Accounting For Dummies. John A. Tracy

transactions include paying employees, making sales to customers, borrowing money from the bank, and buying products that will be sold to customers. The bookkeeping process begins by determining the relevant information about each transaction. The chief accountant (controller) of the business establishes the rules and methods for measuring the financial effects of transactions. Of course, the bookkeeper should comply with these rules and methods.

      3 Make original entries of financial effects in journals, with appropriate references to source documents.Using source documents or electronic files, the bookkeeper makes the first, or original, entry for every transaction into a journal; this information is later recorded in accounts (see the next step). A journal is a chronological record of transactions in the order in which they occur — like a very detailed personal diary.Here’s a simple example that illustrates recording a transaction in a journal: A retail bookstore, expecting a big demand from its customers, purchases, on credit, 100 copies of Accounting For Dummies, 7th Edition, from the publisher, Wiley. The books are received and placed on the shelves. (One hundred copies is a lot to put on the shelves, but our relatives promised to rush down and buy several copies each.) The bookstore now owns the books and also owes Wiley $1,500, which is the cost of the 100 copies. Here we look only at recording the purchase of the books, not recording subsequent sales of the books and paying the bill to Wiley.The bookstore has established a specific inventory asset account called “Inventory–Trade Paperbacks” for books like this one. And the purchase liability to the publisher should be entered in the account “Accounts Payable–Publishers.” Therefore, the original journal entry for this purchase records an increase in the inventory asset account of $1,500 and an increase in the liability accounts payable of $1,500. Notice the balance in the two sides of the transaction: An asset increases $1,500 on the one side, and a liability increases $1,500 on the other side. All is well (assuming there are no mistakes).In ancient days, bookkeepers had to record journal entries by hand, and even today there’s nothing wrong with a good hand-entry (manual) bookkeeping system. But bookkeepers now can use online, real-time computer systems that take over many of the tedious chores of bookkeeping (see Chapter 4). Unfortunately, so much keyboard typing has replaced hand cramps with carpal tunnel syndrome for some bookkeepers, but at least the work gets done more quickly and with fewer errors!Summing up, a journal entry records the whole transaction in one place at one time. All changes caused by the transaction are chronicled in one entry. However, making journal entries does not provide a running balance for the individual assets, liabilities, and other financial components of a business (or other entity) — which leads to the next step in the bookkeeping process.

      4 Post the financial effects of transactions in the accounts changed by the transactions.Journal entries are the sources for recording changes caused by transactions in the accounts of the entity. An account is a separate record or file for each asset, each liability, and so on. The pluses and minuses of the transaction are recorded in the accounts changed by the transaction. In this way, a running balance is kept for each. Recording the effects of transactions from journal entries to accounts is called posting.Think of each account as an address. The changes recorded in the original journal entries are “delivered,” or posted to the accounts. A business (or other entity) establishes an official chart, or list of accounts, that is used for posting transactions. The original journal entry records the whole transaction in one place; then, in the second step called posting, each change is recorded in the separate accounts affected by the transaction. We can’t exaggerate the importance of entering transaction data correctly and in a timely manner — both in original journal entries and in the posting step. The prevalence of data-entry errors is one important reason that most retailers use cash registers that read bar-coded information on products; this approach more accurately captures the necessary information and speeds up the entry of the information. One way of stressing this point is the well-known data-processing expression “garbage in, garbage out.”

      Finishing up for the period

      After doing the four bookkeeping procedures we explain in the preceding section, the business is ready to finish the process. At the end of the period, certain steps are necessary to make the business’s accounts ready for the preparation of its financial statements (and other accounting reports such as tax returns). We continue the numbering from the preceding section, so we start with Step 5:

      1 Perform end-of-period procedures — the critical steps for getting the accounting records up to date and ready for the preparation of management accounting reports, tax returns, and financial statements.A period is a stretch of time — from one day (even one hour) to one month to one quarter (three months) to one year — that is determined by the needs of the business. A year is the longest period of time that a business would wait to prepare its financial statements. Most businesses need accounting reports and financial statements at the end of each quarter, and many need monthly financial statements. Before accounting reports can be prepared at the end of the period, the bookkeeper needs to bring the accounts of the business up to date and to complete the bookkeeping process. Generally these end-of-period procedures consist mainly of making adjusting entries in the accounts of the business. One such end-of-period adjusting entry, for example, is recording depreciation expense for the period (see Chapters 6 and 7 for more on depreciation). Another is taking an actual count and making a critical inspection of the business’s inventory so that the inventory records can be adjusted to recognize any shoplifting, employee theft, and other inventory shrinkage.The accountant needs to be heavily involved in end-of-period procedures and be sure to check for errors in the business’s accounts. Data-entry clerks and bookkeepers may not fully understand the unusual nature of some business transactions and may have entered transactions incorrectly. One reason for establishing internal controls (discussed in the later section “Enforcing Strong Internal Controls”) is to keep errors to a minimum. Ideally, accounts should contain very few errors at the end of the period, but the accountant can’t make any assumptions and should make a final check for any errors that may have fallen through the cracks.

      2 Compile the adjusted trial balance, which is the accountant’s basis for preparing management reports, tax returns, and financial statements.After all the end-of-period procedures have been completed, the bookkeeper compiles a comprehensive listing of all accounts, which is often called the adjusted trial balance. Modest-sized businesses maintain hundreds of accounts for their various assets, liabilities, owners’ equity, revenue, and expenses. Larger businesses keep thousands of accounts, and very large businesses may keep more than 10,000 accounts.In contrast, external financial statements and tax returns contain a relatively small number of accounts. For example, a typical external balance sheet reports only 25 to 35 accounts (maybe even fewer). Apple’s consolidated September 26, 2020, end-of-fiscal year balance sheet contains just 27 accounts, including totals. (Apple’s 2020 10-K annual report to the Securities and Exchange Commission includes more accounts.) The annual income tax return (Form 1120) for business corporations contains a relatively small number of accounts.The accountant takes the adjusted trial balance and telescopes similar accounts into one summary amount that is reported in a financial report or tax return. For example, a business may keep hundreds of separate inventory accounts, every one of which is listed in the adjusted trial balance. The accountant collapses all these accounts into one summary inventory account that’s presented in the balance sheet of the business. In grouping the accounts, the accountant should comply with established financial reporting standards and income tax requirements.

      3 Close the books — bring the bookkeeping for the fiscal year just ended to a close and get things ready to begin the bookkeeping process all over again for the coming fiscal year.Books is the common term for a business’s complete set of accounts. (Well, okay, we should include journal entries in the definition of books, but you get the point.) A business’s transactions are a constant stream of activities that doesn’t end tidily on the last day of the year, which can make preparing