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For general information on our other products and services or to obtain technical support, please contact our Customer Care Department within the United States at (866) 744-2665, or outside the United States at (510) 2530500. Tycho Press publishes its books in a variety of electronic and print formats. Some content that appears in print may not be available in electronic books, and vice versa. TRADEMARKS: Tycho Press and the Tycho Press logo are trademarks or registered trademarks of Callisto Media, Inc., and/or its affiliates, in the United States and other countries, and may not be used without written permission. All other trademarks are the property of their respective owners. Tycho Press is not associated with any product or vendor mentioned in this book. ISBN: Print 978-1-62315-536-0 | eBook 978-1-62315-537-7 CONTENTS INTRODUCTION What Is Accounting? Who Governs the Accounting Industry? Bookkeepers, Accountants, Controllers, and CPAs: Who Does What? Business Structures Types of Small Businesses CHAPTER 1 BASIC ACCOUNTING TERMS The Accounting Equation The Balance Sheet The Income Statement The Statement of Cash Flows The Statement of Retained Earnings CHAPTER 2 BUSINESS SETUP The Accounting Cycle Making Journal Entries Stock Setting Up Payroll Employee Benefits and Taxes Borrowing CHAPTER 3 RUNNING A BUSINESS Ordering Equipment Ordering and Receiving Materials Overseeing Production The Costs of Doing Business Inventory and Cost of Goods Sold CHAPTER 4 SELLING Selling Receiving Orders Fulfilling Orders Receiving Payment CHAPTER 5 END OF CYCLE Insurance Paying Suppliers Managing Payroll Paying Income Taxes Paying Dividends Valuing Your business INTRODUCTION A ccounting is a large and multifaceted field that encompasses many business activities. It serves a fundamental role in businesses of all types, from multinational corporations to nationwide chains to mom-and-pop neighborhood stores. In this book we’re going to break it all down at the level of the small business owner. We’ll discuss what accounting is and the industry rules that govern how accountants operate. You’ll learn about financial statements—what they are and how to use them. We’ll cover stock, payroll, borrowing, and employee benefit and tax payments. Then we’ll go over production and inventory, as well as paying bills and expenses. After reading this book you should have an understanding of some basic principles of accounting and be able to set up your first set of books for your small business. You’ll be able to prepare your own financial statements and determine whether or not your business is making a profit. You’ll also be able to better predict the ups and downs of your business and make more informed decisions, which will keep your enterprise healthy and growing. WHAT IS ACCOUNTING? Accounting is the process of recording business transactions, summarizing that data in financial statements, analyzing it, and then reporting the findings to owners and investors. Owners of small businesses need to know if their sales, costs, and expenses are increasing or decreasing, and if they are making a profit or a loss during a specified time period. A business owner can’t improve the business unless they know what is and isn’t working. As a small business owner, you will need to monitor cash flow so you’ll know if you have enough to cover your upcoming expenses. You’ll also need to keep an eye on receivables and payables so you know if customers are paying you on time, and that you’re paying your vendors timely as well. You’ll need to monitor your sales and expenses to make sure you are earning a profit. If you’re losing money, there’s not much point to being in business! WHO GOVERNS THE ACCOUNTING INDUSTRY? The Federal Accounting Standards Board (FASB) is the governing body that establishes and issues the standards to which all certified public accountants (CPAs) must adhere. FASB standards, known as generally accepted accounting principles (GAAP— pronounced “gap”), consist of a set of guidelines that govern how the accounting industry performs its duties. The goal is to ensure credibility and transparency within the industry. The basic accounting principles include: • Cost principle. Accountants use the term cost for the amount originally spent, so amounts shown on financial statements are referred to as “historical costs.” • Economic entity assumption principle. Accountants consider the business and its owner as separate entities. • Full disclosure principle. If certain information would be relevant to an investor or lender, it should be disclosed in the financial statements. The information is usually included in the form of footnotes. • Going concern principle. Accountants act on the assumption that the business will keep operating indefinitely. • Matching principle. Accountants try to match revenue to expenses (i.e., post them in the time period, month, or quarter in which they were earned). This principle is used in the accrual method of accounting. • Revenue recognition principle. Accountants recognize revenue as it is earned, not as cash is received. This system is also used in the accrual method. A few of these principles are specific only to the accrual method of accounting, as opposed to the cash method. The accrual method recognizes revenue when it is earned (when the product is shipped or services are performed) and expenses when they are incurred (purchases made), not necessarily when money is exchanged. This method allows the business owner to keep the revenue and expenses for products sold or services performed reported in the same time period, such as over a 30-day period. That said, most small businesses use the cash method, which is acknowledged by governing agencies as an acceptable alternative. This method stipulates that revenue be recognized when the cash is received and that expenses be posted when the bill is paid. BOOKKEEPERS, ACCOUNTANTS, CONTROLLERS, AND CPAS: WHO DOES WHAT? Accounting personnel have many job titles, and each specializes in different tasks and duties. If you ever need to hire someone to help you with accounting, you will need to know how these titles differ. A bookkeeper posts transactions and “keeps the books” by recording customer payments and bill payments. This job entails invoicing customers, paying bills, paying employees, making deposits, and so on. An accountant picks up where the bookkeeper leaves off. An accountant takes the information the bookkeeper records and summarizes that information into financial statements. Accountants also conduct a financial analysis on the data in those statements to determine the financial health of the company. A controller (or comptroller) is a job designation found in larger organizations. This person serves as the “head accountant” for the company, usually overseeing a department of several accountants or bookkeepers. This person may report to the owner directly; in larger corporations he or she would report to the treasurer or VP of Finance. The controller keeps the accounting processes on track by making sure all duties are performed accurately and timely, and works with the company owners to help fulfill the business’s financial objectives. A CPA is an accountant who has passed a test (the Uniform CPA Examination) to perform higher-level accounting work, somewhat like an attorney passes the bar exam before practicing law. A CPA may then prepare reviewed or audited financial statements for companies and represent businesses before the IRS in tax matters. During an audit, the CPA goes into a business and examines the accounting records, pulls samples, and tests for the accuracy of financial statements. The CPA can then give an opinion on the accuracy of those records and on whether there are any pending issues that may affect the statements. An accountant who is not a CPA may only prepare compiled financial statements. These statements are nonreviewed—meaning they’re prepared specifically from the business owner ’s data—and the accountant may not give an opinion on the statements. The accounting work required by every small business will vary according to the needs of the owner and the legal structure of the business. An owner should be familiar with the basics of the five main business structures because his or her company will have to be registered as one of them: A business can be structured as a sole proprietorship, a partnership, an LLC, an S corporation, or a C corporation. Let’s look at these in more detail. BUSINESS STRUCTURES An experienced attorney will be able to help you decide which legal structure is right for you and your business. Sole Proprietorship A sole proprietorship is the simplest business structure. The business is run as an extension of the owner. Essentially, the owner is the business. Most part-time and very