Principles Of Accounting

 

What is the full disclosure principle?

 For a business, the full disclosure principle requires a company to provide the necessary information so that people who are accustomed to reading financial information can make informed decisions concerning the company.
The required disclosures can be found in a number of places including the following:
- the company’s financial statements including any supplementary schedules and notes (or footnotes).
- Management’s Discussion and Analysis that is included in a publicly-traded corporation’s annual report to the U.S. Securities and Exchange Commission.
- Quarterly earnings reports, press releases and other communications.
The first note or footnote in a company’s financial statements will disclose the significant accounting policies such as how and when revenues are recognized, how property is depreciated, how inventory and income taxes are accounted for, and more.
Other disclosures in the notes to the financial statements include the effects of foreign currencies, contingent liabilities, leases, related-party transactions, stock options, and much more.
Judgement is used in deciding the amount of information that is disclosed. For example, in 1980 large U.S. corporations were required to report as supplementary information the effects of inflation and changing prices on its inventory and property (and cost of goods sold and depreciation expense). After several years, the disclosure became optional since the cost of providing the information exceeded the benefits.

What are the accounting principles, assumptions, and concepts?

The basic or fundamental principles in accounting are the cost principle, full disclosure principle, matching principle, revenue recognition principle, economic entity assumption, monetary unit assumption, time period assumption, going concern assumption, materiality, and conservatism. The last two are sometimes referred to as constraints. Rather than distinguishing between a principle or an assumption, I prefer to simply say that these ten items are the basic principles or the underlying guidelines of accounting. (My reason is that accounting principles also include the statements of financial accounting standards and the interpretations issued by the Financial Accounting Standards Board and its predecessors, as well as industry practices.)
There are also “qualities” of accounting information such as reliability, relevance, consistency, comparability, and cost/benefit. These are discussed in the Statement of Financial Accounting Concepts No. 2, which can be found on the Financial Accounting Standards Board’s website www.FASB.org/st.

What is principles of accounting?

Three meanings come to mind when you ask about principles of accounting…
1. Principles of Accounting was often the title of the introductory course in accounting. It was also common for the textbook used in the course to be entitled Principles of Accounting.
2. Principles of accounting can also refer to the basic or fundamental accounting principles: cost, matching, full disclosure, materiality, going concern, economic entity, and so on. In this context, principles of accounting refers to the broad underlying concepts which guide accountants when preparing financial statements.
3. Principles of accounting can also mean generally accepted accounting principles (GAAP). When used in this context, principles of accounting will include both the underlying basic accounting principles and the official accounting pronouncements issued by the Financial Accounting Standards Board (FASB) and its predecessor organizations. The official pronouncements are detailed rules or standards for specific topics.

Prepaid Expenses-Accounting

What are prepaid expenses?

Prepaid expenses are future expenses that have been paid in advance. You can think of prepaid expenses as costs that have been paid but have not yet been used up or have not yet expired. The amount of prepaid expenses that have not yet expired are reported on a company’s balance sheet as an asset. As the amount expires, the asset is reduced and an expense is recorded for the amount of the reduction. Hence, the balance sheet reports the unexpired costs and the income statement reports the expired costs. The amount reported on the income statement should be the amount that pertains to the time interval shown in the statement’s heading.

A common prepaid expense is the six-month premium for insurance on a company’s vehicles. Since the insurance company requires payment in advance, the amount paid is often recorded in the current asset account Prepaid Insurance. If the company issues monthly financial statements, its income statement will report Insurance Expense that is one-sixth of the amount paid. The balance in the account Prepaid Insurance will be reduced by the amount that was debited to Insurance Expense.

 

When do you adjust the amount of prepaid expenses?

The balance in the current asset account Prepaid Expenses should be adjusted prior to issuing a company’s financial statements. If the company issues financial statements for each calendar month, you will need to adjust the balance in Prepaid Expenses as of the end of each month. If your company issues only quarterly financial statements, you will need to adjust the balance at the end of each quarter.
The goal is to have the balance in Prepaid Expenses be equal to the amount of the unexpired costs as of the end of the accounting period (which is also the date appearing in the heading of the balance sheet).
Usually the adjusting entry for prepaid expenses will be a credit to Prepaid Expenses and a debit to the appropriate expense account(s). For instance, if Prepaid Expenses involve the prepayment of insurance premiums the adjusting entry will include a debit to Insurance Expenses.

What are the two methods for recording prepaid expenses?

The two methods for recording prepaid expenses have to do with the general ledger account that is initially debited at the time of the cash payment. The two methods or approaches are:
1. debit an asset account (such as Prepaid Insurance) which is the balance sheet method, or
2. debit an expense account (such as Insurance Expense) which is the income statement method.
The use of either method will almost always require an adjusting entry prior to issuing the company’s financial statements. However, the amount, the account that will be debited, and the account that will be credited in the adjusting entry will depend on the method used.
In short, either the balance sheet method or the income statement method for recording prepaid expenses may be used as long as the asset account balance is equal to the unexpired or unused cost as of the balance sheet date.

How should the cost of a yearly subscription for a newspaper be recorded?

In theory, the payment in advance for a one-year subscription should initially be recorded as a debit to Prepaid Expenses and a credit to Cash. During the subscription period, you would debit Subscription Expense and would credit Prepaid Expenses.
For example, if the annual subscription cost is $240 and it is paid in advance, you would initially debit Prepaid Expenses for $240 and credit Cash for $240. If your company issues monthly financial statements, then each month during the subscription period you would debit Subscription Expense for $20 and credit Prepaid Expenses for $20. This results in 1) the matching of $20 to expense on each of the monthly income statements, and 2) the balance sheet reporting the amount that is prepaid or not yet expired.
At a large company, the annual cost of $240 will usually be an immaterial amount. The materiality concept will allow you to violate the matching principle, and to avoid the monthly adjusting entry, by simply debiting Subscription Expense for the entire $240 at the beginning of the one-year subscription period.

Hoja de Balance y Cuenta de Resultados

CURSO DE CONTABILIDAD

 

Este curso de contabilidad es un curso gratuito, destinado a toda aquella persona interesada en conocer y dominar la Contabilidad y que no disponga del tiempo libre necesario para poder asistir a un curso presencial.

También, este curso va a ser de gran utilidad para el estudiante universitario que necesite de una herramienta de consulta y de apoyo en el seguimiento de esta asignatura.

Este curso tiene como objetivo que el estudiante alcance un dominio pleno de las técnicas contables, igual o superior al que podría obtener en cursos presenciales.



 1. BALANCE Y CUENTA DE RESULTADOS

La contabilidad es una herramienta que nos ayuda a conocer la situación financiera de una empresa. Se elaboran diversos documentos, pero inicialmente nos vamos a centrar en los dos principales: el Balance y la Cuenta de Resultados.


A. Balance

El Balance nos permite conocer la situación financiera de la empresa en un momento determinado: el Balance nos dice lo que tiene la empresa y lo que debe.

El Balance se compone de dos columnas: el Activo (columna de la izquierda) y el Pasivo (columna de la derecha).

En el Activo se recogen los destinos de los fondos y en el Pasivo los orígenes.

Vamos a explicarnos: si una empresa pide un crédito a un banco para comprar un camión, el crédito del banco irá en el Pasivo (es el origen de los fondos que entran en la empresa), mientras que el camión irá en el Activo (es el destino que se le ha dado al dinero que ha entrado en la empresa).

Las términos Activo y Pasivo pueden dar lugar a confusión, ya que pudiera pensarse que el Activo recoge lo que tiene la empresa y el Pasivo lo que debe. Esto no es correcto, ya que por ejemplo los fondos propios van en el Pasivo.

¿Y por qué van los fondos propios en el Pasivo?

La respuesta es porque son orígenes de fondos.

Si, por ejemplo, en el caso anterior se hubiera financiado la compra del camión con aportaciones de los socios: ¿cuál sería el origen de los fondos que entran en la empresa? los fondos propios aportados por los accionistas.

Vamos a distinguir entre varios Balances, según el momento en que se obtengan: Balance de apertura: al comienzo del ejercicio; nos permite conocer con que recuros cuenta la empresa para iniciar su ejercicio económico. Balances parciales: a cierre del mes, trimestre, semestre, o con la periodicidad que se quiera; nos permite conocer la situación de la empresa en esos momentos determinados. Balance final: al cierre del ejercicio; nos permite conocer como queda la situación financiera de la empresa una vez finalizado su ejercicio económico (normalmente el 31 de diciembre, aunque podría ser otra fecha del año).

Ejemplos de Transacciones de Contabilidad

Accounting Sample Transaction
The fourth transaction occurs on December 3, when a customer gives Direct Delivery a check for $10 to deliver two parcels on that day. Because of double entry, we know there must be a minimum of two accounts involved—one of the accounts must be debited, and one of the accounts must be credited.


Because Direct Delivery received $10, it must debit the account Cash. It must also credit a second account for $10. The second account will be Service Revenues, an income statement account. The reason Service Revenues is credited is because Direct Delivery must report that it earned $10 (not because it received $10). Recording revenues when they are earned results from a basic accounting principle known as the revenue recognition principle. The following tip reflects that principle.

Revenues accounts are credited when the company earns a fee (or sells merchandise) regardless of whether cash is received at the time.

Here are the two parts of the transaction as they would look in the general journal format:

Account Name

Debit

Credit

Cash

10

Service Revenues

10

Accounting Sample Transaction
Let's assume that on December 3 the company gets its second customer—a local company that needs to have 50 parcels delivered immediately. Joe's price of $250 is very appealing, so Joe's company is hired to deliver the parcels. The customer tells Joe to submit an invoice for the $250, and they will pay it within seven days.

Joe delivers the 50 parcels on December 3 as agreed, meaning that on December 3 Direct Delivery has earned $250. Hence the $250 is reported as revenues on December 3, even though the company did not receive any cash on that day. The effort needed to complete the job was done on December 3. (Depositing the check for $250 in the bank when it arrives seven days later is not considered to take any effort.)

Let's identify the two accounts involved and determine which needs a debit and which needs a credit.

Because Direct Delivery has earned the fees, one account will be a revenues account, such as Service Revenues. (If you refer back to the last TIP, you will read that revenue accounts —such as Service Revenues—are usually credited, meaning the second account will need to be debited.)

In the general journal format, here's what we have identified so far:

Account Name

Debit

Credit

???

250

Service Revenues

250

We know that the unnamed account cannot be Cash.

Account Name

Debit

Credit

Accounts Receivable

250

Service Revenues

250

Again, reporting revenues when they are earned results from the basic accounting principle known as the revenue recognition principle.




Accounting Sample Transaction
For simplicity, let's assume that the only expense incurred by Direct Delivery so far was a fee to a temporary help agency for a person to help Joe deliver parcels on December 3. The temp agency fee is $80 and is due by December 12.

If a company does not pay cash immediately, you cannot credit Cash. But because the company owes someone the money for its purchase, we say it has an obligation or liability to pay. Most accounts involved with obligations have the word "payable" in their name, and one of the most frequently used accounts is Accounts Payable. Also keep in mind that expenses are almost always debited.

The accounts and amounts for the temporary help are:

Account Name

Debit

Credit

Temporary Help Expense

80

Accounts Payable

80

Expenses are (almost) always debited.

If a company does not pay cash right away for an expense or for an asset, you cannot credit Cash. Because the company owes someone the money for its purchase, we say it has an obligation or liability to pay. The most likely liability account involved in business obligations is Accounts Payable.

Revenues and expenses appear on the income statement as shown below:

Direct Delivery, Inc. Income Statement For the Three Days Ended December 3, 2011 Service Revenues $ 260 Temporary Help Expense      80 Net Income $ 180

After the entries through December 3 have been recorded, the balance sheet will look like this:

Direct Delivery, Inc. Balance Sheet December 3, 2011 Assets Liabilities & Stockholders' Equity Cash $   4,810 Liabilities Accounts Receivable 250 Accounts Payable $        80 Prepaid Insurance 1,200 Stockholders' Equity Vehicles 14,000 Common Stock 20,000 Retained Earnings         180 Total Stockholders' Equity 20,180 Total Assets $ 20,260 Total Liab. & Stockholders' Equity $ 20,260

Notice that the year-to-date net income (bottom line of the income statement) increased Stockholders' Equity by the same amount, $180. This connection between the income statement and balance sheet is important. For one, it keeps the balance sheet and the accounting equation in balance. Secondly, it demonstrates that revenues will cause the stockholders' equity to increase and expenses will cause stockholders' equity to decrease. After the end of the year financial statements are prepared, you will see that the income statement accounts (revenue accounts and expense accounts) will be closed or zeroed out and their balances will be transferred into the Retained Earnings account. This will mean the revenue and expense accounts will start the new year with zero balances—allowing the company "to keep score" for the new year.


Marilyn suggested that perhaps this introduction was enough material for their first meeting. She wrote out the following notes, summarizing for Joe the important points of their discussion:

1. When a company pays cash for something, the company will credit Cash and will have to debit a second account. Assuming that a company prepares monthly financial statements—
   
   
   • If the amount is used up or will expire in the current month, the account to be debited will be an expense account. (Advertising Expense, Rent Expense, Wages Expense are three examples.)
     
   • If the amount is not used up or does not expire in the current month, the account to be debited will be an asset account. (Examples are Prepaid Insurance, Supplies, Prepaid Rent, Prepaid Advertising, Prepaid Association Dues, Land, Buildings, and Equipment.)
     
   • If the amount reduces a company's obligations, the account to be debited will be a liability account. (Examples include Accounts Payable, Notes Payable, Wages Payable, and Interest Payable.)
     
2. When a company receives cash, the company will debit Cash and will have to credit another account. Assuming that a company will prepare monthly financial statements—
   
   
   • If the amount received is from a cash sale, or for a service that has just been performed but has not yet been recorded, the account to be credited is a revenue account such as Service Revenues or Fees Earned.
     
   • If the amount received is an advance payment for a service that has not yet been performed or earned, the account to be credited is Unearned Revenue.
     
   • If the amount received is a payment from a customer for a sale or service delivered earlier and has already been recorded as revenue, the account to be credited is Accounts Receivable.
     
   • If the amount received is the proceeds from the company signing a promissory note, the account to be credited is Notes Payable.
     
   • If the amount received is an investment of additional money by the owner of the corporation, a stockholders' equity account such as Common Stock is credited.
     
   
   
3. Revenues are recorded as Service Revenues or Sales when the service or sale has been performed, not when the cash is received. This reflects the basic accounting principle known as the revenue recognition principle.
4. Expenses are matched with revenues or with the period of time shown in the heading of the income statement, not in the period when the expenses were paid. This reflects the basic accounting principle known as the matching principle.
5. The financial statements also reflect the basic accounting principle known as the cost principle. This means assets are shown on the balance sheet at their original cost or less and not at their current value. The income statement expenses also reflect the cost principle. For example, the depreciation expense is based on the original cost of the asset being depreciated and not on the current replacement cost.

Samples of Acounting Transactions

Sample Transactions 

Sample Transaction
Marilyn illustrates for Joe a second transaction. On December 2, Direct Delivery purchases a used delivery van for $14,000 by writing a check for $14,000. The two accounts involved are Cash and Vehicles (or Delivery Equipment). When the check is written, the accounting software will automatically make the entry into these two accounts.

Marilyn explains to Joe what is happening within the software. Since the company pays $14,000, the Cash account is credited. (Accountants consider the checking account to be Cash, and the TIP you learned is that when cash is paid, you credit Cash.) So we know that the Cash account will be credited for $14,000 and we know the other account will have to be debited for $14,000. We need only identify the best account to debit. In this case we choose Vehicles (or Delivery Equipment) and the entry is:

Account Name

Debit

Credit

Vehicles

14,000

Cash

14,000

The balance sheet will look like this after the vehicle transaction is recorded:

Direct Delivery, Inc. Balance Sheet December 2, 2011 Assets Liabilities & Stockholders' Equity Cash $   6,000 Liabilities Vehicles 14,000 Stockholders' Equity                Common Stock $ 20,000 Total Assets $ 20,000 Total Liab. & Stockholders' Equity $ 20,000

The balance sheet and the accounting equation remain in balance:

Assets	=	Liabilities	+	Stockholders' (or Owner's) Equity
$20,000	=	$0	+		$20,000

As you can see in the balance sheet, the asset Cash decreased by $14,000 and another asset Vehicles increased by $14,000. Liabilities and stockholders' equity were not involved and did not change.



Sample Transaction
The third sample transaction also occurs on December 2 when Joe contacts an insurance agent regarding insurance coverage for the vehicle Direct Delivery just purchased. The agent informs him that $1,200 will provide insurance protection for the next six months. Joe immediately writes a check for $1,200 and mails it in.

Let's consider this transaction. Using double entry, we know there must be a minimum of two accounts involved—one (or more) of the accounts must be debited, and one (or more) must be credited.

Since a check is written, we know that one of the accounts involved is Cash. Since cash was paid, the Cash account will be credited. (Take another look at the last TIP.) While we have not yet identified the second account, what we do know for certain is that the second account will have to be debited.

At this point we have most of the entry—all we are missing is the name of the account to be debited:

Account Name

Debit

Credit

whats the name

1,200

Cash

1,200

We know the transaction involves insurance, and a quick look through the chart of accounts reveals two possibilities:

Prepaid Insurance (an asset account reported on the balance sheet) and Insurance Expense (an expense account reported on the income statement)

Assets include costs that are not yet expired (not yet used up), while expenses are costs that have expired (have been used up). Since the $1,200 payment is for an expense that will not expire in its entirety within the current month, it would be logical to debit the account Prepaid Insurance. (At the end of each month, when $200 has expired, $200 will be moved from Prepaid Insurance to Insurance Expense.)

The entry in the general journal format is:

Account Name

Debit

Credit

Prepaid Insurance

1,200

Cash

1,200

After the first three transactions have been recorded, the balance sheet will look like this:

Direct Delivery, Inc. Balance Sheet December 2, 2011 Assets Liabilities & Stockholders' Equity Cash $   4,800 Liabilities Prepaid Insurance 1,200 Stockholders' Equity Vehicles    14,000 Common Stock $ 20,000 Total Assets $ 20,000 Total Liabilities & Stockholders' Equity $ 20,000

Again, the balance sheet and the accounting equation are in balance and all of the changes occurred on the asset/left/debit side of the accounting equation. Liabilities and Stockholders' Equity were not affected by the insurance transaction.

Statement of Cash Flow

English: Statement of Cash Flows of San Narciso, Zambales (Photo credit: Wikipedia)

Statement of Cash Flows

The third financial statement that Joe needs to understand is the Statement of Cash Flows. This statement shows how a company cash amount has changed during the time interval shown in the heading of the statement. Joe will be able to see at a glance the cash generated and used by his company's operating activities, its investing activities, and its financing activities. Much of the information on this financial statement will come from Direct Delivery's balance sheets and income statements.


The three financial reports that Marilyn introduced to Joe—the income statement, the balance sheet, and the statement of cash flows—represent one segment of the valuable output that good accounting software can generate for business owners.
Marilyn now explains to Joe the basics of getting started with recording his transactions.

Whats the Double Entry System

The field of accounting—both the older manual systems and today's basic accounting software—is based on the 500-year-old accounting procedure known as double entry. Double entry is a simple yet powerful concept: each and every one of a company's transactions will result in an amount recorded into at least two of the accounts in the accounting system.

The Chart of Accounts
To begin the process of setting up Joe's accounting system, he will need to make a detailed listing of all the names of the accounts that Direct Delivery, Inc. might find useful for reporting transactions. This detailed listing is referred to as a chart of accounts. (Accounting software often provides sample charts of accounts for various types of businesses.)

As he enters his transactions, Joe will find that the chart of accounts will help him select the two (or more) accounts that are involved. Once Joe's business begins, he may find that he needs to add more account names to the chart of accounts, or delete account names that are never used. Joe can tailor his chart of accounts so that it best sorts and reports the transactions of his business.

Because of the double entry system all of Direct Delivery's transactions will involve a combination of two or more accounts from the balance sheet and/or the income statement. Marilyn lists out some sample accounts that Joe will probably need to include on his chart of accounts:

Balance Sheet accounts:

• Asset accounts (Examples: Cash, Accounts Receivable, Supplies, Equipment)
• Liability accounts (Examples: Notes Payable, Accounts Payable, Wages Payable)
• Stockholders' Equity accounts (Examples: Common Stock, Retained Earnings)

Income Statement accounts:

• Revenue accounts (Examples: Service Revenues, Investment Revenues)
• Expense accounts (Examples: Wages Expense, Rent Expense, Depreciation Expense)

To help Joe really understand how this works, Marilyn illustrates the double entry with some sample transactions that Joe will likely encounter.

Sample Transactions #1

On December 1, 2011 Joe starts his business Direct Delivery, Inc. The first transaction that Joe will record for his company is his personal investment of $20,000 in exchange for 5,000 shares of Direct Delivery's common stock. Direct Delivery's accounting system will show an increase in its account Cash from zero to $20,000, and an increase in its stockholders' equity account Common Stock by $20,000. Both of these accounts are balance sheet accounts. There are no revenues because no delivery fees were earned by the company, and there were no expenses.

After Joe enters this transaction, Direct Delivery's balance sheet will look like this:

Direct Delivery, Inc. Balance Sheet December 1, 2011 Assets Liabilities & Stockholders' Equity Cash $ 20,000 Liabilities Stockholders' Equity                Common Stock $ 20,000 Total Assets $ 20,000 Total Liab. & Stockholders' Equity $ 20,000

Marilyn asks Joe if he can see that the balance sheet is just that—in balance. Joe looks at the total of $20,000 on the asset side, and looks at the $20,000 on the right side, and says yes, of course, he can see that it is indeed in balance.

Marilyn shows Joe something called the basic accounting equation, which, she explains, is really the same concept as the balance sheet, it's just presented in an equation format:

Assets	=	Liabilities	+	Stockholders' (or Owner's) Equity
$20,000	=	$0	+		$20,000

The accounting equation (and the balance sheet) should always be in balance.



Debits and Credits
Did the first sample transaction follow the double entry system and affect two or more accounts? Joe looks at the balance sheet again and answers yes, both Cash and Common Stock were affected by the transaction.

Marilyn introduces the next basic accounting concept: the double entry system requires that the same dollar amount of the transaction must be entered on both the left side of one account, and on the right side of another account. Instead of the word left, accountants use the word debit; and instead of the word right, accountants use the word credit. (The terms debit and credit are derived from Latin terms used 500 years ago.)

Debit means left.
Credit means right.

Joe asks Marilyn how he will know which accounts he should debit—meaning he should enter the numbers on the left side of one account—and which accounts he should credit—meaning he should enter the numbers on the right side of another account. Marilyn points back to the basic accounting equation and tells Joe that if he memorizes this simple equation, it will be easier to understand the debits and credits.

Memorizing the simple accounting equation will
help you learn the debit and credit rules for
entering amounts into the accounting records.

Let's take a look at the accounting equation again:

Assets

=

Liabilities

+

Stockholders' (or Owner's) Equity

Just as assets are on the left side (or debit side) of the accounting equation, the asset accounts in the general ledger have their balances on the left side. To increase an asset account's balance, you put more on the left side of the asset account. In accounting jargon, you debit the asset account. To decrease an asset account balance you credit the account, that is, you enter the amount on the right side.

Just as liabilities and stockholders' equity are on the right side (or credit side) of the accounting equation, the liability and equity accounts in the general ledger have their balances on the right side. To increase the balance in a liability or stockholders' equity account, you put more on the right side of the account. In accounting jargon, you credit the liability or the equity account. To decrease a liability or equity, you debit the account, that is, you enter the amount on the left side of the account.

As with all rules, there are exceptions, but Marilyn's reference to the accounting equation may help you to learn whether an account should be debited or credited.

Since many transactions involve cash, Marilyn suggests that Joe memorize how the Cash account is affected when a transaction involves cash: if Direct Delivery receives cash, the Cash account is debited; when Direct Delivery pays cash, the Cash account is credited.

When a company receives cash, the Cash account is debited.

When the company pays cash, the Cash account is credited.

Marilyn refers to the example of December 1. Since Direct Delivery received $20,000 in cash from Joe in exchange for 5,000 shares of common stock, one of the accounts for this transaction is Cash. Since cash was received, the Cash account will be debited.

In keeping with double entry, two (or more) accounts need to be involved. Because the first account (Cash) was debited, the second account needs to be credited. All Joe needs to do is find the right account to credit. In this case, the second account is Common Stock. Common stock is part of stockholders' equity, which is on the right side of the accounting equation. As a result, it should have a credit balance, and to increase its balance the account needs to be credited.

Accountants indicate accounts and amounts using the following format:

Account Name

Debit

Credit

Cash

20,000

Common Stock

20,000

Accountants usually first show the account and amount to be debited. On the next line, the account to be credited is indented and the amount appears further to the right than the debit amount shown in the line above. This entry format is referred to as a general journal entry.

(With the decrease in the price of computers and accounting software, it is rare to find a small business still using a manual system and making entries by hand. Accounting software has made the process of recording transactions so much easier that the general journal is rarely needed. In fact, entries are often generated automatically when a check or sales invoice is prepared.)

What are Liabilities and Stockshares Equity

 

Balance Sheet – Liabilities and Stockholders' Equity

 What are Liabilities Liabilities are obligations of the company; they are amounts owed to others as of the balance sheet date. Marilyn gives Joe some examples of liabilities: the loan he received from his aunt (Notes Payable or Loan Payable), the interest on the loan he owes to his aunt (Interest Payable), the amount he owes to the supply store for items purchased on credit (Accounts Payable), the wages he owes an employee but hasn't yet paid to him (Wages Payable).

Another liability is money received in advance of actually earning the money.

 For example, suppose that Direct Delivery enters into an agreement with one of its customers stipulating that the customer prepays $600 in return for the delivery of 30 parcels every month for 6 months. Assume Direct Delivery receives that $600 payment on December 1 for deliveries to be made between December 1 and May 31. Direct Delivery has a cash receipt of $600 on December 1, but it does not have revenues of $600 at this point. It will have revenues only when it earns them by delivering the parcels. On December 1, Direct Delivery will show that its asset Cash increased by $600, but it will also have to show that it has a liability of $600. (It has the liability to deliver $600 of parcels within 6 months, or return the money.)

The liability account involved in the $600 received on December 1 is Unearned Revenue. Each month, as the 30 parcels are delivered, Direct Delivery will be earning $100, and as a result, each month $100 moves from the account Unearned Revenue to Service Revenues. Each month Direct Delivery's liability decreases by $100 as it fulfills the agreement by delivering parcels and each month its revenues on the income statement increase by $100.



What is a Stockholders' Equity
If the company is a corporation, the third section of a corporation's balance sheet is Stockholders' Equity. (If the company is a sole proprietorship, it is referred to as Owner's Equity.) The amount of Stockholders' Equity is exactly the difference between the asset amounts and the liability amounts. As a result accountants often refer to Stockholders' Equity as the difference (or residual) of assets minus liabilities. Stockholders' Equity is also the "book value" of the corporation.

Since the corporation's assets are shown at cost or lower (and not at their market values) it is important that you do not associate the reported amount of Stockholders' Equity with the market value of the corporation. (Hence, it is a poor choice of words to refer to Stockholders' Equity as the corporation's "net worth".) To find the market value of a corporation, you should obtain the services of a professional familiar with valuing businesses.

Within the Stockholders' Equity section you may see accounts such as Common Stock, Paid-in Capital in Excess of Par Value-Common Stock, Preferred Stock, Retained Earnings, and Current Year's Net Income.

The account Common Stock will be increased when the corporation issues shares of stock in exchange for cash (or some other asset). Another account Retained Earnings will increase when the corporation earns a profit. There will be a decrease when the corporation has a net loss. This means that revenues will automatically cause an increase in Stockholders' Equity and expenses will automatically cause a decrease in Stockholders' Equity. This illustrates a link between a company's balance sheet and income statement.