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Accounting Demystified This page intentionally left blank Accounting Demystified Jeffry R. Haber, Ph.D., CPA American Management Association New York • Atlanta • Brussels • Chicago • Mexico City • San Francisco Shanghai • Tokyo • Toronto • Washington, D.C. Special discounts on bulk quantities of AMACOM books are available to corporations, professional associations, and other organizations. For details, contact Special Sales Department, AMACOM, a division of American Management Association, 1601 Broadway, New York, NY 10019. Tel.: 212-903-8316. Fax: 212-903-8083. Web site: www.amacombooks.org This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Library of Congress Cataloging-in-Publication Data Haber, Jeffry R., 1960– Accounting demystified / Jeffry R. Haber. p. cm. ISBN 0-8144-0790-0 1. Accounting. I. Title. HF5635.H112 2004 657—dc22 2003017265  2004 Jeffry R. Haber All rights reserved. Printed in the United States of America. This publication may not be reproduced, stored in a retrieval system, or transmitted in whole or in part, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of AMACOM, a division of American Management Association, 1601 Broadway, New York, NY 10019. Printing number 10 9 8 7 6 5 4 3 2 1 Contents Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . ix Chapter 1 Introduction . . . . . . . . . . . . . . . . . . 1 Chapter 2 Financial Statements . . . . Income Statement . . . . . . . . Statement of Retained Earnings Balance Sheet . . . . . . . . . . Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 5 7 8 12 Chapter 3 The Accounting Process Journalize . . . . . . . . . . . The Accounting Equation . . Post . . . . . . . . . . . . . . . Trial Balance . . . . . . . . . Finding Errors . . . . . . . . . Rest of the Process . . . . . . Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 14 15 17 19 20 24 24 Chapter 4 Making the Entries . . Analogies to Personal Life Some Examples . . . . . . Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 26 27 29 Chapter 5 Assets . . . . . . . . . . . . . . . . . . . . . . . 30 v . . . . vi Contents Chapter 6 Cash . . . . . . . . . . . . . . . . . . . . . . . . Petty Cash . . . . . . . . . . . . . . . . . . . . . Bank Reconciliation . . . . . . . . . . . . . . . 32 32 34 Chapter 7 Accounts Receivable . . . . . . . Control Account/Subsidiary Ledger Bad Debts . . . . . . . . . . . . . . . . Direct Write-Off Method . . . . . . Allowance Method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 42 45 45 46 Chapter 8 Inventory . . . . . . . Specific Identification . First-In, First-Out . . . . Last-In, First-Out . . . . . Weighted Average . . Things to Keep in Mind . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 54 55 59 61 63 Chapter 9 Prepaid Expenses . . . . . . . . . . . . . . 66 Chapter 10 Other Receivables Loan Term . . . . . . . Interest . . . . . . . . . Entries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 68 69 70 Chapter 11 Fixed Assets . . . . . . . . . . . . Land . . . . . . . . . . . . . . . . . . Land Improvements . . . . . . . . . Leasehold Improvements . . . . . . Buildings . . . . . . . . . . . . . . . . Equipment and Machinery . . . . . Furniture . . . . . . . . . . . . . . . . Fixtures . . . . . . . . . . . . . . . . . Vehicles . . . . . . . . . . . . . . . . Depreciation . . . . . . . . . . . . . Straight-Line Depreciation . . . . Declining-Balance Depreciation Partial-Year Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 74 74 75 75 75 75 76 76 76 76 78 81 vii Contents Retirement . . . . . . . . . . . . . . . . . . . . . Asset Sale . . . . . . . . . . . . . . . . . . . . . 81 82 Chapter 12 Intangible Assets . . . . . . . . . . . . . . . 85 Chapter 13 Liabilities . . . . . . . . . . . . . . . . . . . . Unearned Revenue . . . . . . . . . . . . . . . Accrued Expenses . . . . . . . . . . . . . . . . 89 90 91 Chapter 14 Accounts Payable . . . . . . . . . . . . . . 92 Chapter 15 Other Payables . . Interest Payable . . . Rent Payable . . . . . Taxes Payable . . . . Salaries Payable . . . Payroll Taxes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 95 96 96 97 97 Chapter 16 Stockholders’ Equity Types of Stock . . . . . . Common Stock . . . . . . Recording the Issuance . Treasury Stock . . . . . . Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 100 101 102 103 104 Chapter 17 Merchandising Companies . . . . . . . Perpetual Inventory System . . . . . . . . . . . Periodic Inventory System . . . . . . . . . . . Discounts for Early Payment . . . . . . . . . . Side-by-Side Comparison of the Periodic and Perpetual Systems . . . . . . . . . . . . . . . . 107 111 114 115 Chapter 18 Adjusting and Closing Entries . Payroll Accrual . . . . . . . . . . . . . Reversing Entries . . . . . . . . . . . . Interest Expense . . . . . . . . . . . . Unearned Revenue . . . . . . . . . . 118 119 121 123 124 . . . . . . . . . . . . . . . . . . . . . . . . . 117 viii Contents Prepaid Expenses . . . . . . . . . . . . . . . . Closing Entry . . . . . . . . . . . . . . . . . . . Chapter 19 Specialized Journals . . Cash Receipts Journal . . . . Cash Disbursements Journal Purchases Journal . . . . . . Sales Journal . . . . . . . . . Payroll Journal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 130 131 133 134 134 Chapter 20 Statement of Cash Flows . . . . . . . . . Direct Method . . . . . . . . . . . . . . . . . . Indirect Method . . . . . . . . . . . . . . . . . 136 138 139 Chapter 21 Ratio Analysis . . . . . . . . . . Horizontal and Vertical Analysis Ratio Analysis . . . . . . . . . . . . Liquidity Ratios . . . . . . . . . Efficiency Ratios . . . . . . . . . Profitability Ratios . . . . . . . . Summary . . . . . . . . . . . . . . . . . . . . . 143 144 145 146 146 147 149 Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151 Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 125 . . . . . . . Acknowledgments I would like to thank my wonderful wife, Holly, and the greatest group of children any father could be blessed with: Jonathan, Amy, and Lauren. They were extremely understanding during the process of writing this book. I would also like to thank the team at AMACOM, especially Ray O’Connell and Jim Bessent, who made the development of this book painless. Finally, I would like to thank you, the reader, for your interest in financial accounting, without which this book would not be necessary. ix