Today’s post is by Tech Support Specialist and our resident accounting guru Andrea Whitney.
People can get perplexed when it comes down to anything having to do with General Ledger. It is worse than a foreign language. (At least with a foreign language, you can visit an exotic land for more in-depth research, but I digress.) In any case, the best thing someone can do to understand the items in the General Ledger is to describe these different accounts in a person’s everyday life.
Accounting as a whole is based on a balanced double entry. The left column is debit and right is credit, and the two must always equal each other. If you’re into science, think of it as a law of thermodynamics: matter and energy (or money, in this case) is never created or destroyed; it just changes which side of the balance sheet it’s on. Or if you’re into working out, it’s like doing a rep of anything. You don’t just hold a weight up infinitely; you lift it, then lower it back down (and put the weight plates back where you got them or you’ll get glared at by the other gym folks).
Accounting statements are in the double-entry format. The Trial Balance puts everything together including Assets, Liabilities, Equity, Income and Expenses. The Profit and Loss Statement (P/L) lays out the income and expenses for a specific moment in time. And the Balance Sheet puts Assets, Liabilities and Equity all on one report as of a period end date.
A Balance Sheet contains this equation: Assets minus Liabilities equals Owner’s Equity. The balancing of the report is around that equals sign: Assets are the same amount as the sum of the Liabilities and Owner’s Equity.
Well first, what are assets? Assets are what you own, and they come in two types: current and long-term. In the Assets section, your accounts are listed in decreasing order of liquidity (how easily they can be converted to cash). Current Assets are the assets that are the most liquid, starting off with cash itself.
Long-Term Assets are also called fixed assets, or property, plant and equipment (PPE). A Long-Term Asset’s value starts at the price the user paid for it, and it’s usually depreciated over time based on its use. But because money never disappears from a balance sheet, that accumulated depreciation shows as a counter-asset, reducing the Long-Term Asset’s value to zero by increasing an accumulated depreciation line item or account until the depreciation equals the original value of the Long-Term Asset.
On the other side of the equation are Liabilities. These are what you owe. Expenses such as rent, utilities and other items billed on a monthly basis are Current Liabilities, meaning they must be paid within a fiscal year or the company’s operating cycle. A liability with a payment term that’s longer than one year are Long-Term Liabilities. These normally include car loans, notes that mature in more than a year and mortgages.
Lastly, we have Owner’s Equity. This is often referred to as the “book value” of the company, because Owner’s Equity is equal to Assets minus Liabilities. In layman’s terms, what the company owns minus what the company owes equals what your company is worth. Owner’s Equity can include retained earnings, equity and the current year’s income. The company owner can make a direct withdrawal from the worth of the company; this is shown on the Balance Sheet as a Counter Equity account called Drawing.
Now that you have the breakdown, do a few reps on your own Balance Sheet, making sure that both columns balance and that every action in one column has an equal and opposite reaction in the other. Review your total Assets and confirm that they balance the total of your Liabilities and Owner’s Equity before you send your reports off to your accountant.
So get out there and do a vigorous Balance Sheet Workout, then hit the showers. Next time, we’ll do the Income Statement Throwdown.
To get more great advice on accounting and how easy it is to do in COATS, call Andrea at 1-800-888-5894 or email her.