The Liabilities

A Liability is a legal obligation of a business to pay a debt. Debt can be paid with money, goods, or services, but is usually paid in cash. The most common liabilities are notes payable and accounts payable. Accounts payable is an unwritten promise to pay suppliers or lenders specified sums of money at a definite future date.

Current Liabilities

Current Liabilities are liabilities that are due within a relatively short period of time. The term Current Liability is used to designate obligations whose payment is expected to require the use of existing current assets. Among current liabilities are Accounts Payable, Notes Payable, and Accrued Expenses. These are exactly like their receivable counterparts except the debtor-creditor relationship is reversed.

Accounts Payable is generally a liability resulting from buying goods and services on credit

Suppose a business borrows $5,000 from the bank for a 90-day period. When the money is borrowed, the business has incurred a liability – a Note Payable. The bank may require a written promise to pay before lending any amount although there are many credit plans, such as revolving credit where the promise to pay back is not in note form.

On the other hand, suppose the business purchases supplies from the ABC Company for $1,000 and agrees to pay within 30 days. Upon acquiring title to the goods, the business has a liability – an Account Payable – to the ABC Company.

In both cases, the business has become a debtor and owes money to a creditor. Other current liabilities commonly found on the balance sheet include salaries payable and taxes payable.

Another type of current liability is Accrued Expenses. These are expenses that have been incurred but the bills have not been received

for it. Interest, taxes, and wages are some examples of expenses that will have to be paid in the near future.

Long-Term Liabilities:

Long-Term Liabilities are obligations that will not become due for a comparatively long period of time. The usual rule of thumb is that long-term liabilities are not due within one year. These include such things as bonds payable, mortgage note payable, and any other debts that do not have to be paid within one year.

You should note that as the long-term obligations come within the one-year range they become Current Liabilities. For example, mortgage is a long-term debt and payment is spread over a number of years. However, the installment due within one year of the date of the balance sheet is classified as a current liability.

The Account Types

In order to track money within an organization, different types of accounting categories exist. These categories are used to denote if the money is owned or owed by the organization. Let us discuss the three main categories: Assets, Liabilities, and Capital.

Assets

An Asset is a property of value owned by a business. Physical objects and intangible rights such as money, accounts receivable, merchandise, machinery, buildings, and inventories for sale are common examples of business assets as they have economic value for the owner. Accounts receivable is an unwritten promise by a client to pay later for goods sold or services rendered.

Assets are generally listed on a balance sheet according to the ease with which they can be converted to cash. They are generally divided into three main groups:

• Current
• Fixed
• Intangible

Current Asset

A Current Asset is an asset that is either:

• Cash – includes funds in checking and savings accounts

• Marketable securities such as stocks, bonds, and similar investments

• Accounts Receivables, which are amounts due from customers

• Notes Receivables, which are promissory notes by customers to pay a definite sum plus interest on a certain date at a certain place.

• Inventories such as raw materials or merchandise on hand

• Prepaid expenses – supplies on hand and services paid for but not yet used (e.g. prepaid insurance)

In other words, cash and other items that can be turned back into cash within a year are considered a current asset.

Fixed Assets

Fixed Assets refer to tangible assets that are used in the business. Commonly, fixed assets are long-lived resources that are used in the production of finished goods. Examples are buildings, land, equipment, furniture, and fixtures. These assets are often included under the title property, plant, and equipment that are used in running a business. There are four qualities usually required for an item to be classified as a fixed asset. The item must be:

• Tangible
• Long-lived
• Used in the business
• Not be available for sale

Certain long-lived assets such as machinery, cars, or equipment slowly wear out or become obsolete. The cost of such as assets is systematically spread over its estimated useful life. This process is called depreciation if the asset involved is a tangible object such as a building or amortization if the asset involved is an intangible asset such as a patent. Of the different kinds of fixed assets, only land does not depreciate.

The Cash versus Accrual Accounting

Accounts Receivable is an asset that is owed to you but you do not have money in the bank or property to show you own something -it is intangible, on paper. It grows or accumulates as you issue invoices; therefore, Accounts Receivable is part of an accrual accounting system.

Double-entry accounting is the most accurate and best way to keep your financial records. With a computer, you don’t have to fully understand all the accounting details. Basically, in double entry accounting each transaction affects two or more categories or accounts, so everything stays in balance. Therefore, if you change an asset balance by issuing an invoice some other category balance changes as well. In this case, when you issue an invoice, the category that balances the asset called Accounts Receivable is an income or a sales account.

When you bill your client, there is an increase in income (on paper) and hence an increase in Accounts Receivable. When you are paid, the paper asset turns into money you put in the bank – a tangible asset. Through a process of recording the payment and the deposit, Accounts Receivable decreases and the bank balance increases. This accounting program takes care of all the accounting details.

This paper income can be confusing if you don’t understand that it is the total of all invoiced work, both paid and unpaid. If you have invoiced clients for a total of $10,000 but only $2,000 has been paid, your income will be $10,000 and your Accounts Receivable balance will be $8,000, and your bank account has increased by the $2,000 you received. An accountant would call this an accrual accounting method.

A cash accounting method only counts income when money is received, and it does not keep track of Accounts Receivable.

However, in real life, small businesses tend to use both methods without realizing the difference until income tax time.

This program can handle both accrual and cash based accounting. You can use the G/L Setup option in the G/L module to select either Cash or Accrual based accounting. We recommended that you consult with your accountant to determine which system will work best for you.

Types of Accounting

The two methods of tracking your accounting records are:

• Cash Based Accounting
• Accrual Method of Accounting

Cash Based Accounting

Most of us use the cash method to keep track of our personal financial activities. The cash method recognizes revenue when payment is received, and recognizes expenses when cash is paid out. For example, your personal checkbook record is based on the cash method. Expenses are recorded when cash is paid out and revenue is recorded when cash or check deposits are received.

Accrual Accounting

The accrual method of accounting requires that revenue be recognized and assigned to the accounting period in which it is earned. Similarly, expenses must be recognized and assigned to the accounting period in which they are incurred.

A Company tracks the summary of the accounting activity in time intervals called Accounting periods. These periods are usually a month long. It is also common for a company to create an annual statement of records. This annual period is also called a Fiscal or an Accounting Year.
The accrual method relies on the principle of matching revenues and expenses. This principle says that the expenses for a period, which are the costs of doing business to earn income, should be compared to the revenues for the period, which are the income earned as the result of those expenses. In other words, the expenses for the period should accurately match up with the costs of producing revenue for the period.

In general, there are two types of adjustments that need to be made at the end of the accounting period. The first type of adjustment arises when more expense or revenue has been recorded than was actually incurred or earned during the accounting period. An example of this might be the pre-payment of a 2-year insurance premium, say, for $2000. The actual insurance expense for the year would be only $1000. Therefore, an adjusting entry at the end of the accounting period is necessary to show the correct amount of insurance expense for that period.

Similarly, there may be revenue that was received but not actually earned during the accounting period. For example, the business may have been paid for services that will not actually be provided or earned until the next year. In this case, an adjusting entry at the end of the accounting period is made to defer, that is, to postpone, the recognition of revenue to the period it is actually earned.

Although many companies use the accrual method of accounting, some small businesses prefer the cash basis. The accrual method generates tax obligations before the cash has been collected. This benefits the Government because the IRS gets its tax money sooner.

What Are The Corporations

The Corporation is the most dominant form of business organization in our society. A Corporation is a legally chartered enterprise with most legal rights of a person including the right to conduct business, own, sell and transfer property, make contracts, borrow money, sue and be sued, and pay taxes. Since the Corporation exists as a separate entity apart from an individual, it is legally responsible for its actions and debts.

The modern Corporation evolved in the beginning of this century when large sums of money were required to build railroads and steel mills and the like and no one individual or partnership could hope to raise. The solution was to sell shares to numerous investors (shareholders) who in turn would get a cut of the profits in exchange for their money. To protect these investors associated with such large undertakings, their liability was limited to the amount of their investment.

Since this seemed to be such a good solution, Corporations became a vibrant part of our nation’s economy. As rules and regulations evolved as to what a Corporation could or could not do, Corporations acquired most of the legal rights as those of people in that it could receive, own sell and transfer property, make contracts, borrow money, sue and be sued and pay taxes.

The strength of a Corporation is that its ownership and management are separate. In theory, the owners may get rid of the Managers if they vote to do so. Conversely, because the shares of the company known as stock can sold to someone else, the Company’s ownership can change drastically, while the management stays the same. The Corporation’s unlimited life span coupled with its ability to raise money gives it the potential for significant growth.

A Company does not have to be large to incorporate. In fact, most corporations, like most businesses, are relatively small, and most small corporations are privately held.

Some of the disadvantages of Corporations are that incorporated businesses suffer from higher taxes than unincorporated businesses. In addition, shareholders must pay income tax on their share of the Company’s profit that they receive as dividends. This means that corporate profits are taxed twice.

There are several different types of Corporation based on various distinctions, the first of which is to determine if it is a public, quasi-public or Private Corporation. Federal or state governments form Public Corporations for a specific public purpose such as making student loans, building dams, running local school districts etc. Quasi-public Corporations are public utilities, local phones, water, and natural gas. Private Corporations are companies owned by individuals or other companies and their investors buy stock in the open market. This gives private corporations access to large amounts of capital.

Public and private corporations can be for-profit or non-profit corporations. For-profit corporations are formed to earn money for their owners. Non-profit Corporations have other goals such as those targeted by charitable, educational, or fraternal organizations. No stockholder shares in the profits or losses and they are exempt from corporate income taxes.

Professional Corporations are set up by businesses whose shareholders offer professional services (legal, medical, engineering, etc.) and can set up beneficial pension and insurance packages.
Limited Liability Companies (LLCs as they are called) combine the advantages of S Corporations and limited partnerships, without having to abide by the restrictions of either. LLCs allow companies to pay taxes like partnerships and have the advantage of protection from liabilities beyond their investments. Moreover, LLCs can have over 35 investors or shareholders (with a minimum of 2 shareholders). Participation in management is not restricted, but its life span is limited to 30 years.

What Are The Types Of PartnerShips

A partnership is a legal association of two or more individuals called partners and who are co-owners of a business for profit. Like proprietorships, they are easy to form. This type of business organization is based upon a written agreement that details the various interests and right of the partners and it is advisable to get legal advice and document each person’s rights and responsibilities.

There are three main kinds of partnerships

• General partnership
• Limited partnership
• Master limited partnership
General Partnership

A business that is owned and operated by 2 or more persons where each individual has a right as a co-owner and is liable for the business’s debts. Each partner reports his share of the partnership profits or losses on his individual tax return. The partnership itself is not responsible for any tax liabilities.

A partnership must secure a Federal Employee Identification number from the Internal Revenue Service (IRS) using special forms.

Each partner reports his share of partnership profits or losses on his individual tax return and pays the tax on those profits. The partnership itself does not pay any taxes on its tax return.
Limited Partnership

In a Limited Partnership, one or more partners run the business as General Partners and the remaining partners are passive investors who become limited partners and are personally liable only for the amount of their investments. They are called limited partners because they cannot be sued for more money than they have invested in the business.

Limited Partnerships are commonly used for real-estate syndication.
Master Limited Partnership

Master Limited Partnerships are similar to Corporations trading partnership units on listed stock exchanges. They have many advantages that are similar to Corporations e.g. Limited liability, unlimited life, and transferable ownership. In addition, they have the added advantage if 90% of their income is from passive sources (e.g. rental income), then they pay no corporate taxes since the profits are paid to the stockholders who are taxed at individual rates.

The Advantages of Computerized Accounting

Here are some of the advantages of using a computerized accounting system:

• The arithmetic of adding up debits and credits columns is done automatically and with total accuracy by the computer.

• Audit trails or details are automatically maintained for you.

• Produce financial statements simply by selecting the appropriate menu item.

• A computerized system lets you retrieve the latest accounting data quickly, such as today’s inventory, the status of a client’s payment, or sales figures to date.

• Data can be kept confidential by taking advantage of the security password systems that most accounting programs provide.

Computerized accounting programs usually consist of several modules.
The principal modules commonly used are:

• General Ledger
• Inventory
• Order Entry
• Accounts Receivable
• Accounts Payable
• Bank Manager
• Payroll

In a good accounting system, the modules are fully integrated. When the system is integrated, the modules share common data. For example, a client sales transaction can be entered in as an invoice, which automatically posts to the General Ledger module without re-entering any data. This is one of the greatest advantages of a computerized accounting system – you need to enter the information only once. As a result of this:

• Data entry takes less time.

• There is less chance that errors will occur.

• You do not have to re-enter data for posting.

What Accountants Do...

We have said that accounting consists of these functions:

• Recording

• Classifying

• Summarizing

• Reporting and evaluating the financial activities of a business
Before any recording can take place, there must be something to record. In accounting, the something consists of a transaction or event that has affected the business. Evidence of the transaction is called a document.

For example:

• A sale is made, evidenced by a sales slip.

• A purchase is made, as evidenced by a check and other documents such as an invoice and a purchase order.

• Wages are paid to employees with the checks and payroll records as support.

• Accountants do not record a conversation or an idea. They must first have a document.

In almost any business, these documents are numerous and their recording requires some sort of logical system. Recording is first carried out in a book of original entry called the journal. A journal is a record, listing transactions in a chronological order.

At this point, we have a record of a great volume of data. How can this data best be used? Aside from writing down what has occurred for later reference, what has been accomplished? The answer is, of course, that the accountant has only started on his task. This greatvolume of data in detailed listings must be summarized in a meaningful way.
When asked, the accountant must turn to these summaries to answer questions like:

• What were total sales this month?
• What were the total expenses and what were the types and amounts of each expense?
• How much cash is on hand?
• How much does the business owe?
• How much are the accounts receivable?

The next task after recording and classifying is summarizing the data in a significant fashion.

The records kept by the accountant are of little value until the information contained in the records is reported to the owner(s) or manager(s) of the business. These records are reported to the owners by preparing a wide variety of financial statements.

The accountant records, classifies, summarizes, and reports transactions that are mainly financial in nature and affect the business. The reporting, of course, involves placing his interpretation on the summarized data by the way he arranges his reports.

Every business has a unique method of maintaining its accounting books. However, all accounting systems are similar in the following manner:

• Business documents representing transactions that have taken place. (A business transaction occurs when goods are sold, a contract is signed, merchandise is purchased, or some similar financial transaction has occurred).
• Various journals where the documents are recorded in detail and classified
• Various ledgers where the details recorded in the journals are summarized
• Financial reports where the summarized information is presented
Where variations exist, they have to do with the way the business transaction is assembled, processed, and recorded.

Profit and Loss Accounts - Accounting Basics Every Business Owner Should Know

There is absolutely no doubt that business owners, especially those who attached with small businesses should have a firm understanding of the basics of accountancy and bookkeeping. This is not to suggest of course, that they should be able to set themselves up as accountants in their own right, or indeed that they should be attempting to take the place that should rightly be filled by an accountant in their own business, but far too many business owners totally abdicate all responsibility for their business finances and hand it all over to their accountant, without the slightest idea what he will do with it.

This state of affairs is a very dangerous way to run a business of any size; a good business owner should be able to sit down with his accountant and discuss things, and understand what he is being told. The same goes for bookkeeping; there is nothing wrong with hiring a professional to keep your books, but there is no excuse for not knowing how they are kept.

Take for instance P&L or 'Profit and Loss', for some business owners the very thought of looking at something that sounds so accountancy is terrifying, and yet this particular job is so incredibly simple as to be almost child's play. It is also an incredibly important tool in business, as it allows the business owner to check how well or otherwise their business is doing.

A P&L account, although only needed on a formal basis if you are a Limited Company, in which case a full account will need to be submitted to HMRC each year to enable them to assess for Corporation Tax, is essentially, as the name suggests, a report of the profit and any losses made by your firm usually over a 12 month period. To prepare a P&L account, simply take a summary of all your business' expenditure and sales and deduct your expenditure from your sales and you will have your profit (or loss).

If you are looking for any sort of future funding for your business, an accurate P&L will be vital, as most lenders won't move without one, but it will also help you to know whether or not your business is moving in the right direction; making a continually loss will set alarm bells ringing.

In order to make your P&L as accurate as it should be, your records will need to be properly kept, without omissions or missing information. The figure that comes out at the end will only be as accurate as the figures you have used to produce it, so ensure that you are careful.

Like so much of the rest of the rather complex sounding business terminology P&L is actually very simple, and nothing more or less than the answer to a subtraction sum.

So, the next time that an accountant wants to talk profit and loss over tea and crumpets, tell them you'd be happy to and perhaps take a little more control over other aspects of your business' finance; the rewards you reap may be more than simply financial.

Small Business Accounting - The Basics You Should Know

In my point of view, a lot of small businesses just starting out believe that accounting is a matter of just watching the checkbook. As long as nothing bounces, business is good. But, more and more small business owners are realizing the importance of understanding accounting and the critical role it plays in the success of their business. Good accounting is needed to make successful and profitable decisions. Accounting is known as the language of business. So, whether you want to or not, it is important that you learn this "second" language and understand some of the basic terms to help you make those important decisions.

Definitions of Basic Terms

As with learning any language, the best place to start is by learning the basics. The more you learn the more you will understand as you delve deeper into your business' finances. Fortunately, once you get the basics down there really isn't any need to learn in-depth ratios or extremely difficult reports or tables, unless, of course, you are going into some kind of financial analytical field.

To get you started, the following is a list of basic terms (the backbone of accounting, if you will):

Assets are simply what you own (i.e. checking account balances, cash, accounts receivables, inventory, furniture, fixtures, equipment, vehicles, buildings, land, goodwill, etc...).

Liabilities are what you owe (i.e. payroll liabilities, accounts payable, loans, credit card balances, etc...).

Equity is investment and equity from the company's owners, or partners (owner contributions, owner draws, stock, paid in capital, retained earnings, etc...).

The first three accounts are found on your balance sheet.

Income is what the business sales. This could be products, or services. It is generally referred to as revenue.

Cost of Goods Sold is used to track how much a particular product or service cost, and what type of margins the business is making on them. Businesses can choose to use these type of accounts, or not. I recommend using a cost of goods sold account for businesses who sale higher volumes of products.

Expenses are accounts that are used for administrative and overhead costs to a business (i.e. telephone, rent, payroll, travel, etc...). Too many expense accounts can be cumbersome to maintain, while too few keep the business from knowing where its money is going.

Net Income, also referred to as Net Profit, is not an account, but rather an amount that comes from subtracting your expenses and cost of good sold from your income. The saying "in the black" comes from whether this amount is positive (in the black) or negative (in the red).

The basics of accounting is a good place to start learning this critical language for your business. Remember, knowledge is power and the correct application of knowledge is wisdom. Be wise with your business!

The Certification of Financial Statements

In response to a number of financial scandals (including Enron and WorldCom)
involving a lapse of internal financial controls, the American Competitiveness and
Corporate Accountability (or Sarbanes-Oxley) Act was established in 2002 and introduced
new standards for financial audits and internal controls.

The Sarbanes-Oxley Act (SOX) established detailed procedures that U.S. companies,
along with foreign firms listed on the U.S. stock exchange, as well as their auditors
must follow in order to document, assess, and improve their internal controls
relating to financial reporting.

Pursuant to the Act, CEOs and CFOs of U.S. public companies must certify that:

* They have reviewed the companies’ financial reports.

* These reports do not exclude any significant information.

* Information presented in financial reports is accurate and fairly represents the
companies’ operational and financial condition.

* Each of the certifying officers is responsible for the company’s internal controls,
has evaluated them over the course of the period (quarterly or annual) for which
the financial reports have been prepared, and has reported any deficiencies in or
changes to the existing internal controls.

By signing off on these reports the company officers can be held
personally and criminally responsible if financial information in the company’s
reports is later shown to have been false and misleading.

How To Find Financial Reports

All filings made with the SEC constitute public information and can be found on:
* The SEC’s official web site (http://www.sec.gov)
* Company web sites, investor relations section
* Electronic Data Gathering, Analysis, and Retrieval (EDGAR) web site (http://
www.freeedgar.com)

Form 10-K (Annual Filing)

At the end of each fiscal year, publicly traded companies must file a 10-K report,
which includes a thorough overview of their businesses and finances as well as their
financial statements.

Why Is the 10-K Important?

Companies are required by the SEC to file it annually. Form 10-K usually provides
the most detailed overview of companies’ financial operations and regulations governing
them.

Other Important Filings:

Form 8-K

An 8-K is a required filing any time a company undergoes or announces a materially
significant event such as an acquisition, a disposal of assets, bankruptcy, and so
forth.

Form S-1

An S-1 registration is filed by a company when it decides to go public (i.e., sell its
securities to the public for the first time) in the process known as an Initial Public
Offering (IPO).

Form 14A

Form 14A is a required annual filing prior to a company’s annual shareholder meetings.
It contains detailed information about top officers and their compensations.
The form often solicits shareholder votes (proxies) for Board nominees and other
important matters.

Form 20-F

Form 20-F is an annual report filed by foreign companies whose shares trade in the
United States.

Four Underlying Principles In Accounting:

1. Historical Cost: Financial statements report companies’ resources
and obligations at an initial historical cost. This conservative measure precludes
constant appraisal and revaluation.

2. Revenue Recognition: Revenues must be recorded when earned and
measurable.

3. Matching Principle: Costs of a product must be recorded during the
same period as revenue from selling it.

4. Disclosure: Companies must reveal all relevant economic
information determined to make a difference to
their users.