventory valuation? 15

M and MM What does M and MM stand for? 13

Mileage Rate for Use of Car for Business

What is IRS mileage rate for use of a car for business? 31

Mortgage Payment If a mortgage payment is due on Jan. 1, should the payment be accrued at Dec. 31?

7

Net Assets What is the meaning of net assets? 13

Net Working Capital What will cause a change in net working capital? 29

Overhead What is the difference between actual overhead and applied overhead?

27

Overhead Costs What are the advantages of departmentalizing manufacturing overhead costs?

30

Overstated What does overstated mean? 32

Owner’s Equity Is it possible for owner’s equity to be a negative amount? 26

Payback Period How do you calculate the payback period? 25

Payroll Accrual Calculation

How do you calculate the payroll accrual? 31

Period Costs How are period costs reported in the financial statements? 20

Petty Cash How is petty cash reported on the financial statements? 7

Petty Cash What is petty cash? 21

Petty Cash What is a petty cash voucher? 22

Post-Closing Trial Balance

What is a post-closing trial balance? 18

Principal Payment Is a loan’s principal payment included on the income statement? 20

Product Warranty, Manufacturing

Is a manufacturer’s product warranty part of its manufacturing overhead or is it part of its SG&A expense?

34

Profit What is the difference between gross profit and net profit? 26

Purchase Price Variance

In standard costing, how is the purchase price variance reclassified to arrive at actual cost?

20

Purchases Why does a company debit Purchases instead of Inventory? 17

Regression In least squares regression, what do y and a represent? 19

Rent What is the difference between Rent Receivable and Rent Payable?

6

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Reorder Point What is the reorder point? 16

Residual Value What is the difference between residual value, salvage value, and scrap value?

8

Revenues At what point are revenues considered to be earned? 30

Revenue Budget What are the benefits of a revenue budget? 8

Reversing Entry Is the reversal of a previous year’s accrued expense permanent? 29

Rolling Budget What is a rolling budget? 10

Selling Price Computation

How do you compute a selling price if you know the cost and the required gross margin?

34

Social Security Tax What is the Social Security tax rate for 2011? 35

Sole Proprietorships Why do people start their businesses as sole proprietorships? 14

Statement of Activities What is the statement of activities? 33

Subchapter S What is Subchapter S? 24

Understated What does understated mean? 35

Unpresented Check What is an unpresented check? 23

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Where is the discount on the purchase of office furniture recorded? The discount received on the purchase of office furniture that will be used by a company is recorded in the same asset account in which the office furniture is recorded. That account might be Furniture and Fixtures or Office Furniture. (The discount is not recorded in Purchase Discounts as this account is only for the discounts on the purchase of merchandise that will be sold.) To illustrate, let’s assume that a company purchases furniture for the office of a newly appointed executive. The cost of the furniture is $10,000 and the invoice allows a discount of 1% if it is paid within 10 days. If the company pays the invoice within 10 days, the Furniture and Fixtures account will increase by $9,900 ($10,000 minus the discount of $100). The depreciation calculations will be based on the cost of $9,900.

What is the difference between equity financing and debt financing? Equity financing often means issuing additional shares of common stock to an investor. With more shares of common stock issued and outstanding, the previous stockholders’ percentage of ownership decreases. Debt financing means borrowing money and not giving up ownership. Debt financing often comes with strict conditions or covenants in addition to having to pay interest and principal at specified dates. Failure to meet the debt requirements will result in severe consequences. In the U.S. the interest on debt is a deductible expense when computing taxable income. This means that the effective interest cost is less than the stated interest if the company is profitable. Adding too much debt will increase the company’s future cost of borrowing money and it adds risk for the company.

Can a cost be both a direct cost and an indirect cost? A cost can be both a direct cost and an indirect cost. One of many examples is the cost of a supervisor in a department within a factory. Let’s assume that Sam earns $50,000 per year as the supervisor of the machining department of a factory. Sam’s $50,000 is a direct cost of the machining department because Sam works only in the machining department. Hence, this $50,000 is directly traceable to the machining department. Sam’s $50,000 is also an indirect product cost. It is an indirect cost because the supervisor of the machining department is part of the factory overhead costs that must be assigned to the products. (Instead of being assigned we could say that manufacturing overhead must be allocated or applied to products by using an overhead rate.) We might also say that Sam’s $50,000 is part of the factory overhead costs that must be absorbed by the products by means of a factory overhead rate.

What is the difference between Rent Receivable and Rent Payable? The asset account Rent Receivable is used by the landlord to report the amount of rent that has been earned by the landlord but has not been received from the tenant as of the balance sheet date. The liability account Rent Payable is used by the tenant to report the amount of rent that the tenant owes for rent but has not been paid as of the balance sheet date. If the rent is to be paid on the first day of each month, and if the rent is paid on time, the landlord will have a zero balance in Rent Receivable. Similarly, the tenant will have a zero balance in Rent Payable. It is only if the tenant falls behind in making the rent payments that amounts will be entered into the Rent Receivable and Rent Payable accounts.

What is a dividend and why is it needed? A dividend paid by a corporation is a distribution of profits to the owners of the corporation. The owners of a corporation are known as stockholders or shareholders. (In a sole proprietorship, the distribution of profits to the owner is referred to as a draw.)

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A corporation’s board of directors, which is elected by the stockholders, decides if a cash dividend is needed. The considerations for paying or not paying a dividend include the stockholders’ wishes, the stock market’s reaction, and the corporation’s needs and opportunities for cash in the present and in the future.

If a mortgage payment is due on January 1, should the payment be accrued at December 31? If the interest portion of the January 1 loan payment is for the month of December, then the interest portion should be accrued as of December 31. To illustrate, let’s assume that the amount of the mortgage loan payment due on January 1 is $1,000 and it consists of $300 of interest from December 1 through 31, and a principal payment of $700. Since the $300 of interest has occurred during December and since the company has an obligation as of December 31 to the lender for that interest, the company must accrue the interest. This is accomplished with an adjusting entry dated December 31 in which Interest Expense is debited for $300 and Interest Payable is credited for $300. There is no accrual for the principal portion of the loan payment. The principal balance of the loan is not reduced until the actual principal payment occurs.

Are bonds payable reported as a current liability if they mature in six months? Bonds payable that mature (or come due) within one year of the balance sheet date will be reported as a current liability if the issuer of the bonds must use a current asset or will create a current liability in order to pay the bondholders when the bonds mature. However, the bonds could be reported as a long-term liability right up to the maturity date if: 1. The company has a sufficient, long-term investment that is restricted for the purpose of paying the bondholders when the bonds mature. This type of investment is known as a bond sinking fund. 2. The company has a binding agreement that guarantees that the existing bonds will be refinanced by issuing new bonds or by issuing shares of stock.

How is petty cash reported on the financial statements? The Petty Cash account and its balance could be listed separately as one of the first assets in the current asset section of the balance sheet. This is likely the case at smaller companies. At larger companies, the balance in the Petty Cash account is often combined with the balances in the other cash accounts and the total of the cash accounts will be reported as Cash or as Cash and Cash Equivalents. You will find Cash and Cash Equivalents as the first item in the current asset section of the balance sheet.

What is a fringe benefit rate? A fringe benefit rate is the cost of an employee’s benefits divided by the wages paid to an employee for the hours working on the job. The following is a sample calculation of the fringe benefit rate for a hypothetical, full-time employee with a wage rate of $20 per hour. Let’s begin by assuming that a company operates 5 days per week for 8 hours per day for 52 weeks per year—a total of 2,080 hours per year. Let’s also assume that each year the employee is entitled to 15 days of paid vacation, 8 paid holidays, and 5 paid sick days. This amounts to 28 days of 8 hours each, or 224 hours per year that the employee is paid when not on the job. Therefore, the employee’s wages for working on the job will be 1,856 hours per year (2,080 hours minus 224 hours) times $20 per hour = $37,120 for a year. Next let’s compute the cost of the hypothetical fringe benefits earned by the employee. For the paid vacation, holidays and sick days the annual cost is $4,480 (224 hours not on the job times $20 per hour). Let’s also assume

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that the employer pays the following annual costs for the employee: $7,200 of the employee’s health, life and disability insurance; $2,000 for the employee’s retirement benefits; $1,100 for worker compensation insurance; $210 for unemployment insurance; and $3,182 (2,080 hours X $20 X 7.65%) for the employer’s portion of the Social Security and Medicare taxes. The sum of these costs for employee benefits is $18,172 per year. The hypothetical amounts shown above result in a fringe benefit rate of 49%. This is $18,172 of annual benefits divided by the $37,120 of wages earned while working on the job.

What are the benefits of a revenue budget? The main benefit of a revenue budget is that it requires looking into the future. The revenue budget should contain the assumptions made about the future and the details about the number of units to be sold, the expected selling prices, and so on. The budgeted amount of revenue is then compared to the budgeted amount of expenses in order to determine if the revenues are adequate. Learning of a potential problem before the year begins is a huge benefit because it allows for alternative actions to be developed prior to the start of the new year. When an annual revenue budget is detailed by month, each month’s actual revenues can be compared to the budgeted amount. Similarly, the actual year-to-date revenues can be compared to the budgeted revenues for the same period. In other words, monthly revenue budgets allow you to monitor revenues as the year progresses instead of being surprised at the end of the year. Let’s illustrate the benefits of a church’s revenue budget. A church’s annual revenue budget should be prepared independently of the expense budget. The total of the revenue budget is then compared to the annual expense budget. If the annual revenue budget is less than the annual expense budget, action can be taken to develop additional revenues or to reduce the planned expenses before the accounting year begins. An additional benefit occurs when the annual revenue budget is also detailed by month. Let’s assume that the church’s monthly revenue budgets will vary by the number of days of worship in the month, the time of year, and other factors. As a result, an annual budget of $370,000 might consist of the following sequence of monthly amounts: $26,000 + $28,000 + $35,000 + $30,000 + $30,000 + $32,000 + $27,000 + $28,000 + $30,000 + $28,000 + $30,000 + $46,000. Based on these budgeted or planned monthly revenues, the church is expecting to have revenues of $181,000 for the first six months. If the actual revenues for the first six months are only $173,000 the church officials will see that an $8,000 problem at mid-year needs to be addressed. The shortfall also raises the question of whether there will be a similar shortage in the second half of the year. Thanks to the monthly revenue budget, church officials will be alerted early enough to find a solution. The solution could include a message to members asking for additional contributions, an edict to cut expenses for the remainder of the year, and so on. Preparing a detailed, realistic budget requires you to plan ahead. This in turn gives you insights prior to the start of the accounting year. Monthly revenue budgets allow you to monitor the receipts right from the beginning of the year.

How do you balance a checkbook? You balance a checkbook by comparing the amounts on your bank statement or in your bank account to the amounts you have in your checkbook or check register. Accountants refer to this as reconciling the bank statement or doing a bank reconciliation or bank rec (pronounced as “wreck”).

What is the difference between residual value, salvage value, and scrap value? Residual value, salvage value and scrap value are three terms that refer to the expected value at the end of the useful life of the property, plant and equipment used in a business. This estimated amount is used in the calculation of an asset’s depreciation expense, and often the amount is assumed to be zero. The term residual value can also refer to the estimated value of a leased asset at the end of the lease term.

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What is the difference between an accrual and a deferral? An accrual occurs before a payment or receipt. A deferral occurs after a payment or receipt. There are accruals for expenses and for revenues. There are deferrals for expenses and for revenues. An accrual of an expense refers to the reporting of an expense and the related liability in the period in which they occur, and that period is prior to the period in which the payment is made. An example of an accrual for an expense is the electricity that is used in December, but the payment will not be made until January. An accrual of revenues refers to the reporting of revenues and the related receivables in the period in which they are earned, and that period is prior to the period of the cash receipt. An example of the accrual of revenues is the interest earned in December on an investment in a government bond, but the interest will not be received until January. A deferral of an expense refers to a payment that was made in one period, but will be reported as an expense in a later period. An example is the payment in December for the six-month insurance premium that will be reported as an expense in the months of January through June. A deferral of revenues refers to receipts in one accounting period, but they will be earned in future accounting periods. For example, the insurance company has a cash receipt in December for a six-month insurance premium. However, the insurance company will report this as part of its revenues in January through June.

What is the difference between the cash basis and the accrual basis of accounting? Under the cash basis of accounting… 1. Revenues are reported on the income statement in the period in which the cash is received from customers. 2. Expenses are reported on the income statement when the cash is paid out. Under the accrual basis of accounting… 1. Revenues are reported on the income statement when they are earned—which often occurs before the cash is received from the customers. 2. Expenses are reported on the income statement in the period when they occur or when they expire—which is often in a period different from when the payment is made. The accrual basis of accounting provides a better picture of a company’s profits during an accounting period. The reason is that the income statement prepared under the accrual basis will report all of the revenues actually earned during the period and all of the expenses incurred in order to earn the revenues. The accrual basis of accounting also provides a better picture of a company’s financial position at a moment or point in time. The reason is that all assets that were earned are reported and all liabilities that were incurred will be reported. The accrual basis of accounting is required because of the matching principle.

What is the difference between an implicit cost and an explicit cost? An implicit cost is a cost that has occurred but it is not initially shown or reported as a separate cost. On the other hand, an explicit cost is one that has occurred and is clearly reported as a separate cost. Below are some examples to illustrate the difference between an implicit cost and an explicit cost. Let’s assume that a company gives a promissory note for $10,000 to someone in exchange for a unique used machine for which the fair value is not known. The note will come due in three years and it does not specify any interest. Due to the company’s weak financial position it will have to pay a high interest rate if it were to borrow

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money. In this example, there is no explicit interest cost. However, due to the issuer’s financial difficulty and the seller having to wait three years to collect the money, there has to be some interest cost. In other words, there is some interest and it is implicit. To properly record the note and the machine, the accountant must determine the amount of the interest, which is known as imputing the interest. In effect the accountant must convert the implicit interest to explicit interest. This is done by discounting the $10,000 by using the interest rate that the issuer of the note would have to pay to another lender. If the rate is 12% per year, the interest that was implicit in the note is $2,880 and the principal portion of the note is the remaining $7,120. If another company with the same financial condition purchased this unique machine by issuing a $7,120 note with a stated interest rate of 12% per year, the interest cost of $2,880 would be explicit. In this situation, there is no need to impute the interest. Another example of an implicit cost is the opportunity cost of a sole proprietor working in her own business. For example, Gina works as a sole proprietor and her business reported a net income of $30,000 for the year. Since a sole proprietor does not receive a salary or wages, there is no explicit cost reported for Gina’s work in her business. However, if Gina is foregoing a salary of $40,000 from another company, that is an implicit cost for her business. After considering this implicit cost, Gina is losing $10,000 by working in her proprietorship. If Gina operates her business as a corporation, Gina will be an employee of the corporation. If her annual salary is $40,000 the corporation’s income statement would report the $40,000 salary as an explicit cost for Gina’s work.

What is a rolling budget? A rolling budget is also known as a continuous budget, a perpetual budget, or a rolling horizon budget. We will use the following example to explain the meaning of a rolling budget. Let’s assume that a company’s accounting year ends on each December 31. Prior to the start of the year 2011, the company prepares its annual budget which is detailed by month for January through December 2011. This budget could become a rolling budget if after January 2011 the company drops the budget for January 2011 and adds the budget for January 2012. This rolling budget now covers the one year, or 12-month, period of February 1, 2011 through January 31, 2012. At the end of February 2011, the rolling budget will drop February 2011 and will add February 2012. At this point the rolling budget will cover the one year period of March 1, 2011 through February 29, 2012. The benefit of a rolling budget is that the company’s management will always have a budget that looks forward for one full year. A rolling budget could use 3-month periods or quarters instead of months. Also, a company might have a 5-year rolling budget for capital expenditures. In this case a full year will be added to replace the year that has just ended. This 5-year rolling budget means that management will always have a 5-year planning horizon.

What is benchmarking? Benchmarking is a process for improving some activity within an organization. We will illustrate benchmarking with the following example. Company Q has identified one of its activities that needs improvement. The company conducts a search to find another organization that is considered to have mastered the activity. Perhaps it is Corporation J that is recognized as having the best practice for this activity. Corporation J’s performance is viewed as the benchmark or standard or best practice. Company Q will study Corporation J’s performance and procedures in depth and will identify the differences between the organizations. Company Q will likely modify its procedures in order to bring its performance of the activity up to the level attained by Corporation J.

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What is a condensed income statement? A condensed income statement is one that summarizes much of the income statement detail into a few captions and amounts. For example, a retailer’s condensed income statement will summarize hundreds of categories of sales into one amount with the description Net Sales. Its detailed purchases and changes in inventory will be presented as one amount with the description Cost of Goods Sold. Perhaps thousands of operating expenses will be presented as one amount with the description Selling, General and Administrative, or SG&A. The readers of a condensed income statement will be able to easily and quickly focus on the company’s net income and its key components.

What is a compilation? A compilation refers to financial statements that were prepared or compiled by an organization’s outside accountant. A compilation is often the result of an accounting service known as write-up work. With compilations, or compiled financial statements, the outside accountant converts the data provided by the client into financial statements without providing any assurances or auditing services. A compilation report should accompany the compiled financial statements and it should state that the financial statements 1) are the representation of the management of the organization, and 2) have not been reviewed or audited and that the accountant offers no opinion or assurances on them. Compilations allow companies without an accountant to have financial statements prepared at a lower cost than reviewed or audited financial statements.

What is the difference between a deferred expense and a prepaid expense? Often the term deferred expense indicates that a payment was made more than one year before the cost is expensed. This deferred expense will be reported on the balance sheet as a noncurrent or long-term asset. Often the term prepaid expense indicates that a payment was made less than one year before the cost is expensed. This prepaid expense is reported as a current asset. Sometimes an accountant does not intend for there to be a difference. For example, an accountant might say that part of a company’s six-month insurance premium should be deferred to the current asset account Prepaid Insurance. Accountants also state that any prepayment of a future expense will result in an adjusting entry known as a deferral.

What is an impairment? The term impairment is usually associated with a long-lived asset that has a market which has decreased significantly. For example, a meat packing plant may have recently spent large amounts for capital expenditures and then experienced a dramatic drop in the plant’s value due to business and community conditions. If the undiscounted future cash flows from the asset (including the sale amount) are less than the asset’s carrying amount, an impairment loss must be reported. If the impairment loss must be reported, the amount of the impairment loss is measured by subtracting the asset’s fair value from its carrying value.

What does it mean to report expenses by function? To report expenses by function means to report them according to the activity for which the expenses were incurred.

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For a business, the reporting of expenses by function means the income statement will report expenses according to the following functional classifications: manufacturing, selling, general administrative, and financing. For a not-for-profit organization, the reporting of expenses by function means the statement of activities will report expenses according to the following functional classifications: 1) each of its major programs, and 2) the supporting services which are a) management and general, b) fund-raising, and c) membership development. (Classifying expenses according to salaries, electricity, repairs, etc. is referred to as natural classifications, or classifying expenses by their nature.)

What is a controller’s cushion? A controller’s cushion or controller’s reserve involves temporarily recording too much expense for an item that the controller calculates. For example, the controller might budget $48,000 per year for depreciation and then record $4,000 of actual depreciation expense for each month. However, the controller expects the actual depreciation to be only $44,000 for the year. For the first eleven months, the financial statements will report $44,000 of depreciation expense. Then in the 12th and final month of the year no depreciation expense is recorded. This means that depreciation expense will beat its budget by $4,000 ($44,000 of actual depreciation versus the annual budget of $48,000). This favorable $4,000 is the controller’s cushion. The idea is that this will cushion the effects of some unexpected expenses or losses that come to light at the end of the accounting year. The controller’s reserve or controller’s cushion is related to a concept known as budgetary slack.

What is elastic demand? Elastic demand means that demand for a product is sensitive to price changes. For example, if the selling price of a product is increased, there will be fewer units sold. If the selling price of a product decreases, there will be an increase in the number of units sold. Elastic demand is also referred to as the price elasticity of demand. The term inelastic demand means that the demand for a product is not sensitive to price changes. Elastic demand is a major concern for a manufacturer that attempts to set product prices based on costs. For instance, if the manufacturer’s production and sales have declined and it fails to cut fixed costs, the manufacturer could be worse off by increasing selling prices. Use the search box on AccountingCoach.com for our Q&A on death spiral which is pertinent to elastic demand.

Why does commitment and contingencies appear on the balance sheet without an amount? The term or caption commitment and contingencies appears near the end of a balance sheet without an amount in order to direct a reader’s attention to the disclosures included in the notes to the financial statements. An amount is not shown for a variety of reasons. For example, a chain of retail stores may have signed five-year, noncancellable leases to rent retail space for $1 million per year. This commitment needs to be disclosed to the readers of the balance sheet. However, if none of the $5 million is actually due as of the balance sheet date, there is no liability amount to be recorded in a liability account. Another example of a commitment is an electric utility which has signed a noncancellable contract to purchase 100 million tons of coal during the following 10 years. This commitment also needs to be disclosed to the readers of the balance sheet. However, if none of the coal has been delivered as of the balance sheet date, the utility company will not report a liability since nothing is due as of the balance sheet date.

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There are also some loss contingencies which are not recorded with amounts in the general ledger, but must be disclosed in the notes to the financial statements. You can learn more about these contingencies by using the search box on AccountingCoach.com.

Why would a business change its chart of accounts? There can be several reasons for a business to change its chart of accounts. One reason for changing the chart of accounts is to better match how the business is organized. Perhaps the chart of accounts was established when the business was much smaller (fewer products, fewer customers, fewer managers). Now the company’s more sophisticated operations require more detailed reporting that is segmented by processes and/or by each manager’s area of responsibility. Another reason for changing the chart of accounts is a company’s decision to acquire and install a new computerized system for controlling its operations. The new system’s general ledger might result in a chart of accounts which is different from the previous chart of accounts.

What is the meaning of net assets? Net assets is defined as total assets minus total liabilities. In a sole proprietorship the amount of net assets is reported as owner’s equity. In a corporation the amount of net assets is reported as stockholders’ equity. In a not-for-profit (NFP) organization the amount of total assets minus total liabilities is actually reported as net assets in its statement of financial position. The net asset section for the NFP organization is divided into three classifications:

1. unrestricted net assets

2. temporarily restricted net assets

3. permanently restricted net assets.

The changes in these net asset classifications are reported in the organization’s statement of activities.

What does M and MM stand for? The Roman numeral M is often used to indicate one thousand, and MM is used to indicate one million. For example, an expense of $60,000 might appear as $60M. Sales of $3,000,000 might be written as $3MM. Internet advertisers are familiar with CPM which is the cost per thousand impressions. In recent years some people began using k to represent one thousand. For example, an annual salary of $60,000 might appear as $60k instead of $60M. In a recent business publication I saw million represented by mn and also by m (both lower case). This means it is possible for you to see $1,400,000 expressed as $1.4 million or $1.4mn or $1.4m or $1.4MM or $1,400k or $1,400M.

What is the death spiral? In cost accounting and managerial accounting, the term death spiral refers to the repeated elimination of products resulting from spreading costs on the basis of volume instead of their root causes. The death spiral is also known as the downward demand spiral. To illustrate the death spiral let’s assume that Product X is a simple, high-volume product that requires little manufacturing attention. If the accountant spreads the company’s manufacturing overhead costs based on volume, Product X will appear to have high overhead costs. (In reality, Product X causes very little overhead cost especially when compared to the company’s many complex, low-volume products.) If management responds to Product X’s allocated high overhead costs and 1) seeks a price increase which causes the customer to move the

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production to a competitor with a lower price, 2) outsources the production, or 3) drops the product, then the company’s manufacturing volume will decrease. If the company does not reduce its fixed overhead to correspond to the decreased manufacturing volume and the accountant continues to spread the overhead costs—including the cost of excess capacity—on the basis of volume, the remaining products will have to be assigned more of the overhead costs. If management again reacts to the new, higher, allocated costs by seeking price increases which cause a loss of sales, outsources production, or drops the products, the company’s manufacturing volume will again decrease. If fixed costs are not decreased accordingly and the accountant again spreads the overhead on the basis of a new, even smaller volume, the entire company could die from the high fixed costs and a small volume of products being produced and sold. To avoid the death spiral, some companies attempt to allocate overhead costs based on activities and product complexities rather than simply spreading them on volume. You can learn more about this by reading our Explanation of Activity Based Costing. Also, some companies do not allocate the costs of excess capacity to products in order to minimize the death spiral.

Why do people start their businesses as sole proprietorships? I believe that people start their businesses as a sole proprietorship because a sole proprietorship can be formed easily, quickly, and with little cost. Further, it is likely that the sole proprietor can also register the company as a limited liability company, or LLC. This process is often done online with the proprietor’s state of residence. The fee to originate the LLC status and the annual renewal fee vary from state to state. If you are planning to form a company, you should seek professional advice as to which structure will best serve your needs.

What is a deferred asset? I assume that the term deferred asset refers to a deferred charge or a deferred debit. A deferred charge is reported on the balance sheet in the long-term asset section other assets. An example of a deferred charge is bond issue costs. These costs include all of the fees that a corporation incurs in order to register and issue bonds. The fees are paid near the time that the bonds are issued but they will not be expensed at that time. Rather, the bond issue costs are initially deferred to the long-term asset section of the balance sheet. Then in each year of the life of the bonds, a portion of the bond issue costs will be systematically moved from the balance sheet and will appear as an expense on the income statement. The process of systematically reducing this deferred charge is known as amortizing the bond issue costs.

What are byproducts? Byproducts, or by-products, are products with relatively little value that emerge from a common process along with the main products. The main products have significant value and are referred to as joint products. The point at which the byproducts and joint products emerge from the common process is known as the split-off point. The costs prior to the split-off point are known as the common costs. Since the value of the byproducts is usually insignificant, the accounting for the byproducts can vary. Here are two of several methods of accounting for byproducts: 1. The byproducts could be valued at the split-off point at their net realizable value. This amount reduces the common costs which will be allocated to the joint products at the split-off point. 2. None of the common costs is assigned to the byproducts. As a result the full amount of the common costs are allocated to the joint products at the split-off point. When the byproducts are sold, the amount received is reported as revenues.

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What is a financial statement? We use the term financial statement to mean one of the general-purpose, external financial statements such as the income statement, balance sheet, statement of cash flows, and the statement of stockholders’ equity. These financial statements for a U.S. company must be prepared in accordance with U.S. generally accepted accounting principles—also referred to as US GAAP.

What are the accounting entries for a fully depreciated car? If the car continues to be used after it is fully depreciated, there will be no further depreciation entries. If you sell the car after it is fully depreciated, you 1) debit Cash for the amount received, 2) debit Accumulated Depreciation for the car’s accumulated depreciation, 3) credit the asset account containing the car—such as Vehicles, Automobiles, or Cars, 4) credit the account Gain on Sale of Vehicles for the amount necessary to have the entry’s debit dollars equal to credit dollars. If the earlier depreciation amounts assumed a salvage value of zero, the gain will equal the cash received.

What is inventory valuation? Inventory valuation is the dollar amount associated with the items contained in a company’s inventory. Initially the amount is the cost of those items. However, under certain situations the cost could be replaced with a lower dollar amount. The inventory valuation includes all of the costs to get the inventory items in place and ready for sale. The inventory valuation excludes the costs of selling and administration. Since the inventory items are constantly being sold and restocked and since the costs of the items are constantly changing, a company must select a cost flow assumption. Cost flow assumptions include first-in, first-out; weighted average; and last-in, first out. The company must consistently follow its stated cost flow assumption. A manufacturer’s inventory valuation will include the costs of production, namely direct materials, direct labor, and manufacturing overhead. Manufacturers are also required to consistently follow their cost flow assumptions. Inventory valuation is important in that it affects the cost of goods sold reported on the company’s income statement. Inventory is also an important component of a company’s current assets, working capital, and current ratio.

What is a/c? In accounting, a/c is often used as an abbreviation for the word account. For example, an accountant might write the following message “Review the balance in the Interest Payable a/c.” Find pertinent accounting information by using the search box on AccountingCoach.com.

Why doesn’t the balance sheet equal the post-closing trial balance? The totals on the balance sheet will not equal the totals on the post-closing trial balance due to contra accounts. We will use the contra account Accumulated Depreciation to illustrate why this occurs. The account Accumulated Depreciation will have a credit balance and it will be listed in the credit column of the trial balance. Its credit balance will be included with the other credit balances, most of which are liability accounts and owner or stockholder equity accounts. On the balance sheet, the credit balance in Accumulated Depreciation will not be reported with the other credit balances. Rather, the credit balance in Accumulated Depreciation will be a deduction from the debit balances reported in the asset section entitled property, plant and equipment.

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What is the reorder point? The reorder point is the quantity of units in inventory that will trigger an order to purchase additional units. Let’s assume that a company’s reorder point for its Product X is 80 units. When the inventory of Product X drops to 80 units, the company places an order for additional units of Product X. The reorder point is calculated by 1) estimating the sales in the near future, 2) estimating the number of days between ordering and receiving the additional units, and 3) the number of units of safety stock. The reorder point indicates when to place an order. The economic order quantity indicates the optimum number of units to be ordered.

What is the consistency principle? The consistency principle requires accountants to be consistent from one accounting period to another in applying accounting principles, methods, practices, and procedures. In other words, the readers of a company’s financial statements can presume that the same rules and measurements were followed in all of the years being reported. If a change is made to a more preferred accounting method, the effects of the change must be clearly disclosed. The Financial Accounting Standards Board refers to consistency as one of the characteristics or qualities that makes accounting information useful.

What are conversion costs? Conversion costs are the combination of direct labor costs plus manufacturing overhead costs. You can think of conversion costs as the manufacturing or production costs necessary to convert raw materials into products. Expressed another way, conversion costs are a manufacturer’s product or production costs other than the costs of raw materials. The term conversion costs often appears in the calculation of the cost of an equivalent unit in a process costing system.

What is the difference between information and data? I was taught that information is useful data. The point is there are lots of data (plural of datum) everywhere, and most of the data will not be useful to a decision maker. Only after the data have been sorted and the relevant portions presented to a decision maker will the data become information. While that is the distinction that I learned many years ago, I believe that most people use the terms information and data interchangeably. In other words, one person might say data processing and another might say information processing, and both could be referring to the same thing.

What is the entry to remove equipment that is sold before it is fully depreciated? When equipment that is used in a business is sold for cash before it is fully depreciated, there will be two journal entries: The first entry will be a debit to Depreciation Expense and a credit to Accumulated Depreciation to record the depreciation right up to the date of the sale (disposal). The second entry will consist of the following:

1. Credit the account Equipment to remove the equipment’s cost.

2. Debit Accumulated Depreciation to remove the equipment’s up-to-date accumulated depreciation.

3. Debit Cash for the amount received.

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4. Get this journal entry to balance. If a debit amount is needed, it is a loss on the disposal. If a credit amount is needed, it is a gain on the disposal. If the equipment is traded-in or exchanged for another asset, the second journal entry will be different from the one we presented.

Why does a company debit Purchases instead of Inventory? Under the periodic inventory system a company determines its inventory value based on an estimated or actual physical count of goods multiplied by the unit costs of the items. As a result, the costs of the goods purchased by the company will be debited to the temporary account Purchases. Under the periodic inventory system, there will also be temporary accounts that will be credited for Purchase Returns and Allowances and for Purchase Discounts. If a company wants its Inventory account to have a running dollar amount, it will use the perpetual inventory system. Under the perpetual inventory system, the costs of the goods purchased are debited to Inventory. The perpetual system also requires that the Inventory account be credited for the cost of the goods sold, for purchase returns and allowances, and for purchase discounts.

What is the weakness of traditional cost allocations? Traditional cost allocations are often based on volume such as number of products manufactured, number of direct labor hours, number of production machine hours, number of square feet, etc. Unfortunately, it is becoming more frequent that the common costs or indirect costs that require allocation are not caused by volume. In other words, traditional cost allocations are often based on something other than the root causes of the costs. For example, a significant amount of manufacturing overhead might not be caused by production machine hours, yet the overhead is allocated using those hours. For example, a few of a manufacturer’s low volume products may require significant amounts of engineering changes, additional inspections, frequent machine setups with unusually short production runs, special handling, additional storage, and so on. To allocate these special costs to all products on the basis of the number of production machine hours (instead allocating those costs based on their root causes) will result in individual product costs that are inaccurate and misleading.

What are the methods for separating mixed costs into fixed and variable? I know of three methods for separating mixed costs into their fixed and variable cost components: 1. Prepare a scattergraph by plotting points onto a graph. 2. High-low method. 3. Regression analysis. It is wise to prepare the scattergraph even if you use the high-low method or regression analysis. The benefit of the scattergraph is that it allows you to see if some of the plotted points are simply out of line. These points are referred to as outliers and will need to be reviewed and possibly adjusted or eliminated. In other words, you don’t want incorrect data to distort your calculations under any of the three methods. Let’s assume that a company uses only one type of equipment and it wants to know how much of the monthly electricity bill is a constant amount and how much the electricity bill will increase when its equipment runs for an additional hour. The scattergraph’s vertical or y-axis will indicate the dollars of total monthly electricity cost. Its horizontal or x-axis will indicate the number of equipment hours. For each monthly electricity bill, a point will be entered on the graph at the intersection of the dollar amount of the total electricity bill and the equipment hours occurring between the meter reading dates shown on the electricity bill. If you plot this information for the most

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recent 12 months, you may see some type of pattern, such as a line that rises as the number of equipment hours increase. If you draw a line through the plotted points and extend the line through the y-axis, the amount where the line crosses the y-axis is the approximate amount of fixed costs for each month. The slope of the line indicates the variable cost per equipment hour. The slope or variable rate is the increase in the total monthly electricity cost divided by the change in the total number of equipment hours. The high-low calculation is similar but it uses only two of the plotted points: the highest point and the lowest point. Regression analysis uses all of the monthly electricity bill amounts along with their related number of equipment hours in order to calculate the monthly fixed cost of electricity and the variable rate for each equipment hour. Software can be used for regression analysis and it will also provide statistical insights. If a scattergraph of data shows no clear pattern, you should not place much confidence in the calculated amount of the fixed cost and variable rate regardless of the method used.

What is a post-closing trial balance? A post-closing trial balance is a trial balance which is prepared after all of the temporary accounts in the general ledger have been closed. The temporary accounts include 1) the income statement accounts consisting of revenue, expense, gain, and loss accounts, 2) the summary accounts, and 3) the few temporary balance sheet accounts such as the sole proprietor’s drawing account or the corporation’s dividend account. All trial balances should have a heading that includes the company name, the words Trial Balance, and the date of the account balances. After the heading you will likely see the following four columns: account number, account title, debit balance amount, and credit balance amount. Most trial balances will not list any account having a $0.00 balance. As a result, the post-closing trial balance will list only the balance sheet accounts with a balance other than zero. The debit and credit amount columns will be summed and the totals should be identical. Today’s accounting software will likely generate a post-closing trial balance or any other trial balance with the click of a mouse. Thanks to accounting software, trial balances are likely to be in balance since the manual calculations have been eliminated.

What is a contra liability account? A contra liability account is a liability account where the balance will be either a debit balance or a zero balance. Since a debit balance in a liability account is contrary to the normal or expected credit balance, the account is referred to as a contra liability account. The most common contra liability accounts are Discount on Bonds Payable and Discount on Notes Payable. The debit balances in these accounts are amortized or allocated to Interest Expense over the life of the bonds or notes. The credit balance in the liability account Bonds Payable minus the debit balance in the contra liability account Discount on Bonds Payable is the carrying value or book value of the bonds. The credit balance in Notes Payable minus the debit balance in Discount on Notes Payable is the carrying value or book value of the notes payable.

What is a contra asset account? A contra asset account is an asset account where the balance will be either a credit balance or a zero balance. (A debit balance in a contra asset account will violate the cost principle.) Since a credit balance in an asset account is contrary to the normal or expected debit balance the account is referred to as a contra asset account. The most common contra asset account is Accumulated Depreciation. Accumulated Depreciation is associated with property, plant and equipment and it is credited when Depreciation Expense is recorded. Recording the

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credits in the Accumulated Depreciation means that the cost of the property, plant and equipment will continue to be reported. Reporting the accumulated depreciation separately allows the readers of the balance sheet to see how much of the cost has been depreciated and how much has not yet been depreciated. Another contra asset account is Allowance for Doubtful Accounts. This account appears next to the current asset Accounts Receivable. The account Allowance for Doubtful Account is credited when a company enters estimated amounts as debits to Bad Debts Expense under the allowance method. The use of Allowance for Doubtful Accounts permits a reader to see the documented amounts in Accounts Receivable that the company has a right to collect from its credit customers. The separate credit balance in the account Allowance for Doubtful Accounts tells the reader how much of the debit balance in Accounts Receivable is unlikely to be collected. A less common example of a contra asset account is Discount on Notes Receivable. The credit balance in this account is amortized or allocated to Interest Income or Interest Revenue over the life of a note receivable.

What is cash from operating activities? Cash from operating activities usually refers to the net cash inflow reported in the first section of the statement of cash flows. Cash from operating activities focuses on the cash inflows and outflows from a company’s main business activities of buying and selling merchandise, providing services, etc. Cash from operating activities excludes the amount spent on capital expenditures such as new equipment and new facilities, the cash used for other long-term investments, and the cash received from the sale of long-term assets. Cash from operating activities also excludes the amount paid to stockholders in dividends or to acquire treasury stock, the amounts received from issuing stock and bonds, and the amounts spent to retire bonds.

In least squares regression, what do y and a represent? Here are the meanings of the components or symbols used in the least squares equation of y = a + bx: y is the dependent variable, such as the estimated or expected total cost of electricity during a month. The amount of y is dependent upon the amounts of a and bx. a is the estimated total amount of fixed electricity costs during the month. It is the value of y, when x is zero. If the total cost line intersects the y-axis at $1,000 then it is assumed that the total fixed costs for a month are $1,000. b is the estimated variable cost per unit of x. It determines the slope of the total cost line. If b is $5, this means that the variable cost portion of electricity is estimated to be $5 for every unit of x. x is the independent variable. For example, x could represent the known number of machine hours used in the month. bx is the total variable cost of electricity. If the company’s electricity cost is estimated to be $5 per unit of x, and x is 4,000 machine hours, then the total variable cost of electricity for the month is estimated to be $20,000. In our example the total estimated cost of electricity (y) in a month when x is 4,000 machine hours will be $21,000.

Where are accruals reflected on the balance sheet? Accrued expenses are reported in the current liabilities section of the balance sheet. Accrued expenses reported as current liabilities are the expenses that a company has incurred as of the balance sheet date, but have not yet been recorded or paid. Typical accrued expenses include wages, interest, utilities, repairs, bonuses, and taxes. Accrued revenues are reported in the current assets section of the balance sheet. The accrued revenues reported on the balance sheet are the amounts earned by the company as of the balance sheet date that have not yet been recorded and the customers have not yet paid the company.

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Accrued expenses and accrued revenues are also reflected in the income statement and in the statement of cash flows prepared under the indirect method. However, these financial statements reflect a time period instead of a point in time.

In standard costing, how is the purchase price variance reclassified to arrive at actual cost? I assume that the purchase price variance was recorded at the time that the raw materials were purchased. If that price variance is significant, it should be reclassified to the following: raw materials inventory, work-in-process inventory, finished goods inventory, and cost of goods sold. The reclassification is also known as prorating the variance or allocating the variance. The reclassification of the purchase price variance should be based on the location of the raw materials which had created the price variance. If those raw materials were recently purchased and are entirely in the raw materials inventory, then all of the price variance should be assigned to the raw materials inventory. If the price variance occurred throughout the year, the variance should be assigned to the raw materials inventory, work-in-process inventory, finished goods inventory, and cost of goods sold based on the quantity of the raw materials in each of these categories. If the amount of the purchase price variance is very small and/or the inventory turnover rates are very high, the entire amount of the price variance might be reclassified entirely to the cost of goods sold.

How are period costs reported in the financial statements? Under the accrual method of accounting, period costs such as selling, general and administrative expenses are reported on the income statement in the accounting period in which they are used up or expire. They are referred to as period costs because they are not assigned to products, and therefore cannot be included in the cost of items held in inventory. If a selling, general and administrative (SG&A) expense is prepaid, the prepaid portion will be reported as a current asset. When the prepaid expense expires, it will move to the income statement and become part of that period’s SG&A expenses. Interest expense is also a period cost unless it is determined to be a necessary cost of a self-constructed, long-lived asset.

Is a loan’s principal payment included on the income statement? A loan’s principal payment will not be included on the income statement. The principal payment is a reduction of a liability, such as Notes Payable or Loans Payable, which is reported on the balance sheet. The principal payment will also be reported as a cash outflow on the Statement of Cash Flows. Only the interest portion of a loan payment is reported on the income statement, and it is reported as Interest Expense.

What are goods in transit? Goods in transit refers to merchandise and other inventory items that have been shipped by the seller, but have not yet been received by the purchaser. To illustrate goods in transit, let’s use the following example. Company J ships a truckload of merchandise on December 30 to Customer K, which is located 2,000 miles away. The truckload of merchandise arrives at Customer K on January 2. Between December 30 and January 2, the truckload of merchandise is goods in transit. The goods in transit requires special attention if the companies issue financial statements as of December 31. The reason is that the merchandise is the inventory of one of the two companies, but the merchandise is not

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physically present at either company. One of the two companies must add the cost of the goods in transit to the cost of the inventory that it has in its possession. The terms of the sale will indicate which company should report the goods in transit as its inventory as of December 31. If the terms are FOB shipping point, the seller (Company J) will record a December sale and receivable, and will not include the goods in transit as its inventory. On December 31, Customer K is the owner of the goods in transit and will need to report a purchase, a payable, and must add the cost of the goods in transit to the cost of the inventory which is in its possession. If the terms of the sale are FOB destination, Company J will not have a sale and receivable until January 2. This means Company J must report the cost of the goods in transit in its inventory on December 31. (Customer K will not have a purchase, payable, or inventory of these goods until January 2.)

How do you calculate the cost of carrying inventory? The cost of carrying or holding inventory is the sum of the following costs: 1. Money tied up in inventory, such as the cost of capital or the opportunity cost of the money. 2. Physical space occupied by the inventory including rent, depreciation, utility costs, insurance, taxes, etc. 3. Cost of handling the items. 4. Cost of deterioration and obsolescence. Often the costs are computed for a year and then expressed as a percentage of the cost of the inventory items. For example, a company might express the holding costs as 20%. If the company has $300,000 of inventory cost, its cost of carrying or holding the inventory is estimated to be $60,000 per year. The cost of carrying inventory will vary from company to company. For instance, if a company has a large cash balance with no attractive investment options, has excess space for storage, and its products have a low probability for deterioration or obsolescence, the company’s holding or carrying costs are very low. A company with enormous debt, little space, and products subject to deterioration will have very high holding costs. For decision making, such as determining the economic order or production quantity, it is important to determine the incremental holding costs for a year. In other words, what will be the additional holding costs expressed as an annual cost for the items being purchased or produced.

What is petty cash? Petty cash is a small amount of cash on hand that is used for paying small amounts owed, rather than writing a check. Petty cash is also referred to as a petty cash fund. The person responsible for the petty cash is known as the petty cash custodian. Some examples for using petty cash include the following: paying the postal carrier the 17 cents due on a letter being delivered, reimbursing an employee $9 for supplies purchased, or paying $14 for bakery goods delivered for a company’s early morning meeting. The amount in a petty cash fund will vary by organization. For some, $50 is adequate. For others, the amount in the petty cash fund will need to be $200. When the cash in the petty cash fund is low, the petty cash custodian requests a check to be cashed in order to replenish the cash that has been paid out.

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What is a petty cash voucher? A petty cash voucher is usually a small form that is used to document a disbursement (payment) from a petty cash fund. Petty cash vouchers are also referred to as petty cash receipts and can be purchased from office supply stores. The petty cash voucher should provide space for the date, amount disbursed, name of person receiving the money, reason for the disbursement, general ledger account to be charged, and the initials of the person disbursing the money from the petty cash fund. Some petty cash vouchers are prenumbered and sometimes a number is assigned for reference and control. Receipts or other documentation justifying the disbursement should be attached to the petty cash voucher. When the petty cash fund is replenished, the completed petty cash vouchers provide the documentation for the replenishment check.

What is the difference between fixed assets and noncurrent assets? Fixed assets are one of several categories of noncurrent assets. Fixed assets are usually reported on the balance sheet as property, plant and equipment. In addition to property, plant and equipment, the other categories of noncurrent assets include long-term investments, intangible assets, deferred charges, and other noncurrent assets.

What is inventory shrinkage? Inventory shrinkage is the term used to describe the loss of inventory. For example, if the inventory records of a retailer report that 3,261 units of Product X are on hand, but a physical count indicates that there are only 3,248 units on hand, there is an inventory shrinkage of 13 units. The retailer’s inventory shrinkage might be due to shoplifting, employee theft, damage, obsolescence, etc. The term shrinkage is also used by manufacturers when referring to the loss of raw materials during a production process. For example, a manufacturer of baked food items will experience shrinkage throughout its processes due to ingredients adhering to the beaters and bowls, and also due to evaporation. This shrinkage is also known as spoilage or waste and it can be either normal or abnormal.

Where is interest on a note payable reported on the cash flow statement? The interest paid on a note payable is included in the first section of the cash flow statement entitled cash flows from operating activities. If a company reports its cash flows from operating activities by using the indirect method, the interest expense for the period is included in the company’s net income or net earnings. The interest expense will be adjusted to a cash amount through the changes to the working capital amounts, which are also reported as part of the operating activities. In addition, the actual amount of interest paid must be disclosed. If the cash flow statement, or statement of cash flows, is prepared using the direct method, the amount of interest paid should appear as a separate line within the cash flows from operating activities. The cash payments and cash receipts of principal on a note payable are reported in the financing activities section of the cash flow statement.

Is it a requirement for a small business to have a CPA? Generally, a small business is not required to have a CPA or certified public accountant. A CPA would be needed if the small business must have its financial statements audited or reviewed in order to obtain a bank loan, to apply for a grant, to bid on a job, or some other unique requirement.

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Although most small businesses are not required to have a CPA involved, a small business may engage a CPA to review its internal controls, evaluate accounting software, obtain tax advice, and so on. Some businesses utilize accountants who are not certified, but are very experienced and effective. You could ask your banker to recommend an accountant who works well with clients such as yourself.

What is ERP? In accounting, ERP is the acronym for enterprise resource planning. ERP could be described as a database software package that supports all of a business’s processes and operations including manufacturing, marketing, financial, human resources, and so on. In other words, the goal of ERP is to have one integrated system for the entire company. The integration of all of a company’s information from all departments, processes, operations, etc. requires that an ERP system be very sophisticated. This in turn requires a company to commit considerable resources for planning, training, and implementing an ERP system. Two of the suppliers or vendors of major ERP systems are SAP and Oracle.

What is an unpresented check? An unpresented check is a check written by a company and entered in its records, but the check has not yet cleared the company’s checking account. In other words, the check has not yet been paid by the bank on which the check is drawn. An unpresented check is also known as an outstanding check. An unpresented check is listed on a bank reconciliation as a subtraction from the bank balance.

What is the cost of sales? Cost of sales is the caption commonly used on a manufacturer’s or retailer’s income statement instead of the caption cost of goods sold or cost of products sold. The cost of sales for a manufacturer is the cost of finished goods in its beginning inventory plus the cost of goods manufactured minus the cost of finished goods in ending inventory. The cost of sales for a retailer is the cost of merchandise in its beginning inventory plus the net cost of merchandise purchased minus the cost of merchandise in its ending inventory. The cost of sales does not include selling expenses or general and administrative expenses, which are commonly referred to as SG&A.

What are the disclosures for a manufacturer’s inventory? A manufacturer should disclose the following categories of inventory: raw materials, work-in-process, finished goods, manufacturing supplies, and packaging supplies. When some of these amounts are not significant, some categories may be combined, such as raw materials and supplies, or raw materials and work-in-process. In addition, a manufacturer (and others with inventory) should disclose the method for valuing the inventory. This includes whether it is cost or the lower of cost or market, and also the cost flow assumption such as 1) first-in, first-out or FIFO, 2) last-in, first-out or LIFO, 3) weighted average, etc. If LIFO is used, the company must disclose what the dollar amount of inventory would have been if FIFO had been used.

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What is the advantage of using historical cost on the balance sheet for property, plant and equipment? The main advantage of using historical cost on the balance sheet for property, plant and equipment is that historical cost can be verified. Generally, the cost at the time of purchase is documented with contracts, invoices, payments, transfer taxes, and so on. The historical cost of plant and equipment (not land) is also used to determine the amount of depreciation expense reported on the income statement. The accumulated amount of depreciation is also reported as a deduction from the assets’ historical costs reported on the balance sheet. (In the case of impairment, some assets might be reported at less than the amounts based on historical cost.) The use of historical cost is also a disadvantage to those users of the financial statements who want to know the current values.

What is accrued income? Accrued income is an amount that has been 1) earned, 2) there is a right to receive the amount, and 3) it has not yet been recorded in the general ledger accounts. One example of accrued income is the interest earned on a bond investment. To illustrate, let’s assume that a company invested $100,000 on December 1 in a 6% $100,000 bond that pays $3,000 of interest on each June 1 and December 1. On December 31, the company will have earned one month’s interest amounting to $500 ($100,000 x 6% per year x 1/12 of a year, or 1/6 of the semiannual $3,000). No interest will be received in December since it will be part of the $3,000 to be received on June 1. The $500 of interest earned during December, but not yet received or recorded as of December 31 is known as accrued income. Under the accrual basis of accounting, accrued income is recorded with an adjusting entry prior to issuing the financial statements. In our example, there will need to be an adjusting entry dated December 31 that debits Interest Receivable (a balance sheet account) for $500, and credits Interest Income (an income statement account) for $500.

What is Subchapter S? Subchapter S refers to a section of Chapter 1 of the U.S. Internal Revenue Code. A subchapter S corporation, which is also referred to as an S corporation, is a corporation that does not pay the income taxes on its income. Rather, the owners of the S corporation are responsible for the income taxes which pertain to their share of the S corporation’s income. Hence, the income statement of an S corporation does not report income tax expense, and the balance sheet does not report income taxes payable. There are certain requirements in order to elect the Subchapter S status. Learn more about S corporations at IRS.gov or from a tax professional.

What is the purpose of the cash flow statement? The purpose of the cash flow statement or statement of cash flows is to provide information about a company’s gross receipts and gross payments for a specified period of time. The gross receipts and gross payments will be reported in the cash flow statement according to one of the following classifications: operating activities, investing activities, and financing activities. The net change from these three classifications should equal the change in a company’s cash and cash equivalents during the reporting period. For instance, the cash flow statement for the calendar year 2010 will report the causes of the change in a company’s cash and cash equivalents between its balance sheets of December 31, 2009 and December 31, 2010.

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In addition to the cash amounts being reported as operating, investing, and financing activities, the cash flow statement must disclose other information, including the amount of interest paid, the amount of income taxes paid, and any significant investing and financing activities which did not require the use of cash. The statement of cash flows is to be distributed along with a company’s income statement and balance sheet.

What is included in cash and cash equivalents? The term cash and cash equivalents includes: currency, coins, checks received but not yet deposited, checking accounts, petty cash, savings accounts, money market accounts, and short-term, highly liquid investments with a maturity of three months or less at the time of purchase such as U.S. treasury bills and commercial paper. The items included as cash and cash equivalents must also be unrestricted. The amount of cash and cash equivalents will be reported on the balance sheet as the first item in the listing of current assets. The change in the amount of cash and cash equivalents during an accounting period is explained by the statement of cash flows.

Why does the internal rate of return equate to a net present value of zero? Internal rate of return and net present value are discounted cash flow techniques. To discount means to remove the interest contained within the future cash amounts. If the net present value of an investment or project is more than $0, the project is earning more than the interest rate used to discount the future cash amounts. If the net present value of a project is less than $0, the project is earning less than the interest rate used to discount the future cash amounts. If the present value of a project is exactly $0, the project is earning exactly the interest rate used to discount the future cash amounts. In other words, if a project has an internal rate of return of 15%, and you discount the project’s future cash amounts by 15%, the project’s net present value will be exactly $0.

How do you calculate the payback period? The payback period is calculated by counting the number of years it will take to recover the cash invested in a project. Let’s assume that a company invests $400,000 in more efficient equipment. The cash savings from the new equipment is expected to be $100,000 per year for 10 years. The payback period is 4 years ($400,000 divided by $100,000 per year). A second project requires an investment of $200,000 and it generates cash as follows: $20,000 in Year 1; $60,000 in Year 2; $80,000 in Year 3; $100,000 in Year 4; $70,000 in Year 5. The payback period is 3.4 years ($20,000 + $60,000 + $80,000 = $160,000 in the first three years + $40,000 of the $100,000 occurring in Year 4). Note that the payback calculation uses cash flows, not net income. Also, the payback calculation does not address a project’s total profitability. Rather, the payback period simply computes how fast a company will recover its cash investment.

What is the meaning of debit? Debit means left or left side. For example, every accounting entry will have a debit and credit amount. The debit amount is usually listed first and will be entered on the left side of the general ledger account indicated. (The credit amount will be entered on the right side of another account.) The general ledger accounts will have both a debit and credit side, or left and right side. The balance in a general ledger account will be either a debit balance or a credit balance. Asset accounts, expense accounts, and the owner’s drawing account are expected to have debit balances. These debit balances will be increased when additional debit amounts are entered.

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To illustrate the above, let’s assume that a company has cash of $500. The company’s general ledger asset account Cash should indicate a debit balance of $500. If the company receives an additional $200, a debit entry will be made and will result in the Cash account having a debit balance of $700. Sometimes the word charge is used in place of debit. For example, if a company does advertising of $900, the accountant will charge Advertising Expense for $900. The accepted abbreviation for debit is dr.

What is a toxic asset? I would define a toxic asset as an investment whose value has dropped significantly and there is no market in which to sell the asset. To illustrate, let’s assume that at the peak of the real estate market you lent $150,000 to someone who was purchasing a house for $170,000. In other words, you made a $150,000 investment and recorded it as the asset Mortgage Loan Receivable. The house is the collateral for the loan receivable. Within one year, the local housing market drops by 30% and the borrower loses her job. She stops making the loan payments and at that point your Mortgage Loan Receivable account shows a balance of $147,000. This scenario is widespread in your community and houses are not selling. I would consider your Mortgage Loan Receivable to be a toxic asset. There are few investors willing to purchase a loan without payments being made by the borrower, the value of the collateral has dropped to less than $120,000 ($170,000 minus the 30% average drop in value), and a lot of houses are for sale with virtually no buyers.

Is AccountingCoach.com based on GAAP or IFRS? The materials presented on AccountingCoach.com are based on U.S. GAAP. Since the accounting materials on AccountingCoach.com are generally introductory concepts, the differences between U.S. GAAP and IFRS at this level are minimal. The differences become wider in more advanced accounting topics, which are not presented on AccountingCoach.com.

Is it possible for owner’s equity to be a negative amount? It is possible for owner’s equity to be a negative amount. The following illustrates how it might occur. In 2005, a sole proprietorship was begun with the owner investing $100,000. During the years 2005 through 2008 the owner withdrew most of each year’s net income. As a result, the total owner’s equity at the end of 2008 was $110,000 (original investment of $100,000 plus $10,000 of net income not withdrawn). During 2009 the company’s expenses exceed revenues by $125,000 and there were no draws or additional investments by the owner. The owner’s equity at the end of 2009 would be a negative $15,000. The negative amount of owner’s equity also means that the company’s balance sheet will report liability amounts greater than the amount of assets. The company could operate under those conditions if its assets are turning to cash before the liabilities need to be paid.

What is the difference between gross profit and net profit? Gross profit is sales revenues minus the cost of goods sold. The term net profit might have a variety of definitions. I assume that net profit means all revenues minus all expenses including the cost of goods sold, the selling, general, and administrative (SG&A) expenses, and the nonoperating expenses. At a corporation it may also mean after income tax expense.

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What is the difference between actual overhead and applied overhead? In accounting, overhead usually refers to the indirect manufacturing costs. These are the manufacturing costs other than direct materials and direct labor. The actual overhead refers to the indirect manufacturing costs actually occurring and recorded. These include the manufacturing costs of electricity, gas, water, rent, property tax, production supervisors, depreciation, repairs, maintenance, and more. The applied overhead refers to the indirect manufacturing costs that have been assigned to the goods manufactured. Manufacturing overhead is usually applied, assigned, or allocated by using a predetermined annual overhead rate. For example, a manufacturer might estimate that in its upcoming accounting year there will be $2,000,000 of manufacturing overhead and 40,000 machine hours. As a result, this manufacturer sets its predetermined annual overhead rate at $50 per machine hour. Since the future overhead costs and future number of machine hours were not known with certainty, and since the actual machine hours will not occur uniformly throughout the year, there will always be a difference between the actual overhead costs incurred and the amount of overhead applied to the manufactured goods. Hopefully, the differences will be minimal at the end of the accounting year.

Is there a difference between an expense and an expenditure? An expense is reported on the income statement. An expense is a cost that has expired, was used up, or was necessary in order to earn the revenues during the time period indicated in the heading of the income statement. For example, the cost of the goods that were sold during the period are considered to be expenses along with other expenses such as advertising, salaries, interest, commissions, rent, and so on. An expenditure is a payment or disbursement. The expenditure may be for the purchase of an asset, a reduction of a liability, a distribution to the owners, or it could be an expense. For instance, an expenditure to eliminate a liability is not an expense, while expenditures for advertising, salaries, etc. will likely be recorded immediately as expenses. Here’s another example to illustrate the difference between an expense and an expenditure. A company makes an expenditure of $255,500 to purchase equipment. The expenditure occurs on a single day and the equipment is placed in service. Assuming the equipment will be used for seven years, the cost of the equipment will be reported as depreciation expense of $100 per day for the next 2,555 days (7 years of service with 365 days each year).

If we dispose of an asset, will there be a change in the owner’s equity? The owner’s equity of a sole proprietorship will change only if the disposal of an asset causes a gain or loss to be reported on the income statement. To illustrate this, let’s assume that a truck that was used in the business is sold for $5,000. If the truck had a cost of $40,000 and accumulated depreciation of $35,000 there will be no gain or loss reported on the income statement. The reason is the $5,000 received is equal to the $5,000 of book value that is being removed from the balance sheet. With no gain or loss on the disposal, the owner’s equity is unchanged. On the other hand, if the same truck is sold for $3,000 there will be a $2,000 loss ($3,000 of cash received versus the $5,000 of book value removed) reported on the income statement. When the account Loss on Disposal of Assets is closed, the owner’s capital account will be reduced by the $2,000 loss.

How do you record the interest that is unpaid on a note payable? Interest that has occurred, but has not been paid as of a balance sheet date, is referred to as accrued interest. Under the accrual basis of accounting, the amount that has occurred but is unpaid should be recorded with a debit to Interest Expense and a credit to the current liability Interest Payable.

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To illustrate, let’s assume that a company’s December loan payment included interest up until December 10. On the company’s financial statements dated December 31, the company will need to report the interest expense and liability for December 10 through 31. This is done with an accrual-type adjusting entry dated December 31.

What to do with the balance in Allowance for Doubtful Accounts? You need to adjust the balance in the contra asset account Allowance for Doubtful Accounts to be your best estimate of the amount in Accounts Receivable which are not collectible. In other words, adjust the credit balance in the allowance account to become the amount of the receivables that is not expected to turn to cash. If the Allowance for Doubtful Accounts presently has a credit balance of $2,000 and you believe there is a total of $2,900 of accounts receivable that will not be collected, you need to enter an additional credit of $900 into the Allowance for Doubtful Accounts, and you need to enter a debit of $900 into Bad Debts Expense. The allowance account appearing on the balance sheet might be titled Allowance for Uncollectible Accounts, Provision for Bad Debts, or some combination of these. The income statement account might have a title such as Uncollectible Accounts Expense, Doubtful Accounts Expense, etc.

What is a credit? In accounting there are several meanings of a credit. In the context of debits and credits, a credit is an entry made on the right side of an account. For example, accountants will state that a payment on a company’s outstanding bills will be recorded with a credit to Cash and a debit to Accounts Payable. Accountants also state that a credit balance is the likely balance for liability and revenue accounts. A credit is also used when a customer returns some recently purchased goods. For example, the seller might tell the customer that a credit will be given for the returned goods. The seller then processes a credit memo which will be recorded as a credit in the Accounts Receivable records. The word credit, as opposed to a credit, could refer to the terms of a sale in which the customer is allowed to pay at a later date. Credit could also refer to a company’s ability to borrow money.

Is the deposit for a booth at a future trade show an asset? The deposit for a booth at a future trade show is an asset until the trade show occurs. Once the trade show occurs the deposit amount should be moved from the balance sheet asset account to an income statement expense account.

What does a balance sheet tell us? A balance sheet reports the dollar amounts of a company’s assets, liabilities, and owner’s equity (or stockholders’ equity) as of a previous date. Assets include cash, accounts receivable, inventory, investments, land, buildings, equipment, some intangible assets, and others. Generally assets are reported at their cost or a lower amount due to depreciation, the cost principle, and conservatism. The cost principle also means that some very valuable aspects of the company are not listed as assets. For example, a company’s outstanding reputation, its effective management team, and its amazing brand recognition are not reported as assets if they were not acquired in a transaction involving another party or entity. Liabilities are obligations of a company as of the balance sheet date. These include loans payable, accounts payable, warranty obligations, taxes payable, and more.

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The stockholders’ equity or owner’s equity report the amount of the assets that came from the owners and not from its creditors. The balance sheet allows you to easily determine the amount of a company’s working capital and whether the company is highly leveraged. With every balance sheet distributed by a company there should be notes or footnotes. These notes provide important additional information about the company’s financial position including potential liabilities not yet appearing as amounts on the balance sheet.

Is the reversal of a previous year’s accrued expense permanent? Yes, a reversing entry is permanent. To illustrate, let’s assume that a company had accrued interest expense of $10,000 as of December 31, the end of its accounting year. The accrual adjusting entry will record an additional $10,000 of expense to be reported on the December income statement and an additional $10,000 liability on the December 31 balance sheet. On January 1 the account Interest Expense will begin with a zero balance, since expenses are temporary accounts that are closed at the end of each accounting year. On January 2, a reversing entry is recoded which removes the $10,000 liability and causes a $10,000 credit balance in Interest Expense. The negative amount in Interest Expense will disappear as soon as the interest portion of the January loan payment is recorded. The accrual entry on December 31 was needed only for the December financial statements. Early in January the December 31 accrued interest must be permanently removed or reversed because the actual interest will soon be recorded. The reversing entry will assure that the interest expense amount is reported only once.

What will cause a change in net working capital? Net working capital or working capital is defined as current assets minus current liabilities. Therefore, a change in the total amount of current assets without a change of the same amount in current liabilities will result in a change in the amount of working capital. Similarly, a change in the total amount of current liabilities without an identical change in the total amount of current assets will cause a change in working capital. For instance, if the owner makes an additional investment of $20,000 in her company, the company’s total current assets will increase by $20,000 but there is no increase in its current liabilities. As a result, the company’s working capital increases by $20,000. (The other change is an increase in the owner’s capital account.) If a company borrows $50,000 and agrees to repay the loan in 90 days, the company’s working capital has not increased. The reason is that the current asset Cash increased by $50,000 and the current liability Loans Payable also increased by $50,000. The use of $30,000 to buy merchandise for inventory will not change the amount of working capital. The reason is that the total amount of current assets will not change. The current asset Cash decreases by $30,000 and the current asset Inventory increases by $30,000. If a company sells a product for $3,400 which is in its inventory at a cost of $2,500 the company’s working capital will increase by $900. Working capital increased because 1) the current asset accounts Cash or Accounts Receivable will increase by $3,400 and Inventory will decrease by $2,500; 2) current liabilities will not change. Owner’s equity will increase by $900. The use of $100,000 for the construction of a storage building will reduce working capital because the current asset Cash decreased and a long-term asset Storage Building has increased.

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What are the advantages of departmentalizing manufacturing overhead costs? The departmentalizing of manufacturing overhead costs allows for better planning and control if the head of each department is held responsible for the costs and productivity of his or her department. The departmentalizing of manufacturing overhead costs also allows for the computation and application of several departmental overhead cost rates instead of having a single, plant-wide overhead rate. This is important when there are a variety of products and some require many operations in a department with high overhead rates, while other products require very few operations in the high cost department. There may also be products which require many hours of processing, but they occur in low cost departments. For instance, the assembly and packing departments of a manufacturer are likely to have very low overhead cost rates. On the other hand, the fabricating and milling departments will likely have much higher overhead cost rates.

At what point are revenues considered to be earned? Revenues, which are derived from an entity’s main activities such as the sale of merchandise or the performance of service, are considered to be earned when the earning process has been substantially completed. For example, a merchandiser’s sales revenues are considered earned when the goods have been shipped or delivered to the customers and the merchandiser has a right to a collectible accounts receivable. (Under accrual accounting it is not necessary to have received the cash in order to have earned the revenues.) The reason is that the substantial and difficult parts of the selling process (having the merchandise, finding customers, getting customers to place orders, and delivering the merchandise to customers) have been completed. Collecting the accounts receivable is usually an automatic process which requires little or no effort. General guidance for determining when revenues are earned can be found in paragraphs 83 and 84 of the FASB’s Statement of Financial Accounting Concepts No. 5, Recognition and Measurement in Financial Statements of Business Enterprises and in an Intermediate Accounting textbook.

What is an escrow payment? An escrow payment is an amount deposited with another party and it is to be released only for its specified purpose. The following is one example of an escrow payment. A borrower and lender arrange for the borrower’s monthly mortgage payment to include an amount equal to one-twelfth of the property’s annual real estate tax. Assuming the annual tax is $6,000 the monthly mortgage payment will include an escrow payment of $500. When the lender receives these monthly escrow payments of $500 each, the lender must hold them in escrow, or hold the funds in an escrow account. When the annual real estate taxes come due, the lender pays the real estate taxes by using the money in the borrower’s escrow account.

Can a fully depreciated asset be revalued? No. A fully depreciated asset cannot be revalued because of accounting’s cost principle, matching principle, and going concern assumption. For instance, let’s assume that a company purchased a building 30 years ago at a cost of $600,000. The company then depreciated the building at a rate of $20,000 per year for 30 years. Today the building continues to be used by the company and it plans to continue using it for many more years. The company’s current balance sheet will report the building at its cost of $600,000 minus its accumulated depreciation of $600,000. In other words, the building will be reported at its book value of $0. The cost principle prevents the company from recording and reporting more than its actual cost of $600,000. The matching principle requires that only the actual cost of $600,000 can be allocated or matched to the years in which the company benefits from the use of the building. Lastly, the company is assumed to be a going concern and therefore it is not liquidating. Hence the amount that the company would receive if it sold the building is not appropriate for its financial statements.

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Even if the building’s current value is estimated to be $2 million, the financial statements must report the actual cost and the depreciation based on that cost—even if this means reporting a book value of $0. It also means there will be no additional depreciation expense reported after the $600,000 of actual cost has been reported as depreciation expense.

What is IRS mileage rate for use of a car for business? The standard rate allowed by the Internal Revenue Service for the business use of an automobile in the year 2010 is 50 cents per mile. (This is lower than the rate allowed in the year 2009.) In addition to the standard rate of 50 cents per mile, you are also allowed to claim an expense for parking fees and tolls associated with the business use of your car. An alternative to the standard rate per mile is to compute the business portion of the actual expenses for gasoline, repairs, insurance, depreciation, licenses, etc. You can learn more about income tax issues at www.irs.gov.

What is a comparative balance sheet? A comparative balance sheet will usually have two columns of amounts presented to the right of the account titles or other descriptions such as Cash and Cash Equivalents, Accounts Receivable, Accounts Payable, etc. The first column of amounts contains the amounts as of a recent moment or point in time, say December 31, 2009. To the right will be a column containing corresponding amounts from an earlier date, such as December 31, 2008. The older amounts appear further from the account titles or descriptions as the older amounts are less important. Providing the amounts from an earlier date gives the reader of the balance sheet a point of reference—something to which the recent amounts can be compared.

How do you calculate the payroll accrual? The payroll accrual is the amount that needs to be entered into a liability account in order for the liability account balance to be the amount owed to employees. The amount owed is the amount the employees have earned from working, but as of the date of the balance sheet the amount has not been paid to the employees. To illustrate the payroll accrual, assume that a company’s employees were paid on September 30 for their work through September 25. The balance needed in the liability account as of September 30 is the amount that the employees earned from September 26 through September 30.

Why do bonds rarely sell for their maturity value? The reasons why bonds rarely sell for their maturity value are:

1. The interest paid is usually fixed at the interest rate that is stated on the face of the bond. As a result, the amount of interest paid each year does not change during the life of the bond.

2. The market interest rate—the rate that bond buyer’s demand—is changing daily. To illustrate, let’s assume that a 6% bond will mature in ten years and has a maturity value of $100,000. This means that the bondholders will be receiving $6,000 in interest in each of the ten years. If there is a day when bond buyers demand an interest rate of 6.2% then the bond’s value on that day will be less than $100,000. If on another day the bond buyers demand 5.9% interest, the bond’s value on that day will be greater than $100,000.

What is the difference between correlation and cause and effect? Correlation means that two or more sets of data move in some consistent pattern. Perhaps during a 10-year period the number of cars sold in the U.S. moved in the same direction as the country’s rate of inflation. Even with

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a 10-year correlation between the two sets of data, it is unlikely that more inflation is the cause of the increase in the number of cars sold. In other words correlation does not assure that there is a cause and effect relationship. On the other hand, if there is a cause and effect relationship, there will have to be correlation.

How does the aging of accounts receivable determine bad debts expense? The aging of accounts receivable allows you to quickly identify the credit customers that are past due and the length of time that the amounts have been past due. Focusing on the past due accounts receivable will assist you in estimating how much of the accounts receivable will never be collected. The estimated amount of accounts receivable that will never be collected should be the credit balance in the general ledger account Allowance for Doubtful Accounts. This credit balance when combined with the debit balance in Accounts Receivable will mean that the amount that is likely to be collected will be reported on the balance sheet. When the Allowance for Doubtful Accounts is credited to increase its credit balance, the entry will debit the general ledger account Bad Debts Expense.

What does overstated mean? When an accountant states that a reported amount is overstated, it means two things:

1. The reported amount is incorrect, and 2. The reported amount is more than the true or correct amount.

For example, a company reports that its prepaid insurance is $8,000. However, the true or correct amount of prepaid insurance is only $7,000. The accountant will say that the reported amount for prepaid insurance is overstated by $1,000. Because of double-entry accounting or bookkeeping, another general ledger account will also have a reporting error. In our example, if Prepaid Insurance is overstated (too much is being reported) it is likely that Insurance Expense will be understated (too little is being reported).

What is a comparative income statement? A comparative income statement will consist of two or three columns of amounts appearing to the right of the account titles or descriptions. For example, to the right of the word Revenues will be an amount for each of the years 2010, 2009, and 2008. As a courtesy to the reader, the amounts from the most recent period are in the column closest to the titles. The older amounts are deemed to be less significant and thus appear furthest from the titles. A comparative income statement gives the reader a frame of reference for comparing the current year amounts.

Where can I get official information for federal payroll taxes? For official information on federal payroll taxes we recommend the Internal Revenue Service (IRS) Publication 15 (Circular E), Employer’s Tax Guide. This free publication is available at IRS.gov. The Employer’s Tax Guide is updated each year by the IRS and contains approximately 70 pages of information on payroll. The information includes required withholdings, employer’s payroll taxes, required reporting, income tax withholding tables, and more.

Is the drawing account a capital account? Yes, an owner’s drawing account is a capital account. However, the drawing account is expected to have a debit account, whereas the owner’s main capital account is expected to have a credit balance.

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The drawing account will have a debit balance because the owner’s cash draws or withdrawals are recorded with a credit to the Cash account and therefore a debit to the drawing account. At the end of the accounting year, the debit balance in the drawing account is closed and the debit amount is debited to the owner’s capital account.

What is a cost driver? Ideally, a cost driver is an activity that is the root cause of why a cost occurs. In the past century, the root cause of indirect manufacturing costs has changed from a single cost driver such as direct labor hours to several cost drivers. Due to sophisticated manufacturing and increased customer demands direct labor is no longer the main cost driver. Over time direct labor has become a smaller part of a product’s cost and indirect manufacturing costs have become a larger part. Examples of the cost drivers of today’s indirect manufacturing costs might be the number of machine setups required, the number of engineering change orders, the amount of special inspections, handling, and storage required by customers, the number of components in the units produced, and the number of production machine hours. Companies that want to know the true costs of products need to identify the cost drivers—the root causes of costs to occur. For these companies it is not sufficient to merely spread overhead costs to products based on a single factor such as production machine hours.

What is the statement of activities? The statement of activities is one of the main financial statements of a nonprofit or not-for-profit organization. A nonprofit’s statement of activities is issued instead of the income statement that is issued by a for-profit business. The statement of activities is focused on the total organization and reports the following:

1. Revenues such as contributions, grants, program fees, investment income, and amounts released from restrictions.

2. Expenses such as programs, fundraising, and management and general expenses. 3. Changes in net assets which is the difference between revenues and expenses.

The statement of activities will have multiple columns in order to report the amounts for each of the following classes of net assets: unrestricted, temporarily restricted, permanently restricted, and total.

What is a cash discount? A cash discount is a deduction allowed by the seller of goods or by the provider of services in order to motivate the customer to pay within a specified time. The seller or provider often refers to the cash discount as a sales discount. The buyer often refers to the same discount as a purchase discount. Not all sellers offer cash discounts, but a common cash discount is 1/10, net 30 and it will appear on the sales invoice. If the invoice is $1,000 and the buyer returns $100 the net amount due to the seller is $900 if paid within 30 days. However, the buyer can deduct $9 (1% of $900) if the buyer pays the seller $891 within 10 days of the invoice date. The seller often records the $9 cash discount as Sales Discounts. The buyer will record the $9 savings as Purchase Discounts or as a reduction to the cost recorded in inventory. Occasionally some service providers allow a cash discount if their fee is paid at the time of the service. For example, my dentist allows a cash discount of 5% to patients without insurance if they pay on the day of the

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service. This cash discount saves the time and cost of billing, mailing statements, receiving partial payments, and can result in the dentist having more cash and less receivables.

Is the depreciation of delivery trucks a period cost or is it manufacturing overhead? The depreciation on the trucks used to deliver products to customers is a period cost. The depreciation on delivery trucks will be reported as an expense on the income statement in the period in which it occurs. It might be reported as part of Selling Expenses or as part of Selling, General and Administrative (SG&A) Expenses. The depreciation on the trucks used to transport materials or work-in-process between the facilities of a manufacturer is a component of manufacturing overhead. In other words, the depreciation on trucks used in the manufacturing process is assigned to the goods produced rather than being expensed directly.

How do you compute a selling price if you know the cost and the required gross margin? To compute the selling price, let’s assume that a product has a cost of $100 and the seller wants to have a 30% gross margin on its selling price, or 30% of SP. The relationship between a selling price, cost, and gross margin or gross profit is: SP - cost = gross profit or gross margin. If the gross margin is 30% of SP, the cost of $100 will be 70% of SP. Algebra allows us to compute the selling price as follows:

SP - cost = gross margin

SP - $100 = 30% of SP

1SP - $100 = 0.3SP

1SP - 0.3SP = $100

0.7 SP = $100

0.7SP/0.7 = $100/0.7

SP = $142.85. To verify that a selling price of $142.85 will give us the correct gross margin, we subtract the cost of $100 from the $142.85 selling price. The result is a gross profit of $42.85 which when divided by the selling price gives us the required gross margin of 30% ($42.85/$142.85 ).

Is a manufacturer’s product warranty part of its manufacturing overhead or is it part of its SG&A expense? The costs associated with a manufacturer’s product warranty are part of its selling expenses and therefore part of its SG&A expenses. If the future costs of the warranty coverage are probable and can be estimated, they are recorded at the time of the sale. The accounting entry will debit Warranty Expense and will credit Warranty Liability. If the estimated warranty costs are recorded at the time of the sale, the actual costs of the repair work or the replacement of the product during the warranty period will be debited to the Warranty Liability account—thereby reducing the liability balance.

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What is the difference between a balance sheet of a nonprofit organization and a for-profit business? One difference in the balance sheets of a nonprofit or not-for-profit organization and a for-profit business is the name or title shown in its heading. In a nonprofit, the name of this financial statement is the statement of financial position. In the for-profit business this financial statement is the balance sheet. Another difference is the section that presents the difference between the total assets and total liabilities. The nonprofit’s statement of financial position refers to this section as net assets, whereas the for-profit business will refer to this section as owner’s equity or stockholders’ equity. The reason for this difference is the nonprofit does not have owners. This means that the nonprofit organization’s statement of financial position will reflect this equation: assets - liabilities = net assets. The net assets section will consist of the following parts: unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets. The amounts reported in each of these parts are based on the donor’s stipulations.

What is the Social Security tax rate for 2011? The Social Security tax withheld from employees during 2011 will be 6.2% of the first $106,800 of each employee’s taxable earnings. The employee’s earnings in excess of $106,800 are not subject to the Social Security tax. In addition to the Social Security tax, the entire amount of each employee’s taxable earnings is subject to the Medicare tax of 1.45%. These rates and the Social Security wage base limit are unchanged from the years 2010 and 2009. Both the Social Security tax and the Medicare taxes must be matched by the employer. This means that the employer must remit to the federal government 12.4% of each employee’s first $106,800 of taxable earnings plus 2.9% of each employee’s earnings regardless of the amount. Self-employed individuals are responsible for paying both the employee and the employer portions of the Social Security tax and the Medicare tax.

What does understated mean? When an accountant says that an amount is understated, it means two things: 1. The amount is not the correct amount, and 2. The amount is less than the true amount. In other words, the amount is too small. To illustrate the term understated, let’s assume that a company is reporting its accounts payable as $21,000. Let’s also assume that the correct or true amount of accounts payable is $23,000. An accountant will say that the reported amount of $21,000 is understated by $2,000. Because of double-entry bookkeeping or accounting there will also be a second general ledger account with an error for the same amount.

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AccountsQ&a 2010