Current Liabilities

Payrolls represent the entire amount paid to all employees over a given accounting period. Because employees are very sensitive to payroll errors or any irregularities, payroll systems should assure accurate and timely payments. Accurate records are also required by federal and state government agencies. Payroll expenditures typically have a significant impact on the income statement of a firm. Manual labor, whether skilled or unskilled usually receives renumeration in the form of wages. Wages are usually stated in terms of an hourly rate, weekly rate, or on a piecework basis.

Determining Employee Earnings

1. Earnings are computed by multiplying hours worked by a hourly rate.
2. When hours worked is less than or equal to 40, Earnings = Hours * Rate (E = H * R).
   
3. When a employee works more than fourty hours and is entitled to time and a half for each hour worked over fourty, the following formula should be used: E = 40R + 1.5(H - 40).
   

Introduction to Payrolls

Salaries are paid to those individuals that hold administrative, executive, managerial or sales positions. Their pay is usually stated on a monthy or annual basis. Payment for work can take the form of property, shelter, food, services, securities, or promissory notes. Salaries and wages are often supplemented by commissions, bonuses, cost-of-living adjustments, profit sharing and/or pension plans. Employers and employees typically meet and agree on a fair salary or wage rate.

Profit-Sharing Bonuses

Bonuses are usually based upon the productivity of an individual. Today's companies are relying less on salary and more on bonuses to attract and reward executives. Bonuses can be computed in several different ways, each yielding a different amount. The bonus percentage can be based on income

1. before deducting the bonus and income taxes,
2. after deducting the bonus, but before deducting income taxes,
3. before deducting the bonus, but after deducting income taxes,
4. after deducting the bonus and income taxes.
   

Calculating A Bonus Based on Income Before Deducting A Bonus or Taxes

1. Formula: bonus = bonus rate * income (B = BR * Y)
2. Example: income = $75,000, bonus rate = 15%, and tax rate = 43%.
3. Solution: B= .15($75,000) = $11,250
   

Employee Earnings Deductions

Gross pay is total earnings of an employee before any deductions. Net pay is the ammount an employee receives after all deductions. Deductions are commonly made for federal, state, and local income taxes. While state and local income taxes vary from state to state, all employers must withhold federal income and FICA taxes. Deductions can be made for voluntary items such as health insurance, charitable contributions, pension fund contributions and union dues.

Fica Taxes

The Federal Insurance Contributions Act requires most employers to withhold FICA taxes from their employees. The purpose of FICA taxes is to use them for federal programs that provide medicare benefits, old-age and disability benefits, and survivor benefits. The amount of FICA taxes that may be collected is subject to a ceiling, making it necessary for the employer to keep track of cumulative earnings of each employee.

Employer's Payroll Tax Liabilities

Employers can be subject to both federal and state taxes based on the amount of compensation paid to their employees. FICA taxes by the employer are equal to the payments made by an employee. Federal Unemployment Compensation Tax is levied on employers only, and the funds collected are used to provide a temporary relief to individuals unemployed as a result of economic forces beyond their control. State Unemployment Compensation Taxes are paid by employers only.

Income Taxes

Most employers are required to withhold federal income taxes. State and local income taxes do not exist everywhere. In areas where they do exist, income taxes should also be withheld. Factors that influence the amount of income tax deductions are: gross pay, estimated deductions, exemptions claimed, and marital status.

Payroll Accounting Systems

The three major components of a payroll system are:

1. payroll register: it is used to assemble and summarize data for each payroll period,
2. employee's earnings record: it provides detailed information for each employee, and
3. payroll checks, direct ATM deposits or cash, usually accompanied by a statement showing all the deductions.
   

Payroll Register

The payroll register is a multicolumn journal used to assemble and summarize payroll data. Information that can typically be found is the following: employee names, total hours worked, regular earnings, overtime earnings, total earnings, tax deductions, net amount paid, check number, and a debit to an expense account. Checks are recorded in the payroll register so no other records need to be maintained on payments. The accuracy of the payroll register can be determined by cross-verification of its columns. The regular and overtime pay columns should always be equal to the salary and wage expense columns.

Components of The Payroll System

The payroll register consists of constant and variable elements. Wage rate are typical constant element. Hours worked vary. Information obtained from the payroll register is used for general ledger entries, to issue payroll checks and statements, and to update employees' earnings records. Data from the employees' earnings records are used to prepare wage and tax statements and payroll tax returns. Entries recorded in the general ledger are used to prepare the income statement and balance sheet.

Payroll System Controls

Internal controls for payroll systems are similar to those for cash disbursements. A voucher system is recommended. When names are to be deleted or added to the payroll register, they should be supported by a written statement from personnel. Attendance records are taken by personnel to ensure accurate determination of pay, vacation benefits and sick leave benefits. As an extra measure of safety, employee identification cards are often issued and must be presented by employees when receiving paychecks.

Liabilities for Employee Fringe Benefits

When employers agree to pay part or all of the costs of fringe benefits, they incur an expense and a liability. Fringe benefits commonly offered by employers are vacations, health insurance, pension plans, life insurance and disability insurance. The cost of the fringe benefits should be properly matched to the period an employee has worked. If the employee has not received the fringe benefit, a liability remains. Depending on when the liability is expected to be paid, it may be classified as either short-term or long-term on the balance sheet.

Notes Payable & Interest Expense

Promissory notes are commonly issued for goods purchased on account or when a bank extends a short-term loan. Notes issued by banks can be interest-bearing or non-interest bearing. Non-interest bearing notes deduct the interest from the face value (or maturity value) of the note from the amount loaned to the borrower. An interest bearing note requires payment of both the principal and interest accrued at maturity. An adjusting entry is necessary whenever interest is paid a day other than the end of the financial periods.

Product Warranty Liabilities

To record a product warranty liability, Debit Product Warranty Expense and credit Product Warranty Payable. When a product is repaired or replaced, debit Product Warranty Payable and credit Inventory or an expense account. The amount recorded for product warranty liabilities is estimated, and adjustments may be necessary if more or less goods are actually replaced or repaired.

by John Petroff

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Fixed Assets

Plant assets are assets that are held for more than one year and are uses in business operations. Land, buildings, equipment, furniture, and machinery are examples of plant assets. When a plant asset is initially acquired, all costs incurred for acquisition and installation are debited to the plant asset account. Expenditures that are related to land can be debited to either Land, Land Improvements, or Buildings depending upon how permanent they are and how long they are expected to last.

Depreciation

All plant assets, except land, depreciate. Factors that contribute to depreciation are physical and functional. Physical depreciation arises from the actual use of a plant asset. Functional depreciation is due to obsolescence factors such as technological advances and less demand for a product. The purpose of recording depreciation is to show the decline of usefulness of an asset, not a decline in its market value. Depreciation merely reduces the value of plant asset accounts, it does not reduce the cash account or affect cash flows.

Determining Depreciation

Factors that determine depreciation expense are the initial cost, the residual value and the useful life. Depreciation can only be estimated because it depends on several potentially changing elements. Residual value is any value that remains after an asset has been retired. The calculation of depreciation is based on the initial cost minus residual value. Several methods used to calculate depreciation. The straight-line method is the most popular. Different depreciation methods can be used for financial statement information and tax purposes.

Straight-Line Method

The straight-line method of depreciation charges equal amounts of depreciation to each period over the useful life of the asset. It is determined by subtracting the residual value from the initial cost and dividing it by the number of the years of estimated life. Due to its simplicity, it is the most widely used method.

Units-Of-Production Method

The units-of-production method determines depreciation expense based on the amount the asset is used. The length of life of an asset is expressed in a form of productive capacity. The initial cost less any residual value is divided by productive capacity to determine a rate of unit-of-production depreciation per units of usage. Units of usage c can be expressed in quantity of goods produced, hours used, number of cuttings, miles driven or tons hauled, for instance. The depreciation expense of a period is determined by multiplying usage by a fixed unit-of-production rate of usage. This depreciation method is commonly used when asset usage varies from year-to-year.

Declining-Balance Method

The declining-balance (also known as double-declining-balance) method is a popular form of accelerated depreciating. The rate used is usually twice the rate employed by the straight-line method. This method does not consider the estimated salvage value in determining the depreciation rate or in computing the periodic depreciation. However, an asset cannot be depreciated beyond the estimated salvage value. Depreciation expense is highest in the first year, and becomes smaller each subsequent year.

Sum-of-The-Years-Digits Method

The sum-of-the-years-digits method is an another form of accelerated depreciation. The annual depreciation is calculated by subtracting salvage value from original cost, and multiplying this figure by a fractional rate of depreciation. The denominator of the fraction is the sum of the years of useful life; for a life of 5 years, the denominator is = 1 + 2 + 3 + 4 + 5 = 15. The numerator is the year in reverse order. For the first year, the numerator is 5 and the fraction is 5/15.

Comparing Depreciation Methods

Different depreciation methods produce different results, and in some circumstances the use of a particular depreciation method is recommended. When the use of an asset fluctuates from period to period, the units-of-production method is recommended. For assets that decline in usefulness early, and are subject to high maintenance costs as they age, a form of accelerated depreciation should be used, i.e. declining-balance and the sum-of-the-years- digits methods.

Depreciation & Income Taxes

For tax purposes, the straight-line, declining-balance, sum-of-the-years-digits, and units-of-production methods of depreciation were allowed prior to 1981. Between 1980 and 1987, either the straight-line method or the Accelerated Cost Recovery System (ACRS) could be used. The Tax Reform Act of 1986 revised the ACRS by providing a depreciation rate schedule for eight classes of plant assets. The use of an accelerated depreciation method reduces tax liabilities and increases cash flows.

Revising Depreciation Estimates

Because depreciation is estimated, it often needs to be revised periodically over the life of the asset. An error in estimating the salvage value, the years of useful life, or both can require a revision. Previously recorded depreciation is not affected by a revision. The revision of depreciation is only affects future depreciation expenses.

Recording Depreciation Expenses

When depreciation is to be recorded, a Depreciation Expense account is debited, and Accumulated Depreciation is credited. Accumulated Depreciation is a contra-asset account that decreases the value of plant assets. The use of a contra-asset account allows assets to be shown at cost, and thus allows easier computations if a revision is necessary or different depreciation methods are used. When an asset is sold, all accounts related to the depreciation of that asset are adjusted.

Capital And Revenue Expenditures

Expenditures on plant assets fall into two categories:

1. capital expenditures: these increase the productive capacity, efficiency or useful life of the asset, and
2. revenue expenditures: these include maintenance and repairs.
   

If an expenditure increases the efficiency or capacity of a plant asset, that Plant Asset account is debited. If an expenditure increases the useful life of a plant asset, the Accumulated Depreciation account is debited. Revenue expenditures are expensed in the year incurred.

Disposing Plant Assets

Plant assets can be disposed of by discarding, selling, or trading in for other assets. No matter how plant assets are disposed of, the book value of the asset must be removed from the account. When an asset becomes completely useless, it is taken of the books by debiting the Accumulated Depreciation account and crediting the Equipment account. In the event an asset is discarded before its estimated useful life, the loss must be debited to the Loss on Disposal of Plant Assets account.

Disposing Plant Assets

When a plant asset is sold, the Cash and Accumulated Depreciation accounts are always debited, and the Equipment account is credited. In the event there is a loss or gain from the sale, either the Loss on Disposal of Plant Assets or the Gain on Disposal of Plant Assets accounts will have an entry. When old plant assets are exchanged for new plant assets, it is generally accepted that any gains from a trade need not be recognized. The amount that is owed after credit for the trade-in is known as the boot, which is also the required cash payment. The entry is this situation is Debit Accumulated Depreciation (old equipment) Debit Plant Assets (new equipment) Credit Plant Assets (old equipment) Credit Cash.

Subsidiary Ledgers for Plant Assets

When a business has a large number of plant assets to keep track of, the use of a subsidiary ledger is recommended. Detailed information on each plant asset is maintained in the subsidiary ledger. All plant assets can be specifically identified by an assigned number. The first part of the number corresponds to the general ledger account, while the second part of the number represents the identification assigned to the asset. Periodically, it is advisable to compare balances of the subsidiary ledger with the controlling accounts in the general ledger. Subsidiary ledgers are very useful in determining depreciation expenses, filing tax and insurance forms, as well as recording the disposal of plant assets.

Composite-Rate Depreciation Method

The composite-rate depreciation method determines depreciation of a group of similar plant assets by using a single rate. This rate is determined by dividing annual depreciation by the total original cost of assets. Although specific equipment in the group may be added and retired, this method assumes that the mix will remain unchanged. Gains and losses from the retirement or disposal of assets are not realized.

Leasing Plant Assets

A business can rent a property for a specified period of time under a contract known as a lease. The lessor is the owner of the property, and the lessee is the party that has the right to use the property. Leases which extent over most of the asset life, and which transfer ownership to the lessee at the end of the lease, are called capital leases. Assets held under capital lease must be shown on the balance sheet, and therefore, the Plant Assets is debited and a lease liability account is credited. Operating leases tend to be more short-term, and the lessee does not acquire the leased property at the end of the lease.

Intangible Assets

Intangible assets do not have physical substance. They are not held for sale, and they are usually highly valuable to the business. They include patents, copyrights, trademarks, goodwill, and franchises. Except for goodwill, most intangible assets receive legal protection of exclusive use. The cost of obtaining legal protection for the intangible asset should be debited to the intangible asset account. The periodic loss of value of the intangible asset is called amortization, and is expensed annually. Research and development costs are treated as expense in the year incurred, and are not treated as intangible assets because it is their future success is uncertain.

Depletion

The periodic allocation of the use of natural resources is a called depletion. Mineral deposits, coal, timber, natural gas, and petroleum are all subject to depletion. Depletion Expense is debited and Accumulated Depletion is credited for the amount of usage during the period. The usage is based on current year production as a fraction of total capacity, and the determination is essentially identical to the unit-of-production depreciation method.

by John Petroff

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Inventory

Inventories are usually the largest current asset of a business, and proper measurement of them is necessary to assure accurate financial statements. If inventory is not properly measured, expenses and revenues cannot be properly matched. When ending inventory is incorrect, the following balances of the balance sheet will also be incorrect as a result: merchandise inventory, total assets, and owner's equity. When ending inventory is incorrect, the cost of merchandise sold and net income will also be incorrect on the income statement.

Inventory Accounting Systems

The two most widely used inventory accounting systems are the periodic and the perpetual. The perpetual inventory system requires accounting records to show the amount of inventory on hand at all times. It maintains a separate account in the subsidiary ledger for each good in stock, and the account is updated each time a quantity is added or taken out. In the periodic inventory system, sales are recorded as they occur but the inventory is not updated. A physical inventory must be taken at the end of the year to determine the cost of goods sold. Regardless of what inventory accounting system is used, it is good practice to perform a physical inventory at least once a year.

Determining Inventory Quantities & Costs

All goods owned by a business (whether or not physically present on the business premises), are included in inventory when an inventory is taken. This requires that all shipping documents be examined, and all merchandise out on consignment be identified. Determining the quantity of goods on hand should be performed by at least two individuals, and a third should verify accuracy of the count (especially if the goods have a high monetary value). When determining the cost of goods, all expenses incurred to acquire them are included in the purchase price.

Inventory Costing Methods - Periodic

The periodic system records only revenue each time a sale is made. In order to determine the cost of goods sold, a physical inventory must be taken. The most commonly used inventory costing methods under a periodic system are

1. first-in first-out (FIFO),
2. last-in first-out (LIFO), and
3. average cost or weighted average cost.
   

These methods produce different results because their flow of costs are based upon different assumptions. The FIFO method bases its cost flow on the chronological order purchases are made, while the LIFO method bases it cost flow in a reverse chronological order. The average cost method produces a cost flow based on a weighted average of unit costs.

Comparing Inventory Costing Methods

The choice of inventory costing method affects the balances of

1. ending inventory,
2. cost of goods sold, and
3. gross and net profit.
   

During periods of rising prices, the FIFO method generally produces a larger ending inventory, a smaller cost of goods sold and a higher profit. During periods of rising prices, the LIFO method produces a smaller ending inventory, a larger cost of goods sold and a smaller profit. During periods of declining prices the effects of the two methods are reversed. The average cost method produces results that are in between the LIFO and FIFO methods.

Using Non-Cost Methods to Value Inventory

Under certain circumstances, valuation of inventory based on cost is impractical. If the market price of a good drops below the purchase price, the lower of cost or market method of valuation is recommended. This method allows declines in inventory value to be offset against income of the period. When goods are damaged or obsolete, and can only be sold for below purchase prices, they should be recorded at net realizable value. The net realizable value is the estimated selling price less any expense incurred to dispose of the good.

Periodic vs. Perpetual Inventory Systems

There are fundamental differences for accounting and reporting merchandise inventory transactions under the periodic and perpetual inventory systems. To record purchases, the periodic system debits the Purchases account while the perpetual system debits the Merchandise Inventory account. To record sales, the perpetual system requires an extra entry to debit the Cost of goods sold and credit Merchandise Inventory. By recording the cost of goods sold for each sale, the perpetual inventory system alleviated the need for adjusting entries and calculation of the goods sold at the end of a financial period, both of which the periodic inventory system requires.

Inventory Costing Methods - Perpetual

The perpetual inventory system requires that a separate inventory ledger be maintained for each good. Inventory ledgers provide detailed information on purchases, cost of goods sold, and inventory on hand. Each column gives information on quantity, unit cost, and total cost. When the average cost method is used, an average unit cost of each good is calculated each time a purchase is made. The advantages of the perpetual inventory system is a high degree of control, it aids in the management of proper inventory levels, and physical inventories can be easily compared. Whenever a shortage (i.e. a missing or stolen good) is discovered, the Inventory Shortages account should be debited.

Methods Used to Estimate Inventory Cost

In certain business operations, taking a physical inventory is impossible or impractical. In such a situation, it is necessary to estimate the inventory cost. Two very popular methods are

1. retail inventory method, and
2. gross profit (or gross margin) method.
   

The retail inventory method uses a cost to retail price ratio. The physical inventory is valued at retail, and it is multiplied by the cost ratio (or percentage) to determine the estimated cost of the ending inventory.

The gross profit method uses the previous years average gross profit margin (i.e. sales minus cost of goods sold divided by sales). Current year gross profit is estimated by multiplying current year sales by that gross profit margin, the current year cost of goods sold is estimated by subtracting the gross profit from sales, and the ending inventory is estimated by adding cost of goods sold to goods available for sale.

by John Petroff

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Receivables

Receivables are any monetary claims against debtors. Credit can be granted in two forms: open account or evidenced by a formal instrument. When a formal instrument of credit, that is a promissory note, the creditor has a stronger legal claim and can endorse it to a third party. The party that promises payment is known as the maker, and the party entitled to receive the payment is the payee. Notes receivable can be interest or non-interest bearing. The amount due at maturity, known as maturity value, is equal to the face value plus any accrued interest. Receivables not expected to be collected within the current year, should be listed as investments on the balance sheet.

Receivable Controls

Receivables require the same internal controls as other assets of a business. Employees responsible for collecting and approving receivables should not be involved with accounting aspect related to them. All accounting functions should be designed so that the work of one employee can be used as verification of another employee's work. A business that has a substantial amount of notes may find the use of a notes receivable register very helpful. It provides detailed information on each note, and assists in the timely collection of notes. Proper controls of receivables also includes obtaining approval for credit sales, sales returns and allowances, and sales discounts.

Calculating Interest

Interest rates are usually stated on an annual basis. The interest is computed by multiplying principal by rate and then by time (principal x rate x time). The maturity value is determined by calculating interest and adding it to the face value of the note. When interest is computed for periods of less than a year, time is expressed as a fraction. The numerator of the fraction is the length of the note and the denominator is the number of days in a year. Government agencies use 365 days in the denominator, while the private sector uses 360 days.

Accounting for Notes Receivable

When a note is received from the debtor (i.e. open account customer), a journal entry should be made debiting Notes Receivable and crediting Accounts Receivable account. Notes receivable that do not mature by the end of a fiscal period, require both adjusting and reversing entries for the accrued interest. This is done so that interest income is allocated to the proper financial periods. When a note matures and is paid, the Cash account is debited and the Notes Receivable and Interest Income accounts is credited.

Discounting A Note Receivable

In the event a business is in need of cash, it has the option to transfer its notes receivable to a bank, which is known as discounting. The interest a bank charges on the period it holds a note is known as discount. Depending upon the arrangement with the bank, the company may still be liable in the event a debtor defaults on the payment. It is necessary to disclose these contingent obligations on a firm's Balance Sheet in a foot note. When proceeds are received for the discounted notes, the Cash account is debited, and the Notes Receivable account credited. If the proceeds exceed the face value of the note, the Interest Income account is credited. If the proceeds are less than the face value of the note, Interest Expense is debited.

Dishonored Notes Receivable

When the maker of a note fails to pay on the due date, the note receivable is considered to be dishonored. A dishonored note is no longer negotiable. In the books of creditors, the following entry is made :
Debit Accounts Receivable
Credit Notes Receivable
Credit Interest Income or Interest Receivable

When a note previously discounted with a bank is dishonored, the holder of the note (the bank) notifies the endorser (i.e the company) of non-payment. Protest fees are charged to the endorser for legal fees.

Receivables Which Become Uncollectible

No matter what kind of credit policy or collection procedures a business establishes, a certain percentage of receivables will usually turn out to be uncollectible. When a receivable is determined to be uncollectible, it is written-off as an operating expense. Strong indications that a receivable may be uncollectible are the declaration of bankruptcy by the debtor, repeated failures to collect, disappearance of the debtor, and debts that are beyond the statute of limitations. Two methods exist to write-off receivables. The direct write-off method records the expense when the receivable is uncollectible, while the allowance method makes a provision for a portion of the current year sales to become uncollectible throughout the entire year.

The Allowance Method

The allowance method of accounting for uncollectibles estimates the percentage of accounts that will be uncollectible. Once the amount is determined, an adjusting entry is made that debits the Uncollectible Accounts Expense and credits the Allowance for Doubtful Accounts (also known as Allowance for Bad Debt). When a specific account is determined to be uncollectible, the Allowance for Doubtful Accounts is debited and the Accounts Receivable account is credited. The advantage of using the allowance method is it provides a reduction of the value of receivables and recognition of expense in the period the corresponding sales have taken place.

Methods Used to Estimate Uncollectibles

There are several methods of estimating uncollectibles. The most commonly used methods base their estimates on sales data or the age of the receivables. Estimates based on sales figures can be determined by taking a percentage of either total sales or credit sales. An estimate of uncollectibles based on an analysis of receivables, classifies accounts into outstanding age groups. The longer a receivable is past due, the higher the probability of nonpayment. If the estimate is larger than the balance of the Allowance for Doubtful Accounts, the excess should be debited to the Uncollectible Accounts Expense and credited to the Allowance for Doubtful Accounts.

The Direct Write-Off Method

The direct write-off method only records an uncollectible account expense when an account has been determined to be uncollectible. This method is not recommended the recognition of the expense does always occur in the year the corresponding revenues were recorded. It has, however, the advantage of simplicity since no adjusting entry is necessary at the end of a financial period. The method is best used by businesses that do not have a large number of credit sales. In the event an account needs to be reinstated, the Accounts Receivable account is debited. Uncollectible Accounts Expense should be credited.

by John Petroff

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Cash

The most effective tool used to control cash is a bank account. It provides a double record of all cash transactions. In order to provide effective controls on the use of bank accounts, special documents are used to evidence transactions. Signature cards are used by all employees authorized to make withdrawals. Deposit tickets must accompany deposits, and checks must be issued for all payments. A remittance advice is sent with each payment to ensure that proper credit is recorded by creditors. Banks commonly require that a minimum balance (compensating balance) be held.

Bank Statements

An advantage of using a bank account to control cash is that banks send a bank statement monthly reporting all the transactions in the account. Information normally present in the bank statement consists of the beginning and ending balances, deposits, other credits, withdrawals and other debits. The cancelled checks are enclosed with the statement, as well as debit and credit memorandums (for items processed by the bank usually unknown to the depositor). Rarely will the bank statement balance and the depositor's Cash in Bank account balance be exactly the same, and they must be reconciled.

Bank Reconciliations

A bank reconciliation is a method used to determine the reasons for discrepancies between the bank statement balance and the Cash in Bank account balance and to calculate an adjusted balance. Discrepancies are usually due to outstanding items which have not yet been recorded by either of the bank or the company, and which typically include checks not yet presented for collection, deposits in transit and bank service charges. Errors are another common cause of discrepancies, which the reconciliation will help correct. Finally, the reconciliation may uncover irregularities.

A bank reconciliation is divided into two sections, the balance per bank statement and the balance per depositor's records. Although it is possible to reconcile one balance to the other, common practice adjusts both balances to prove to one another. Outstanding transactions unknown to the depositor discovered when the bank statement was sent require journal entries.

Cash Accounts

There are often several cash accounts because they serve different purposes. The Cash in Bank account represents the checking account that processes deposits, checks and memorandum items. The Cash Short and Over account is used to record any variance by sales clerks. The Cash on Hand Fund is used to provide change to conduct business with customers. The Petty Cash Fund is used to pay for small items with cash. Each of these cash accounts needs to be strictly controlled to prevent mishandling.

Internal Control Of Cash Accounts

Numerous procedures are available to control cash accounts. Monthly bank statements help verify the cash account balance. The bank reconciliation is particularly useful in controlling cash receipts. The voucher system is used to control cash payments. Different cash funds exist for specific purposes to keep track of each type of cash transaction. It should be noted that it is of utmost importance to separate cash handling and cash related accounting duties.

The Voucher System

One of the most common methods to control cash payments is the voucher system. The components of a voucher system are

1. vouchers: documents establishing proof of payment,
2. a voucher register: to record every voucher,
3. an unpaid voucher file,
4. a paid voucher file, and the
5. a check register: to record the payment of each voucher.
   

The voucher system provides effective accounting controls and aids management decision making.

Important Facts Concerning Vouchers

1. Vouchers must be prepared for all payments.
2. Vouchers represent written authorization of a payment.
3. Before a voucher can be approved; the receiving report,invoice and purchase order should be compared keeping in mind possible discounts.
4. All vouchers should be recorded in the voucher register in a numerical order.
   

Facts Concerning The Voucher Register

1. All vouchers must be recorded in the voucher register.
2. Vouchers are listed in numerical order.
3. The register records the payee, the date the payment is made and the number of the check issued for payment.
4. The Accounts Payable account is always credited, but there may be different accounts to be debited.
5. The Sundry Accounts is used to debit accounts not listed in the other Register columns.
   

Voucher Files Procedures

1. Unpaid vouchers are filed in the unpaid voucher file.
2. Unpaid vouchers should be filed in the order they are due.
3. Paid vouchers are filed in the paid voucher file.
4. Paid vouchers are filed in numerical order.
   

Using The Check Register

1. When a voucher is paid, it is recorded in the check register.
2. The check register is similar to the cash payments journal.
3. All checks should be listed numerically, even those thatare voided.
4. Cash in Bank account should always be credited. If a discount is taken, credit the Purchases Discount account.
5. Voucher numbers and a running cash balance column are used in the check register.
   

Electronic Funds Transfer

The evolution of electronic funds transfer (EFT) will change the way cash transactions are processed. EFT uses electronic impulses that are computerized to perform cash transactions. This eliminates the need for checks and physical money. EFT has a particularly strong presence in retail sales. Point-of-sale systems are used by customers to pay for purchases using credit cards, charge cards, and bank cards. The greatest benefit EFT can provide is reduced costs, and quicker and more accurate information.

by John Petroff

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Accounting Systems

The accounting system of an organization should provide all necessary information. The type of accounting system used depends on the information needs of an organization. All accounting systems should have the following characteristics:

1. cost effectiveness,
2. adequate internal controls,
3. flexibility to a changing environment, and
4. compatibility and adaptability to an organization's structure.
   

Installing & Revising Accounting Systems

The installation and revision of an accounting system requires a complete knowledge of a business operation. The following steps are necessary when installing or changing an accounting system.

1. Systems analysis: this stage determines data needs, the sources of data and any problem in processing current data.
2. Systems design: this stage involves designing new or revising current accounting systems based upon the results of the systems analysis.
3. Systems implementation: this final stage installs and evaluates the new or revised accounting system.
   

Internal Controls

Internal controls are designed to safeguard assets, check accuracy of accounting data, promote efficiency, and encourage adherence to company policies. Internal accounting controls are specifically concerned with the protection of assets and the reliability of accounting information. Internal administrative controls are concerned with operational efficiency, and help determine whether business goals are being met.

Subsidiary Ledgers

Subsidiary ledgers are used for accounts that have a large number of individual accounts with common characteristics. Subsidiary ledgers are commonly used for accounts receivable and accounts payable; both consist of a large number of smaller accounts. The general ledger contains all balance sheet and income statement accounts. Every subsidiary ledger has a controlling account which can be found in the general ledger. The sum of the balances of the subsidiary ledger must be equal to the controlling account.

Special Journals

Special journals are designed to record a specific type of transaction which occurs frequently. The following is a summary of the four most commonly used special journals:

1. purchases journal: used to record purchases on credit,
2. sales journal: used to record all sales made on credit,
3. cash payments journal: records all cash disbursements, and
4. cash receipts journal: records all cash receipts.
   

In certain instances, business documents such as purchases and sales invoices are used instead of special journals to reduce expenses.

Purchases Journal

Items commonly purchased on account are goods held in inventory for sale, supplies, and equipment. The accounts payable account is always credited, and an asset account is debited. Assets purchased on a recurring basis have their own column in the journal. Assets purchased less regularly are posted in the sundry accounts section of the journal. At all times, total debits must equal total credits. At the end of an accounting period, all entries should be posted to a subsidiary ledger or the general ledger.

Cash Payments Journal

When the cash payments journal is used, the cash column is always credited whenever a payment is issued. When a payment is made for goods previously purchased on credit, the accounts payable column is credited. In the event a discount is offered for early payment, the purchases discounts column should be debited. The sundry accounts column is used for debits to accounts which do not have an individual column. At the end of the month, all data from the journal should be posted to subsidiary ledgers or the general ledger. The sum of the accounts payable subsidiary ledger must be equal to the controlling account. In the event it is not, errors must be found and corrected.

Sales Journal

The sales journal is only used to record sales of merchandise on account. A unique feature of the sales journal is that accounts receivable debits and credits share the same column. A column also often exists to record sales tax payable. Any sales returns or allowances granted for goods sold on credit require an entry to the general journal. If a cash refund is given, the transaction should be recorded to the cash payments journal.

Cash Receipts Journal

The cash receipts journal is used to record all transactions that increase the cash balance. The most common sources of cash receipts are cash sales and payments for goods on account. When debtors pay for goods purchased on account, the accounts receivable column should be credited. If a cash discount is taken by a customer, the sales discount column should be debited for the cash discount. All accounts in the cash receipts journal are posted periodically to the general ledger. Accounts receivables should be posted monthly to the accounts receivable subsidiary ledger.

by John Petroff

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Accruals and Deferrals

Deferrals and accruals are instrumental in properly matching revenues and expenses. A deferral delays the recognition of either an expense that has been paid or a revenue that has been collected. An accrual is an expense that has not been paid or a revenue that has not yet been received.

Deferrals - Prepaid Expenses

Prepaid expenses represent the cost of goods and services purchased that are not entirely used up at the end of the year. Adjusting entries are necessary so that asset and expense accounts have the proper balances. Prepaid expenses can be initially recorded as either an asset or an expense. Either method will yield the same results, but adjusting entries to obtain the final result differ. The advantage of recording a prepaid expense initially as an asset is that no reversing entry is necessary.

Deferrals - Unearned Revenues

When revenue is received before goods are delivered or services performed, the revenue is said to be unearned. Unearned revenues can initially be recorded as either a liability or a revenue. When unearned revenues are recorded as liabilities, an unearned revenue account is credited. An advantage of this method is that no reversing entry is necessary.

When unearned income is recorded as a revenue, a revenue account is credited. This method requires a reversing entry at the beginning of the new period. Both methods produce, however, the same end result.

Accruals - Liabilities or Expenses

Many expenses which accumulate on a daily basis are only recorded at set intervals. At the end of an accounting period a portion of such expenses (for instance, salaries) often remains unpaid. Such accruals are considered to be both liabilities or expenses. An adjusting entry is necessary at the end of an accounting period to properly reflect the portion of the accrued but yet unpaid expense and liability. At the start of the next period, the adjusting entry is reversed to simplify accounting.

Accruals - Assets or Revenues

Many businesses only record revenues when they are actually received. At the end of an accounting period, all revenues earned but not yet collected require adjusting entries. The adjustment is performed by debiting an asset account and crediting a revenue account. As a result, financial statements will be able to properly match revenues and expenses. A reversing entry is performed at the first day of the new period to simplify accounting.

Reviewing Accruals and Deferrals

Although all accruals and deferrals require adjusting entries at the end of an accounting period, reversing entries are not necessary for all adjustments. Reversing entries should only be performed under the following circumstances:

1. when an accrued asset or an accrued liability is adjusted,
2. when a prepaid expense is initially recorded as an expense,
3. when an unearned revenue is initially recorded as revenue.
   

by John Petroff

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