Bank Reconciliation

The process by which an account's balance as per the banks records is brought into agreement with the balance per the depositor's records. The form used to reconcile the balances is known as the bank reconciliation statement.

Bank Reconciliation Statement
A statement prepared once a month to bring about an agreement between the checkbook balance and the bank balance.

Bank Statement
A record that is sent by the bank, usually on a monthly basis, to indicate the bank's record of the activities within an individual checking account. The activities recorded on the statement include deposits, paid checks, various bank charges, collections made by the bank to the customer's account, and payments authorized from the customer's account.

A Bank reconciliation is the process of matching and comparing figures from accounting records against those presented on a bank statement. Less any items which have no relation to the bank statement, the balance of the accounting ledger should reconcile (match) to the balance of the bank statement.

Bank reconciliation allows companies or individuals to compare their account records to the bank's records of their account balance in order to uncover any possible discrepancies.

Comparing the Bank Statement to the cashbook
When all of the receipts for a period have been written up in the cash receipts book and all of the cheque payments, standing orders and direct debits have been entered into the cash payment book, it is necessary to carry out any further checks possible on the cashbook. The most obvious check is to compare the entries in the cash receipts and cash payments book for the period, to the entries on the bank statement, although some care does need to be taken here.

Debits and Credits
One of the most obvious differences between the cashbook and the bank statement  is that the use of the terms debit and credit appear to be totally opposed to each other.

If cash is paid into the bank by a business this is a receipt and is entered in the cash receipts book as a debit entry. However, in the bank statement this will described as a credit effectively owes the money back to the business and therefore the business is a creditor to the bank.

Similarly, if the business writes a cheque out of the business bank account this will be entered in the cash payments book as a credit entry. From the bank's perspective however, this is known as a debit entry and any overdrawn balance is a debit balance.

How To Do A Bank Reconciliation
Summarised, the procedure for performing a bank reconciliation, in four simple steps:
Bank Reconciliation Example

1. Compare the cash receipts book to the receipts shown on the bank statement  (the credits on the bank statement) - for each receipt that agrees, tick the item in both cashbook and the bank statement.
2. Compare the cash payments book to the payments shown on the bank statement (the debits on the bank statement) - for each payment that agrees, tick the item in both the cashbook and the bank statement.
3. Any un-ticked items on the bank statement (other than rare errors made by the bank) will be items that should have been entered into the cash books, but have been omitted for some reason - these should be entered into the cashbook and then the amended balance on the cashbook can be found. To find the correct cashbook balance a ledger account is used for the bank with the original cashbook balance shown as the brought forward balance and any additional payments shown as credits and receipts as debits. This is ilustrated in the example.
4. Finally, any un-ticked items in the cashbook will be the timing differences - unpresented cheques and outstanding lodgements - these will be used to reconcile the bank statement closing balance to the corrected cash book closing balance.

Sole Proprietorship

A business structure in which an individual and his/her company are considered a single entity for tax and liability purposes.

Sole Proprietorship is a company which is not registered with the state as a limited liability company or corporation.

The owner does not pay income tax separately for the company., but he/she reports business income or losses on his/her individual income tax return.

The owner is inseparable from the sole proprietorship, so he/she is liable for any business debts.

See the following example:

Exercise 1

Partnership

A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the losses of the business.

A partnership must file an annual information return to report the income, deductions, gain, losses, etc. from its operations, but it does not pay income tax. Instead, it "passes through" any profits or losses to its partners. Each partner includes his or her share of the partnership's income or loss on his or her tax return.

Partner are not employees and should not be issued a Form W-2. The partnership must furnish copies of Schedule K-1 (Form 1065) to the partners by the date Form 1065 is required to be filed, including extensions

The partnership agreement may specify that partners should be compensated for services they provide to the partnership and for capital by partners.

For example, one partner contributed more of the assets, and works full time in the partnership , while the other partner contributed a smaller amount of assets and does not provide as much services to the partnership.

Compensation for services is provided in the form of salary allowance. Compensation for capital is provided in the form of interest allowance. Amount of compensation is added to the capital account of the partner.

Formation Requirements


A partnership's FORMATION REQUIREMENTS are satisfied when two or more parties agree to join forces for the common purpose of  earning a profit within a business environment. The parties to a partnership must simply agree to enter into a partnership. If, at a later date, the partners should decide not to continue the relationship, they can just easily terminate the association.

Agency Relationship

It is important that the selection of partners in a partnership be made with great care. Each partner has the power and right to act as an agent of the partnership.

Co-ownership of Assets

Assets are contributed to the partnership by the individual partners. Once contributed, the asset is said to be owned by the partnership, and the value of the asset given is reflected in the capital account of the contributing partner. Once the asset is contributed, it no longer belongs to the person who gave it. The partner's right is only to the value of the capital resulting from the contribution. This is known as the CO-OWNERSHIP OF ASSETS. in the event of a discontinuance of the partnership, individual partners have no rights to the specific assets they previously contributed, but merely to the dollar value of their investment in the business as evidenced by their capital balance.

Limited Life

In a sole proprietorship, if the owner becomes disabled or dies, the organization comes to an end. In a partnership, one of two possible changes may occur to the partnership. A DISSOLUTION is said to occur as a result of any change in the composition of a partnership, and a LIQUIDATION takes place if the partnership is terminated. Either event is an example of the partnership's LIMITED LIFE. A partnership may dissolve upon the death of a partner, the withdrawal of a partner, the incapacity of a partner, partnership bankruptcy, or even the admission of a new partner. Dissolution only extends to a liquidation in the case of bankruptcy.

Unlimited Liability

The profits or losses of a sole proprietorship are the sole pleasure or burden of the owner. In the case of a partnership, the same is true. The concepts UNLIMITED LIABILITY applies equally to both forms of businesses, but it may have a more serious effect on the partners of a partnership. The creditors who owed money by a partnership are not concerned with who pays the obligation; they are primarily concerned with being paid. The individual partner is said to be held liable for the debts of the partnership both collectively (jointly) and severally (individually). If the other partners are unable to contribute toward the liquidation of the debt, it becomes the obligation of the solvent partner to pay the entire obligation.

Participating in Profit and Losses

Participating in profits and losses comes about through a partnership agreement, and if there is no agreement, then any profit recognized or losses incurred are distributed equally. If an agreement exists that states how profits are to be distributed, but is silent as to losses, these losses, should they occur, are divided in the same manner as the agreed-upon profit distribution. Participation agreements as to profits and losses are recognized by the courts, assuming there was no undue influence or illegality in the making of the agreement.

The distribution of profits or losses is usually determined according to what is known as the PROFIT AND LOSS SHARING RATIO. This ratio is assumed to be equal unless there is a n agreement as to the distribution. If there is an agreement, that is the sole criterion for the determination of participation in profits or losses by the individual partners. Partner A may willingly accept 40% of the profits and 60% of the losses, As long as A agrees to this arrangement, it is perfectly valid.

Articles of Partnership

Participation in the profits or losses is determined by a court if there is no evidence of an agreement. It should be obvious that the rights and responsibilities of the partners in a partnership should be written form. This will serve to eliminate any disputes that may arise from an oral agreement. Such a written agreement is a contract and is referred to as the ARTICLES OF PARTNERSHIP. While there is no legal or governmental requirement that a partnership agreement be in written form, the existence of such a document outlines the obligations of the partners, their specific duties, and the effect on the partnership of such occurrences as the death of  a partner. Other provisions that should be made a part of the articles are the amount of the investment by each partner, the limitations on the withdrawal of funds, the policy with regard to the admissions or withdrawal of partners, and any other contingencies that can be anticipated at the time that the articles are prepared.

See the following example:

Exercise 1

Corporation

A group of people authorized by law to act as a legal personality and having its own powers, duties, and liabilities

The most common form of business organization, and one which is chartered by a state and given many legal rights as an entity separate from its owners. This form of business is characterized by the limited liability of its owners, the issuance of shares of easily transferable stock, and existence as a going concern. The process of becoming a corporation, call incorporation, gives the company separate legal standing from its owners and protects those owners from being personally liable in the event that the company is sued (a condition known as limited liability). Incorporation also provides companies with a more flexible way to manage their ownership structure. In addition, there are different tax implications for corporations, although these can be both advantageous and disadvantageous. In these respects, corporations differ from sole proprietorship's and limited partnerships.

In forming a corporation, prospective shareholders exchange money, property, or both, for the corporation's capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. For federal income tax purposes, A C corporation is recognized as a separate taxpaying entity. A corporation conduct business, realizes net income or loss, pays taxes and distributes profits to shareholders.

The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends, This create a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation.

Reporting and Analyzing Inventory

What is Merchandise Inventory

Merchandise Inventory was defined as the cost of the goods on hand as of the date the inventory was taken. The valuation of the inventory taken is based on its cost. Keep in mind that merchandise inventory represents only those assets that were acquired exclusively for the purpose of resale in the normal course of business.The taking of an inventory of supplies on the other hand was for the purpose of converting an asset on the books to an expense to the extent those supplies had been used up.

Types of Inventory Systems

The Periodic System

There are basically two inventory systems used in accounting: the periodic and the perpetual inventory systems. So far we have discussed only the former. When the PERIODIC INVENTORY SYSTEM is used, only the income from sales is recorded when sales are made. No entries are made in either the merchandise inventory or the purchases account to recognize the cost of the particular items sold.Periodically (at least once, a year, usually at the end of the accounting period), a physical inventory is taken to determine the cost of the ending inventory. A comparison between the cost of goods available for sale (beginning merchandise inventory plus net purchases) and the ending merchandise inventory enabled the accountant to determine the cost of goods sold.
Most businesses use the periodic inventory system, especially if the goods sold consist of large quantities of diverse products.

The Perpetual Inventory System

With the PERPETUAL INVENTORY SYSTEM, accounting records that continuously disclose the amount of inventory are maintained. A separate subsidiary ledger is maintained that contains separate accounts for each type of inventory item. Increases in the specific inventory item are directly to the specific account and corresponding decreases due to sales or returns are credited directly to the specific account. Thus the balance in the individual subsidiary ledger account at any moment in time represents the actual amount of that particular product on hand. Since this method is time-consuming and expensive to maintain, it is primarily used by those organizations that sell relatively small numbers of items with high unit cost, such as automobile dealerships. While perpetual inventory system may be used for the sale of automobiles, the parts department of the dealership will use a periodic inventory system.

To use the perpetual inventory system, the actual cost of the goods assigned to the various accounts in the subsidiary inventory ledger must be known. While the periodic system segregated cost and revenue items related to merchandise purchased into specific accounts, such as purchases returns and allowances, purchases discounts, and freight on purchases, this is not done under the perpetual system. The cost assigned to the various inventory accounts under the perpetual system is composed of the purchase price and all costs incurred in acquiring such merchandise, less savings from discounts and any subsequent authorized purchased returns. The most significant difference in using the perpetual system is the activity that takes place in the merchandise inventory account, which replaces the merchandise purchases account used in the periodic system.

See Example Exercise 1

Major Financial Statement

Objectives 1

Identify the major financial statements and other means of financial reporting.

The essential characteristics of accounting are:

1. the identification, measurement, and communication of financial information about
2. economic entities to 
3. interested parties.

Financial accounting is the process that culminates in the preparation of financial reports on the enterprise for use by both internal and external parties.

Users of these financial reports include investors, creditors, managers, unions, and government agencies.

Managerial Accounting is the process of identifying , measuring, analyzing, and communicating financial information needed by management to plan, control, and evaluate a company's operations.

Financial Statements are the principal means through which a company communicates its financial information to those outside it.These statements provide a company's most frequently provided are:

1. the balance sheet,
2. the income statement,
3. the statement of cash flows, and
4. the statement of owners' or stockholders' equity.

Two types of financial information:

1. the basic financial statements and
2. related disclosures.

Depreciation

A noncash expense that reduces the value of an asset as a result of wear and tear, age, or obsolescence.  Most assets lose their value over time (in other words, they depreciate), and must be replaced once the end of their useful life is reached. There are several accounting methods that are used in order to write off an asset's depreciation cost over the period of its useful life. Because it is a non-cash expense, depreciation lowers the company's reported earnings while increasing free cash flow.

Depreciable
Subject to depreciation; wasting: said of buildings, machinery, equipment, and other limited-life fixed assets.

Depreciable cost
That part of the cost of a fixed asset that is to be spread over useful life; i.e., cost less the estimated recovery from resale or salvage.See service cost; depreciation base.

Depreciation cost

1. Cost less accumulated depreciation, if any, and less any other related valuation account having the effect of reducing original outlay to a recoverable cost; the book value of a fixed asset. The net amount remaining, although equal to a fraction of original cost: that portion of cost judged to be fairly assignable against likely  recoveries or against operations of future years. Compare with depreciable cost.
2. Cost that has been expensed; depreciation expense.

Example:

Shehgarlynn's purchased a machine with a 4 year estimated useful life and a estimated 10% salvage value for $80,000 on January 1, 2007. In its income statement, what would Shehgarlynn report as the depreciation expense for 2009 using the double declining balance method?

Computation below:

Salvage value is ignored when using DDB depreciation method (except that the asset cannot be depreciated below salvage value.)

Beg. of the year book value                    X      DDB rate         =   Depreciation Expense
2007        $80,000                                          50%                =     $40,000
2008       ($80,000-40,000)                            50%                =     $20,000
2009       ($80,000-60,000)                            50%                =     $10,000

The DDB rate is twice the straight-line (1/4 X 2 = 2/4 =50%).
Note: That in  2010, enough depreciation would be recorded to depreciate the asset from its beginning of year book value ($10,0000) down to its salvage value (10% X $80,000 = $8,000) or $2,000 of depreciation.


Using Straight - Line Method
On January 1, 2007, ShehGarLynn's Corporation purchased a machine for $50,000. ShehGarLynn paid shipping expenses of $500 as well as installation costs of $1,200. The Machine was estimated to have a useful life of 10 years and an estimated salvage value of $5,000. In January 2008, additions costing $3,600 were made to the machine in order to comply with pollution control ordinances. These additions neither prolonged the life of the machine nor did they have any salvage value. If ShehGarLynn records depreciation under straight-line method, depreciation expense for 2008 is.

Computation below:
The Machine cost is ............................$50,000.00
Add: Installation cots............................    1,200.00
         Shipping Expense........................       500.00
Total cost of Machine...........................$51,700.00
Less:Salvage value...............................     5,000.00
depreciation base.................................$ 46,700.00
Divided Useful life ............................     ..  10 years
Annual depreciation cost ...................  $    4,670.00
$3,600/9 years..................................           400.00

Depreciation for 2008 ......................   $   5,070.00 

Note:

January 1, 2007................10 years

January 1, 2008..................9 years

Since $3,600 being  amortized over the remaining 9 years.

^^^^^^^^^^^^^^^^^^^^^^^^^^**********************^^^^^^^^^^^^^^^^^^^^^^

In January 2005 Shehgar Company purchased equipment for $150,000, to be used in its manufacturing operations. The equipment was estimated to have a useful life of 8 years, with salvage value estimated at $15,000. Shehgar considered various methods of depreciation and selected the sum of the years digit method. On December 31, 2006, the related allowance for accumulated depreciation should have a balance.

Solution:
Accumulated Depreciation under all three methods at December 31, 2006 must be computed below:

                   Straight Line         SYD                 DDB

2005          $16,875.00          $30,000.00       $37,500.00
2006            16,875.00            26.250.00         28,125.00

Total           $33,650.00         $56,250.00        $65,625.00

Straight Line Method (SL Computation)

Cost of the Machine .......................... $150,000.00
Less: Salvage Value............................     15,000.00
                                                             135,000.00
Divided 8 years (useful life)...................       8 yrs   
Accumulated Depreciation annually.......$ 16,875.00
.2006...................................................   16,875.00
                                                            $ 33,650.00


Sum-Of-The-Years-Digits Method (SYD Computation)
                                                
                                                                   2005                    2006        
Cost of the Machine...............................$150,000.00          $150,000.00
Less: Salvage Value................................    15,000.00              15,000.00
                                                                135,000.00            135,000.00
Multiply 8/36........................................       .222222            
Multiply 7/36.........................................                                     .194444
Accumulated Depreciation annually.............30,000.00               26,250.00


Double Declining Balance Method

Beg. of the Year Book Value                 X   DD Rate            Depreciation

2005......................$150,000.00                   25%                $37,500.00
2006.....................($150,000-37,500.00)     25%                  28,125.00
Total Depreciation.................................................................$65,625.00


1X2 = 2 = 25%
           8

Pricing Merchandise

Trade Discount

When merchandise is offered for sale by manufacturers or wholesalers, a list or catalog price is set for each item. This represents the price that the ultimate consumer will pay for the item.
Rather than printing separate prices for each of the potential purchasers (wholesaler, retailer, consumer), the seller gives the various classes of buyers a separate discount sheet, detailing the discount offered to his or her class of purchaser. Thus, the trade discount is not a true discount but is considered to be an adjustment of the price.

If the seller wishes to change the price offered to the wholesaler or retailer, a revised discount schedule, using the original list or catalog price, would be sent.

The list or catalog price also provides the retailer with a suggested selling price for the item.

The price the buyer pays for the item (net cost price) is computed by multiplying the list or catalog price by the discount rate and then subtracting this discount from the list or catalog price.

Example 1

A $350 (list price) computer is sold to a wholesaler at a 25% trade discount. The cost to the wholesaler is:

Step 1
List price            $350.00
Trade discount   X  25%
Trade discount    $ 87.50

Step 2         
List price              $350.00
Trade discount      -  87.50 
Net cost price       $262.50

Mathematically, this procedure may be simplified by multiplying the list or catalog  of the discount rate (the difference between the discount rate and 100 percent).

Example 2

List price               $350.00
(100%-25%)        X   75%
Net cost price       $262.50
  
Transportation costs (if applicable) are not subject to a trade discount and would be added to the net cost price.

Example 3

A $350 (list price) computer is sold to a wholesaler at a 25% trade discount. Transportation charges on the shipment total $25. The net cost price is:

List price                                               $350.00
(100-25%)                                              X 75%
Net cost price                                       $262.50
Transportation charges                        +    25.00
Net cost price including transportation   $287.50

                       

 Read The Following Details:

Chain Discounts
Cash Discount
Markup
Cost As A Basis 
Markdowns Turnover-Ratio For Inventory
Number Of Days Sales In Inventory

Costing Merchandise

In a merchandising business, inventory is merchandise that is held for resale. As such, it will ordinarily be converted into cash in less than a year and is thus a current asset.

In manufacturing business, there will usually be inventories of raw materials and goods in process in addition to an inventory of finished goods.

Determining Inventory:Physical Count

Under the periodic method, inventory is physically counted at regular intervals (annually, quarterly, or monthly). When this system is used, credits are made to the Inventory account or to Purchases, not as each sale is made, but rather in total at the end of the inventory period.

To approach the problem of inventory measurement, in order to assign the business cost to each item, three methods of valuation

1. First-In, First-Out (FIFO)
2. Last-In, First-Out (LIFO)
3. Weighted Average

Have been developed  and approved by GAAP (General Accepted Accounting Practices). To compare these three methods, the same data chart 1 will be used in all of the following inventory examples.

                                                       Chart 1
Date                     Type                  Units              Unit Cost                   Totals
Jan.   1            Inventory                 100                $8                          $   800.00
Feb.  2            Purchase                  175               $10                           1,750.00
June  2            Purchase                   250               $11                           2,750.00
Nov. 5            Purchase                   275                $12                           3,300.00
Available for sale                             800                                                $8,600.00  

It will be assumed that a physical count of inventory on the last day of the accounting period December 31 showed 375 units on hand. Therefore, 425 units (800-375) were sold during the year.

Costing Inventory: First-In, First-Out (FIFO)

The first-in, first-out (FIFO) method of costing inventory assumes that goods are sold in the order in which they were purchased.Therefore, the goods that were bought first (first-in) are the first goods to be sold (first-out), and the goods that remain on hand (ending inventory) are assumed to be made up of the latest costs. Therefore, for income determination, earlier costs are matched with revenue and the most recent costs are used for balance sheet valuation.

This method is consistent with the actual flow of costs, since merchandisers attempt to sell their old stock first. (Perishable items and high-fashion items are examples.) FIFO is the mos widely used inventory method of those that will be discussed.

Example 1

Under FIFO, those goods left at the end of the period are considered to be those received last. Therefore, the 350 units on hand on December 31 would be costed as follows:

         Most recent purchase (Oct. 4)          290 units @ $15 = $4,350
         Next most recent purchase (June 5)   60 units @ $12 =     720
         Ending inventory                               350 units                $5,070

The latest cost of the inventory consists of 290 units at $15. However, since the ending inventory consists of 350 units, we must refer to the next most recent purchase of 60 units at $12. Therefore, you could say that the process for determining the cost of the units n hand involves working backward through the purchases until there is a sufficient quantity to cover the ending inventory count. Thus the ending inventory under the FIFO method would be valued and recorded at $5,070



Example 2

The cost of goods sold can be determined by subtracting the value of the ending inventory from the  total value of the inventory available for sale ($5,900 - $2,715 = $3,185). Since 350 units remain as ending inventory, the number of units sold is 385  (750 - 365).

This can also be computed as
                  
                           115 units if inventory (Jan. 1)   @ $8  = $  920
                           145 units purchased (Mar. 10) @ $7  =  1,015
                           125 units purchased (June 6)   @ $10 = 1,250
                           385        Total cost of goods sold          $3,185

It should be noted that as a method of assigning costs, FIFO may be used regardless of the actual physical flow of merchandise. Indeed, we might say that FIFO really stands for first-price-in, first-price-out. In a period of rising prices--inflation--the FIFO method will yield the largest inventory value, thus resulting in a larger net income. This situation occurs because this method assigns an inventory cost based on the most recent, higher costs. Conversely, the FIFO method would produce a smaller cost of goods sold, because the earlier, lower costs are assigned to the cost of goods sold. Because FIFO results in the most recent charges to inventory, the value of the ending inventory is closer to its replacement cost than under any other method.

Example 3

Two years of determining the value of the same number of units in the inventory are shown below.

a) First year, 2007 (rising costs):

                  Inventory                       15 units @   $5  = $  75
                  First purchase                15 units @   7  =   105
                  Second purchase           15 units @   8  =   120
                  Third purchase              15 units @    9  =  135
                                                        60 units               $435

  If 15 units are on hand, the value under FIFO would be computed as

                 Third purchase               15 units @ $9 = $135

        Thus, the ending inventory of 15 units is $135.

        The cost of goods sold would be calculated as $435 - $135 = $300.

b) Second year, 2007 (falling cost):

                  Inventory                       15 units @ $9 = $135 
                  First purchase                15 units @   8 =   120
                  Second purchase           15 units @   7 =   105
                  Third purchase              15 units @   5   =   75
                                                        60 units             $435

   If 15 units are on hand, the value under FIFO would be computed as

                Third purchase               15 units @ $5 = $75

        Thus the ending inventory of 15 units is $75.
 
        The cost of goods sold would be calculated as $435 - $75 = $360

Note that even though there are 15 units left in both years, under FIFO, the year 2006 produces a higher ending inventory in a rising market, thus producing a higher net income. This is because the cost of goods sold is lower in a rising market ($435 - $135 = $300) than in declining market ($435 - $75 = $360). Thus the lower the cost, the higher the profit.

Go to Costing Inventory: Last-In, First-Out (LIFO)