doups3

What is a Classified Balance Sheet?

Aug 012011

A simple definition of a classified balance sheet is a balance sheet that categorizes both assets and liabilities into short-term and long-term categories.

For example, a balance sheet could simply lump all types of assets under the sub-heading “Assets.” However it is more useful to break assets up into separate categories like current assets, long-term assets, and intangible assets.

Similarly a company could lump all liabilities into one category. However it is more useful to categorize a company’s debts into current liabilities and long-term liabilities.

Classified Balance Sheet Example

classified balance sheet example

Where to Find Classified Balance Sheet Templates

Microsoft Office has a good template here (this is for Excel):
http://office.microsoft.com/en-us/templates/balance-sheet-TC010073876.aspx

Keep in mind that any accounting software you purchase will come with a classified balance sheet template.

Why is Classified Balance Sheet more Useful?

Let’s pretend for a second that you have two friends who want to borrow money from you. One of your friends has $5,000 worth of cash (a current asset) on his balance sheet. The other friend has $5,000 worth of land (a long-term asset) on his balance sheet. Which one would you prefer to loan the money to if you needed your money back in a few weeks?

Most people would prefer to lend money to the friend with $5,000 cash. Why? Because it is much more likely that this friend will be able to pay you back in the next few weeks. The friend with the land will have to go to the trouble of actually selling the land. His assets are less liquid than your friend with the cash. Liquid assets are easily converted to cash. Illiquid assets like land take time and energy to convert to cash. If all of a company’s assets were lumped into one account then it would be difficult to determine how liquid a company was.

A classified balance sheet clearly illustrates the liquid and illiquid assets. This helps creditors and investors make better decisions. The current assets will be used or converted to cash within the next year. The long-term assets will not be used or converted to cash within the next year.

classified balance sheet template

Net Working Capital is Clearly Illustrated on a Classified Balance Sheet

Net working capital is an accounting ratio that is very useful to credits and investors. Net Working Capital = Current Assets – Current Liabilities. In other words, net working capital shows the amount of current assets a company has left over after it pays off all of its current debt. Remember that current liabilities are all of those liabilities that will need to be paid within the next year. If a company doesn’t have enough money to pay off all of its current liabilities then it is going to have a hard time getting additional financing.

As illustrated in the classified balance sheet example at the top of this post, it is easy to see a company’s net working capital when assets and liabilities are classified.

Is Prepaid Insurance an Asset?

Jul 312011
Is prepaid insurance an asset?

Is prepaid insurance an asset?

This is a great question and one that often gets asked by those learning accounting. The short answer is yes, prepaid insurance is indeed an asset.

Why is Prepaid Insurance an Asset?

Let’s quickly review what an asset is to answer that question. An asset is basically a resource that the company owns. This resource by definition should provide some future economic value to the company to be considered an asset (you can read my complete thoughts on the definition of assets here).

The question then becomes, does the company own the prepaid insurance and does it provide some future benefit to the company? Let’s take a look at what prepaid insurance is before we answer those questions.

Many companies buy insurance on a month-to-month basis. This means that each month the insurance is bought and by the end of the month the insurance is used up. A company that doesn’t buy insurance in advance will normally not take the time to enter prepaid insurance on their balance sheet. At the end of each month they will simply expense the insurance using the following journal entry:

Insurance Expense             $500
                        Cash                     $500

Now, some companies like to pay for their insurance in advance. For example a company might purchase a year’s worth of insurance at $6,000. In this case, when the insurance is purchased the appropriate journal entry would include a debit to prepaid insurance (an asset) and a credit to cash:

Prepaid Insurance                $6,000
                            Cash                   $6,000

Let’s go back to our two questions above. Does the company own the insurance? Well it just paid $6,000 for it so you bet it owns it. Does this insurance provide some future economic benefit? Yes it does. It insures the company and that is considered a benefit. Prepaid insurance meets all of the criteria of an asset and is thus classified.

What happens as time passes and the prepaid insurance asset is effectively used up? As time passes you simply decrease (credit) the prepaid insurance account and debit the insurance expense account. This is the journal entry after one month: ($6,000/12months = $500).

Insurance Expense          $500
                Prepaid Insurance          $500

Hopefully that clears up your question about whether prepaid insurance is an asset. The answer is yes indeedy mcgreedy. Let me know if you have any other questions.

Is Accounts Receivable an Asset or a Liability?

Jul 302011

accounts receivable assets or liabilities

As an introductory accounting teacher I get asked this question a lot. The short answer is that accounts receivable are assets.

Explanation

Let’s take a moment to remember what accounts receivables are. Accounts receivable are monies that are owed to the company. Money owed to the company represents a resource or asset to the company. You can read more about the definition of assets here, but remember that assets are resources that provide future benefit to the company. An account receivable that will be paid off in the future will definitely provide future benefit to a company.

Confusion

Students often get confused about whether accounts receivable is an asset or a liability because to one company they are an asset and to the other company they are a liability. Let’s take a look at an example.

Your company sells snow cones. You decide to name your company Snowies Delight. One particularly hot summer day a restaurant owner approaches you and buys 500 of your snow cones on account (he doesn’t pay for them now, but tells you he will pay for the snow cones in the next 30 days). You sell your snow cones for $10 each (these are premium snow cones we’re talking about here) so you now have a $5,000 account receivable from the restaurant owner. Here’s what the journal entry would look like.

Accounts Receivable        $5,000
           Sales  Revenue            $5,000

You debit accounts receivable because it is an asset. However the owner of the restaurant now has a liability. He owes you $5,000. Here is what his journal entry would look like.

Snow Cones (Inventory)           $5,000
                       Accounts Payable                 $5,000

So as you can see your accounts receivable (liability) is the restaurant owner’s account payable (liability). It’s probably best not to think too much about this. At the end of the day if your company has an accounts receivable then it is an asset.

To conclude our example and solidify in your mind that receivables are assets let’s take a look at what happens when the restaurant owner pays you the money he owes. You receive cash (an asset) and you get rid of accounts receivable (another asset). It would look like this:

Cash                           $5,000
            Accounts Receivable          $5,000

Let me know if you have any more questions.

What are Assets? Asset Definition

Jul 292011

Definition of Asset

Most textbooks define an asset as “ a resource that is owned or controlled by a company and provides a probable future economic benefit.” There is some discussion between the FASB and IASB about what the true definition of an asset should be, but let’s just keep it simple for now: an asset is item that a business owns (not that the item must have some value to be considered an asset. You can own something that has no value, trust me). The best way to understand what an asset is to look at some examples.

Examples of Assets

One of the most common assets is cash. Cash is definitely a resource that provides you with a probable future economic benefit. You can use the cash in the future to purchase something. You can almost be certain that your cash will have value in the future.

Inventory is another great example of an asset. Inventory is a good example because you can use it to really understand what an asset is. Let’s pretend that your business sells tractors. You usually sell a few tractors each day. These tractors are your business’s inventory. It is likely that they will be sold in the future and provide value to your company. They should be listed as assets on the balance sheet.

Now let’s pretend that your business bought some tractors 20 years ago. For some reason these tractors never sold and you are likely never going to sell them. The truth is you know that there isn’t any chance in the world that these tractors are going to be sold and they are basically worthless. These tractors aren’t going to provide you a future economic benefit and thus they should not be listed as an asset on your balance sheet.

asset examples

Classic Assets

List of Other Assets

  • Equipment
  • Office Supplies
  • Buildings
  • Land
  • Patents

Accounts Receivable

Accounts receivable are another interesting asset. An account receivable is simply money that is owed to your business from customers. They bought something on account. If it is probable that your customers will pay, then you should list these receivables as an asset. If you know that the customer isn’t going to pay, then you probably shouldn’t list the receivables as an asset.

There are Several Categories of Assets:

Current Assets:  These are the resources of the company that are expected to be used within one year. Common examples include cash, inventory, and accounts receivable.

Long Term or Fixed Assets: These are the assets that will be around for longer than a year. Common examples include land, buildings, and equipment.

Intangible Assets: These are a company’s assets that are not physical. Common examples include goodwill, patents, and copyrights. Intangibles are more ideas than physical items.

At the end of the day remember that the definition of an asset is an item that the business owns that provides some benefit to the company.

Steps in the Accounting Cycle

Jul 292011
steps in the accounting cycle

The journey of an accountant is very exciting, albeit circular.

The whole purpose of the accounting cycle (also known as the accounting process or system) is to capture all of a company’s economic events or transactions and then output this information in an understandable format. Let’s start with what the outputs from the accounting cycle are and with the end in mind we will be able to begin.

Outputs from the Accounting Cycle or Process or System

  • Financial statements
  • Managerial reports or other insider reports
  • Tax reports to comply with IRS
  • Reports for regulatory bodies like the SEC

Okay, so we now know what it is we are trying to produce. Well, how do we get there? It is quite the journey, but the joy of life is in the journey. Below you will be taken on the best journey that accounting has to offer.

Steps in the Accounting Cycle

Step 1 Step 1 – A business transaction of some sort occurs. A sale, a purchase of inventory, any type of transaction. Business documents (invoices, purchase orders, receipts, etc.) are generated.

step2Step 2 – The transaction is analyzed by the accountant. Normally the accountant isn’t there for the transaction because most business owners don’t want their accountants seen by real people. This means that in reality the accountant analyzes the documents instead of the transaction itself.

Step 1Step 3 – The transaction is recorded in a journal entry. You’ll need to learn all about debits and credits to do this. You can learn more about them on this site.

step3

Step 4 – From the journal entry the transaction is posted to the individual ledgers. The ledgers are just accounts that hold information about the individual assets, liabilities, and owners’ equity of a company.

Step 5

Step 5 – A trial balance is prepared. The trial balance simply lists all the balances from the individual ledgers. This is a nice check on the accuracy of your journal entries and posting.

step6

Step 6 – The journey continues with adjusting entries. Adjusting entries are often necessary because all of the accounting information has not been recorded. There are several reasons why almost all businesses have adjusting entries (we’ll get into that at a later time).

Step 7

Step 7 – Prepare the financial statements (or other reports). From the trial balance and adjusting entries, the financial statements are made. Nowadays accounting software will aggregate the information for you and prepare the statements.

step8

Step 8 – Close all the nominal accounts. Remember that nominal or temporary accounts don’t have a running balance. At the end of each year these accounts are closed out to zero and their balances head on over to retained earnings. The income statement has most of the nominal accounts and the balance sheet has most of the permanent accounts, i.e., the accounts that have a running balance.

You have reached your final destination and the end of the accounting cycle. However, you should realize that it is indeed a cycle meaning that it never ends. After each report is generated you simply start over again.

Two Phases in the Accounting Cycle

Note: Most accounting professors break this cycle up into two different phases: the recording phase and the reporting phase. The recording phase includes three parts: the documents being analyzed, the journal entries being recorded, and the transactions being posted to the ledgers. The reporting phase includes four parts: the trial balance, adjusting entries, financial statements and nominal accounts. I personally don’t think it’s that beneficial to memorize these phases or the cycle in general. However, the steps in the accounting cycle are very useful to see how information about transactions gets to the financial statements and other end reports.

Double Entry Accounting. Is there another way?

Jul 282011

A lot of people get their pants all up in a wad when they start hearing about double-entry bookkeeping or accounting. Allow me to be frank with you: nowadays double-entry accounting is all that there is. In other words, don’t fret for one millisecond about the difference between double-entry accounting and single entry accounting because single entry accounting simply doesn’t exist. All the accounting software out there and all the businesses are using double-entry accounting. In addition, all the schools teach double-entry accounting as well. If you want to learn double-entry accounting then I invite you to start at The ClockWork Accounting School (it’s a fun place to learn accounting).

What is Double Entry Accounting?

In the accounting world there is an equation that must be strictly obeyed: Assets = Liabilities + Owners Equity. Each time a transaction occurs, part of this equation changes. Assets go up or down, liabilities change, etc. For example when Wal-Mart purchases bicycle inventory on credit (or account) then Wal-Mart’s assets go up and so do their liabilities (the amount owed to the company that sold the bicycles).

Every transaction really has two things occurring. That’s why it’s a transaction right? I mean the very definition of a transaction is that you have two parties involved who are exchanging something. In order to completely capture the transaction you need to make more than one entry. In the Wal-Mart example above, Wal-Mart needs to capture the fact that it just received bicycles (first entry) and the fact that it now owes money to a bicycle shop (second entry).

double-entry accounting

You need to learn about debits and credits if you want to understand all of this and to do that you’ll need to start from the beginning. Just head on over to my home page if you really want to learn about accounting. Real accountants who know what they are talking about never even utter the words double-entry accounting because that is all they know (no one teaches anything else).  From now on when you get tempted to say it, just replace it with the word accounting. You want to learn accounting and that’s that. I get frustrated when people start talking double-entry bookkeeping because it just causes stress and anxiety to those who are learning accounting.

ACCOUNTING = DOUBLE ENTRY ACCOUNTING and that’s all there is to it folks.

I honestly feel dumber for having had this conversation.

Common Journal Entries

Jul 282011

This is a popular section for those who want to brush up on their journal entries. Sometimes it’s hard to remember the exact double-entry accounting journal entry for a certain transaction. I’ve listed all the common journal entries below that I could think of. Is there a specific transaction that you would like to see the journal entry for that isn’t listed below? Send me an email at clockworkaccountant@gmail.com and I’ll list the journal entry here.

common journal entries partpopular journal entries

Accounting Ethics

Jul 272011

accounting ethics

Some people see accounting as a land of hard and fast rules. A place where debits are on the left and credits are on the right. They don’t see accounting as a place where tough decisions are made and ethical dilemmas are prevalent. People who see accounting like this are wrong. The truth is most professional accountants have to make a lot of tough decisions. These decisions will impact the way creditors, investors, managers, and other end users of accounting information act. Accountants have the ability to sway these decision makers for better or for worse. In the end, one of the traits accountants need more than anything is integrity, i.e., the ability to make ethical decisions.

There is a common joke amongst accountants. The joke goes that one day an accountant is interviewing for a job. The owner of the business asks the accountant, “What’s two plus two?” The accountant then closes the door and draws the blinds. He looks at the business owner with a slightly mischievous smile on his face and whispers, “What do you want it to be?” This joke illustrates how much influence accountants have over the financial statements. Managers’ careers and performance incentives are based on numbers like net income and earnings per share. Accountants have the ability to influence these numbers dramatically while still acting within the realm of generally accepted accounting principles. Accounting is not always as straight forward as it seems upon first glance.

Increased Attention to Accounting Ethics

In recent years there has been a push toward a more ethical accounting society. The Enron and WorldCom debacles have made it so society as a whole knows a lot more about the decisions accountants make. You can go here to read a brief summary of the Enron Scandal. At the end of the day Enron and WorldCom were manipulating their accounting information in order to make their companies look better on the financial statements. Remember that looking good on the financial statements can be the difference between success and failure for a company.

Code of Ethics for Professional Accountants

Accountants have a code of professional conduct just like doctors and lawyers. Accountants might not be performing heart surgery but they are influencing people’s well-being. Accounting ethics are so important that there are several bodies that dedicate themselves to coming up with ethical codes for accountants. In the United States the AICPA code of ethics is the most important. You can find the AICPA Code of Professional Conduct here: http://www.aicpa.org/Research/Standards/CodeofConduct/Pages/default.aspx . The code is quite large and it dictates how accountants should act under certain situations.

CPA Ethics Exam

Ethics are so important in accounting, that there is a specific ethics test that most states require before you can become a Certified Public Accountant. This exam is usually taken after you pass the Uniform CPA Exam. Some states like Texas require that accountants take a specific course before they are allowed to become a CPA.

One Example of Ethical Decisions Accountants Face on a Regular Basis

It’s your first year out of college and you are working for a mid-sized corporation. You are in charge of accounts receivable. At the end of the year you have to estimate the amount of your company’s receivables that won’t be collectible and then you have to make a bad debt expense entry that will impact the net income of your company. You carefully analyze the receivables and your best judgment says that about 10% of the receivables won’t be collectible 10% of $10,000,000 is $1,000,000. “Wow,” you think to yourself, “a million dollar expense is going to hurt our company’s profitability.” Well it turns out you aren’t the only one who feels this way. The owner of the company says he wants to talk with you in private. He tells you that he likes your work, but that your estimate is a bit too high. He thinks a 5% estimate is much better. That’s a difference of $500,000! He tells you that life won’t be good if you don’t lower the bad debt expense of the company. You spend the rest of the day at work wondering what you should do. You know that 10% is more accurate and ethically the right thing to do, but then again you want to keep your job.

Hopefully this example illustrates to you how difficult it can be to make the correct, ethical decision in the accounting world. Accountants have to make tough decisions like this every day.

As business transactions become more complex and accountants have to make more difficult judgments, ethics will play an increasing role in accounting society. Learn your ethical responsibility and do it.

Accounting Careers

Jul 272011

accounting careers

Contrary to popular belief there are lots of career options available for accountants. Many outsiders believe that all accountants study tax. Tax can be a great career choice but there are many different options available. Below is a list of accounting careers:

  • Audit
  • Tax
  • Corporate Accounting
  • Consulting

Careers in Audit – Almost all large corporations have their financial statements audited. Auditing is the process of ensuring that the financial statements generated by the corporation are materially correct. This is an important job. Many people use the information on these financial statements to make important life decisions. Auditors must be trustworthy and willing to take a stand when something looks fishy. In addition auditors need to have the ability to pay attention to details, work long hours during the busy season, and get along with a team. Most auditors work in teams of at least four or five.

One of the greatest benefits of an auditing career is the clear line of promotion. Auditors at big accounting firms (The Big 4) start out as staff auditors. After two to three years, almost all staff auditors become senior auditors. After another two to three years almost all senior auditors become managers. Add another two to three years of work and you become a senior manager. After another few years (and if you are really good) then you have the chance to become a partner.

careers in audit

I don’t know of any other career that offers such a straight line of promotion. As long as you are doing your job you are almost guaranteed promotion up until the partner stage. At the partner stage, the accounting firm will usually only accept the best. At this stage, the company won’t fire a senior manager, but they will usually let them know they aren’t going to be promoted to partner (this usually means that the senior manager ends up leaving on his or her own).

Now, you should know that it’s not all cream and butterflies within an auditing career. The work is grueling and somewhat tedious. Long hours staring at Excel spreadsheets and financial statements has a tendency to warp the brain. Even though the line of promotion is so clear, very few make it to manager and senior manager. People don’t make it to manager because they simply leave the firm before they make it there. Some estimate 80% turnover within the first two years of an auditing career. That means that after two years only 20% of the people haven’t quit. How’s that for hard work? If you like auditing (or if you can even stomach the stuff) then it’s an excellent career choice with a clear path to the top.

Tax Accounting Careers – This is the career path that many people already know about. These accountants help individuals or corporations prepare their taxes. One advantage of a tax accounting career is that the people you are helping generally love you (as opposed to audit where the relationship is tenuous at best). With a tax career you can work for a CPA firm, a local corporation, the IRS, or as a business owner. It’s a rewarding and profitable career for those who enjoy it.

Corporate Accounting – Accountants that work in a corporation have several jobs. (1) They prepare the financial statements that get audited by the auditors. (2) They do the bookkeeping for the business. (3) They prepare financial information that helps the managers of the company make decisions (managerial accounting). (4) They prepare the tax information for the company. (5) They perform an internal auditing function where they audit the work of their fellow accountants within the business and report what they find to management. Depending on the size of the corporation, an accountant may only perform one of these functions or he may perform all of them.

Consulting – Accountants are also needed for consulting purposes. They consult companies about how to set up an accounting system (some accountants specialize in setting up accounting systems within certain industries—like accounting systems for dentists, doctors, or restaurants). They consult companies about how to set up their taxes. Nowadays, accountants who are well-versed in information systems consult companies about how to set up their information systems in a way that will help with internal controls.

As you can see, there are many types of accounting careers. This list isn’t mean to be comprehensive (I don’t think you can make a comprehensive list of all the jobs that accountants have). However, it does give you a great feel for the type of work you will be performing if you decide to be an accountant.

 

Ask the Professor a Question

Jul 262011

Is there an accounting topic you don’t understand? Do you want advice about accounting degrees, bookkeeping, or accounting software? Is there a feature you would like added to the site?

Sounds like it’s time for you to talk to the Professor.

You can get a hold of me easily through email (clockworkaccountant@gmail.com) or by simply leaving a comment below. I check my email on a regular basis and I’m very willing to answer questions. I’m also happy to add new features to the site, so if you have any ideas then please let me know.

NatePic

Nate Waddoups

 Credentials 

  • Bachelor of Science in Accounting from Brigham Young University BYU (#1 Ranked Accounting School in the world according to Wall Street Journal and others—depending on the year of course).
  • Master of Accountancy from Brigham Young University (Top 5 Ranked Accounting Master’s Program in the world).
  • High Distinction Award, Beta Gamma Sigma Member, Phi Kappa Phi Member, Magna Cum Laude
  • Worked at Ernst & Young (Big 4 Accounting Firm)
  • Great enthusiasm for teaching

 

Older Entries Newer Entries
© 2011 ClockWork Accounting Suffusion theme by Sayontan Sinha