Simply Accounting Accounting Manual Canadian Version © Copyright 1998 ACCPAC INTERNATIONAL, INC. All rights reserved. ACCPAC INTERNATIONAL, INC., Publisher No part of this documentation may be copied, photocopied, reproduced, translated, microfilmed, or otherwise duplicated on any medium without written consent of ACCPAC INTERNATIONAL. Use of the software programs described herein and this documentation is subject to the ACCPAC INTERNATIONAL License Agreement enclosed in the software package. This software and its documentation are intended to provide guidance in regard to the subject matter covered. They are sold with the understanding that the author and publisher are not herein engaged in rendering legal, investment, tax, or other professional services. If such services are required, professional assistance should be sought. All product names referenced herein are trademarks of their respective companies. ® Contents Chapter 1: Listing the Things a Business Owns and Owes Starting a Business ............................................................. 1­1 Chapter 2: The Balance Sheet Assets, Liabilities and Equity....................................................2­1 Changes in Assets, Liabilities and Equity .........................................2­2 Chapter 3: Changes in Equity Changes Caused by Withdrawals................................................3­1 Changes Caused by Earnings....................................................3­1 Chapter 4: Recording How Earnings Were Made Revenues and Expenses ........................................................ 4­1 When to Record Revenues and Expenses .........................................4­3 Chapter 5: Recording Changes to the Balance Sheet Recording Transactions ......................................................... 5­1 Debits and Credits ............................................................. 5­4 Debits and Credits on the Balance Sheet ......................................5­7 Revenues and Expenses ..................................................... 5­8 Accounting Manual iii Chapter 6: A Separate Income Statement Why and How ................................................................ 6­1 Debits and Credits Affect Both Statements ....................................... 6­2 Chapter 7: The Journal Why and How ................................................................ 7­1 National Construction's Journal................................................. 7­3 Chapter 8: The Ledger Why and How ................................................................ 8­1 Posting ....................................................................... 8­2 Chapter 9: Manual Accounting Systems Chapter 10: Classified Financial Statements The Balance Sheet ............................................................ 10­1 Assets ................................................................... 10­1 Liabilities ................................................................ 10­2 Equity ................................................................... 10­2 The Income Statement ........................................................ 10­3 Revenues................................................................. 10­4 Expenses ................................................................. 10­4 Net Income............................................................... 10­4 Chapter 11: Adjusting Entries When and Why............................................................... 11­1 Prepaid Expenses............................................................. 11­2 iv Simply Accounting Use of Supplies ...............................................................11­3 Bad Debts .................................................................... 11­3 Depreciation..................................................................11­4 Accrued Expenses.............................................................11­5 Accrued Revenues ............................................................11­7 Chapter 12: The Finished Financial Statements Chapter 13: Starting the Next Accounting Period Closing the Books .............................................................13­1 Opening the Books ............................................................13­3 Chapter 14: Summary of Financial Statement Preparation Chapter 15: Other Types of Legal Organizations Partnerships ..................................................................15­1 Corporations .................................................................15­3 Chapter 16: Subsidiary Ledgers Why and How ................................................................16­1 Accounts Receivable ..........................................................16­2 Accounts Payable .............................................................16­2 Payroll .......................................................................16­3 Inventory.....................................................................16­3 Accounting Manual v Chapter 17: Open Invoice Accounting for Payables and Receivables Late Payment Charges ........................................................ 17­1 Discounts .................................................................... 17­1 Bad Debts.................................................................... 17­2 Prepayments ................................................................. 17­3 Chapter 18: Payroll Accounting Determining an Employee's Gross Earnings..................................... 18­3 Regular Pay .............................................................. 18­4 Overtime Pay............................................................. 18­4 Salary.................................................................... 18­5 Commission .............................................................. 18­5 Taxable Benefits .......................................................... 18­6 Vacation Pay ............................................................. 18­6 Determining the Employee's Deductions........................................ 18­8 CPP Contribution ......................................................... 18­9 EI Premiums ............................................................ 18­10 Registered Pension Plan Contributions..................................... 18­12 Union................................................................... 18­13 Income Tax.............................................................. 18­13 Medical ................................................................. 18­14 GST Payroll Deductions .................................................. 18­15 Calculating the Employer's Associated Expenses ............................... 18­16 CPP and EI Expenses..................................................... 18­16 Employer's WCB Expenses ............................................... 18­17 Updating the Employee's Payroll Record ...................................... 18­17 Creating the Journal Entries .................................................. 18­19 Remitting Funds to the Receiver General and Other Agencies ................... 18­19 Ontario Employer Health Tax ................................................ 18­20 Payroll Accounting in the Province of Quebec .................................. 18­22 vi Simply Accounting Chapter 19: Inventory Accounting Accounting Control of Inventory ...............................................19­3 General Ledger Accounts in Inventory Accounting...............................19­4 Tax Considerations in Accounting for Inventory .................................19­8 Goods and Services Tax....................................................19­8 Provincial Sales Tax ......................................................19­10 Chapter 20: Cost Accounting Project Costs..................................................................20­1 Profit Centres .................................................................20­2 Chapter 21: Accounting for the GST and PST Preparing for Tax Accounting ..................................................21­1 Setting Up General Ledger Accounts ........................................21­1 Accounting for Purchases ......................................................21­2 Accounting for Sales ..........................................................21­3 GST Payroll Deductions .......................................................21­4 Adjustments ..................................................................21­4 Clearing the Tax Accounts .....................................................21­5 Glossary Index Accounting Manual vii Chapter 1 Listing the Things a Business Owns and Owes This chapter discusses starting a company, and the relationship between the things a company owns and the money it owes. Starting a Business Jim Brown quits his job and starts his own company to do small construction contracts. The company is called National Construction and is a proprietorship. A proprietorship is a business which keeps accounting records separate from those of its owner but is not legally separate from its owner. On February 1, 1995, Brown deposits $50,000 in National Construction's bank account. The financial position of the company is a summary of what it owns and the claims against the things that it owns on the date of the summary. It can be compared to a snapshot that shows the position at a specific point in time. National Construction February 1, 1995 Things Owned: Cash in Bank $50,000 Claims Against Things Owned: Jim Brown $50,000 On February 2, National Construction pays cash to buy a dump truck that costs $10,000. This makes the company's list of things owned and claims against things owned look like this: Accounting Manual 1­1 Starting a Business National Construction February 2, 1995 Things Owned: Cash in Bank Truck $40,000 10,000 Claims Against Things Owned: Jim Brown $50,000 Brown gets his first contract, but to complete it he needs to buy another truck. It costs $12,000, and on February 3 he convinces his banker to lend National Construction the money to buy it. The loan is for a five-year term. National Construction now has more trucks, but a new category is needed to describe the bank's claim: National Construction February 3, 1995 Things Owned: Cash in Bank Trucks $40,000 22,000 Claims Against Things Owned: Bank Loan $12,000 Jim Brown 50,000 Everything the company owns was paid for with either the bank's money or the money invested by the owner. Notice that the value of the things owned equals the value of the claims against things owned. This relationship is always true, and is the basis for the entire accounting process: Things Owned = Claims Against Things Owned Let's look at another example. On February 4, National Construction buys $1,000 worth of maintenance supplies for the trucks and the supplier gives National 30 days to pay. Amounts owed to a supplier who has given you credit are called accounts payable. 1­2 Simply Accounting Starting a Business Here is the updated summary: National Construction February 4, 1995 Things Owned: Cash in Bank $40,000 Trucks 22,000 Maintenance Supplies 1,000 63,000 Claims Against Things Owned: Accounts Payable $ 1,000 Bank Loan 12,000 Jim Brown 50,000 63,000 "Things owned" still equal the "claims against things owned," and the changes which were made resulted in an increase of the same size to both the things owned and the claims against things owned. Because this summary always balances, we call this summary of things owned and claims against things owned a balance sheet. On the balance sheet, things owned are listed on the left, and claims against things owned on the right. The claims against things owned are made by two groups of people: the owner, and others. In law, the owner does not get his investment back until others have been paid back. For this reason, it makes sense to break the claims into two groups, with claims by others ranked first: National Construction Balance Sheet February 4, 1995 Things Owned: Cash in Bank $ Trucks Maintenance Supplies $ 40,000 22,000 1,000 63,000 Claims Against Things Owned: Accounts Payable $ 1,000 Bank Loan 12,000 13,000 Claims by Owner: Jim Brown 50,000 $ 63,000 You are now ready to go to Chapter 2 to find out more about the balance sheet. Accounting Manual 1­3 Chapter 2 The Balance Sheet This chapter discusses a company's assets, liabilities, and equity, and shows how changes in any one of these affect the other two. Assets, Liabilities and Equity Things owned by the company are called assets. Claims by others are called liabilities. If the owner wants to get back his investment, he must sell the assets and pay off the liabilities. What is left over is the owner's equity in the company. The balance sheet is now presented with the new words: National Construction Balance Sheet February 4, 1995 Assets: Cash in Bank $ 40,000 Trucks 22,000 Maintenance Supplies 1,000 $ 63,000 Liabilities: Accounts Payable Bank Loan Equity: Jim Brown $ 1,000 12,000 13,000 50,000 $ 63,000 Our statement "Things Owned = Claims Against Things Owned" can now be rewritten: Assets = Liabilities + Equity This statement is the basis of accounting and is accounting's single most important concept. It is called the accounting equation. Accounting Manual 2­1 Changes in Assets, Liabilities and Equity Changes in Assets, Liabilities and Equity Since assets equal liabilities plus equity, we know that if assets increase, then liabilities plus equity must increase by the same amount. The accounting equation can also be used to say that changes in assets equal changes in liabilities plus changes in equity. Here are some more examples so we can see how assets, liabilities, and equity are related. On February 5, National Construction buys some furniture costing $2,000 for the office Jim Brown has set up in his home. The supplier gives National 30 days to pay the bill. Our updated balance sheet has a new asset called furniture, and accounts payable has increased by the amount of the supplier's bill: National Construction Balance Sheet February 5, 1995 Assets: Cash in Bank Trucks Maintenance Supplies Furniture $ 40,000 22,000 1,000 2,000 $ 65,000 Liabilities: Accounts Payable Bank Loan Equity: Jim Brown $ 3,000 12,000 15,000 50,000 $ 65,000 On February 7, National buys a front-end loader which costs $20,000, but this time the bank will only lend $15,000 and the company must make a down payment of $5,000. Because Brown expects to buy more equipment related to construction, he categorizes the front-end loader as Construction Equipment and puts a value of $20,000 beside it. 2­2 Simply Accounting Changes in Assets, Liabilities and Equity He also records the decrease in Cash in Bank of $5,000 (to $35,000) and the increase in the Bank Loan of $15,000 (to $27,000): National Construction Balance Sheet February 7, 1995 Assets: Cash in Bank Trucks Maintenance Supplies Furniture Construction Equipment $ 35,000 22,000 1,000 2,000 20,000 $ 80,000 Liabilities: Accounts Payable Bank Loan Equity: Jim Brown $ 3,000 27,000 30,000 50,000 $ 80,000 You are now ready to go to Chapter 3 to find out more about changes in withdrawals, earnings, and losses. Accounting Manual 2­3 Chapter 3 Changes in Equity There are two ways for equity to change. They are investments or withdrawals by the owner, and earnings or losses by the company. We have already covered investments by the owner, so this section will now cover withdrawals, earnings, and losses. Changes Caused by Withdrawals On February 22, Brown needs $2,000 to repair the family car and takes it out of the company's bank account because he doesn't have enough money personally. When a proprietor takes money out of his business, it is called a withdrawal. The Cash in Bank category goes down by $2,000 (to $33,000) and the equity category goes down by $2,000 (to $48,000): National Construction Balance Sheet February 22, 1995 Assets: Cash in Bank Trucks Maintenance Supplies Furniture Construction Equipment $ 33,000 22,000 1,000 2,000 20,000 $ 78,000 Liabilities: Accounts Payable Bank Loan Equity: Jim Brown $ 3,000 27,000 30,000 48,000 $ 78,000 Changes Caused by Earnings Brown completes his first gravel hauling contract on February 27 and National Construction is paid $5,000 cash. The Cash in Bank category therefore increases by $5,000 to $38,000. Accounting Manual 3­1 Changes Caused by Earnings The client paid for the gas, so the hauling contract didn't cost National anything except Brown's time. This means that National doesn't owe any of the money to anyone else, and therefore earned the entire $5,000. Now Brown has to decide where to record the money that the company earned. Since assets increased by $5,000 (cash was received), and the amount of liabilities didn't change (National doesn't owe anyone anything extra as a result of earning the $5,000), we know that equity must increase by $5,000 in order to keep the accounting equation in balance. This increase in equity was earned by the company, not invested by the owner, so we show it as a separate category of equity called Earnings. National Construction Balance Sheet February 27, 1995 Assets: Cash in Bank Trucks Maintenance Supplies Furniture Construction Equipment $ 38,000 22,000 1,000 2,000 20,000 $ 83,000 Liabilities: Accounts Payable Bank Loan Equity: Jim Brown Earnings $ 3,000 27,000 30,000 48,000 5,000 53,000 $ 83,000 If the company lost money in the future, the losses would reduce the amount of the earnings by the amount of the loss. For the same reasons that earnings has its own category, withdrawals could also have its own category. It has not been added at this point, though, in order to keep the balance sheet relatively uncluttered. You are now ready to go to Chapter 4 to find out about revenues and expenses. 3­2 Simply Accounting Chapter 4 Recording How Earnings Were Made This chapter tells you how to record the money a company takes in for the goods and services it provides for its customers, and the money it spends to provide those goods and services. Revenues and Expenses Brown completes an excavating contract on March 1 for which National is paid $6,000 cash. This time he has to pay an equipment operator $2,000 in wages, which is paid in cash on March 1. National took in $6,000 cash and paid out $2,000 in cash. Cash in Bank therefore increases by $4,000 (to $42,000). Again, liabilities didn't increase as a result of the contract, so the earnings section of equity on the balance sheet increases by $4,000 (to $9,000) to keep it balanced. Brown can now update his balance sheet for the increase of $4,000 in Cash in Bank (to $42,000) and the $4,000 increase in earnings (to $9,000) and be correct, but he will have left out some very useful and important information. He will not be able to see on the balance sheet how much cash was received and spent in order to earn the $4,000. To show this on the balance sheet, he breaks the earnings category into two parts, revenues, and expenses; which he uses to show how much money the company took in and paid out in order to earn the total of $9,000. Revenues are the money a company is paid, or expects to be paid, for goods or services it provides to its customers. The word Sales is sometimes used in its place for a company that sells products instead of services. National was paid $5,000 for Accounting Manual 4­1 Revenues and Expenses the hauling contract and $6,000 for the excavating contract. Its total revenues are therefore $11,000. Expenses are the amount a company spends to provide goods or services to its customers. National's only expenses for the contracts are $2,000 in wages. Earnings are what is left over after expenses are deducted from revenues. Brown can now update his balance sheet to show the increases in Cash in Bank and Earnings, as well as show how the earnings were earned. He does not have to record the fact that he earned $4,000 for this last contract directly ($6,000 revenues minus $2,000 expenses), because after expenses are subtracted from revenues within the earnings category of the balance sheet, this increase of $4,000 in earnings will have been taken into account automatically: National Construction Balance Sheet March 1, 1995 Assets: Cash in Bank Trucks Maintenance Supplies Furniture Construction Equipment $ 42,000 22,000 1,000 2,000 20,000 $ 87,000 Liabilities: Accounts Payable Bank Loan Equity: Jim Brown Earnings Revenues: Hauling $ 5,000 Excavating 6,000 11,000 Expenses: Wages 2,000 Earnings $ 3,000 27,000 30,000 48,000 9,000 57,000 $ 87,000 4­2 Simply Accounting