EXPANDED ACCOUNTING EQUATION:

ASSETS = LIABILITIES + (CAPITAL - WITHDRAWAL) + REVENUE - EXPENSES)

Analyzing Business Transactions: Revenue and Expense accounts

Revenue and Expenses = directly affect owner's equity. If a business earns revenue, there is an increase in owner's equity. If a business incurs or pays expenses, there is a decrease in owner's equity.

For the present, think of it this way: if the company makes money, the owner's equity is increased. On the other hand, if the company has to pay out money for the costs of doing business, then the owner's equity is decreased.

Revenues and expenses fall under the umbrella of owner's equity: revenue increase owner's equity; expenses decrease owner's equity.

What are Revenue, Expenses, and Profit?

Every business exists primarily to earn a profit. This profit is realized through revenue earned by an organization as a result of the sale of a service or product by that business.

Revenues - Are the amounts earned by a business. Examples of revenues are fees earned for performing services, income from selling merchandise, rent income for providing the use of property, and interest income for lending money.

Revenues - May be in the form of Cash and Credit Card Receipts like those from VISA and MASTER CARD.

Revenue - May also result from credit sales to charge customers, in which case cash will be received at a later time.

Recording Revenue

If revenue of $550 is received by the business, this revenue should be recorded as an increase Cash of $550 and resulting increase in proprietor's capital of $550. Revenue may be received in forms other than cash. An organization may receive payment for services rendered in the form of other assets such as supplies, equipment, and even someone's promise to pay at a future time (accounts receivable). The effects of the accounting equation will still be an increase in the specific asset received and a corresponding increase in capital.

Expenses - Are the costs that relate to the earning of revenue (or the costs of doing business). Examples of expenses are wages expenses for labor performed, rent expense for the use of various media (for example, newspaper, radio, and direct mail).

Expenses - Maybe paid in cash when incurred (that is, immediately) or at a later time.

Expenses - To be paid at a later time involve.

Recording Expenses

Every business, regardless of its nature, must incur certain costs in order to operate. These costs are known as expenses. Expenses are generally referred to as the "costs of doing business." Examples of business expenses are rent expense, insurance expense, salary expense, and supplies expense.

Profit - An excess of revenue over expenses.http://onlinetutorialclass.shehgarlynn.com/

ACCOUNTING CYCLE

STEPS IN ANALYZING TRANSACTION

1. Read the transaction to understand what is happening and how it affects the business. Example, the business has more Revenue, or has more Expenses, or has more Cash, or Owes less to Creditors.
2. Identify the accounts involved, and decide whether the accounts are increased or decrease. Look for Cash first; you will quickly recognize if Cash is coming in or going out.
3. Decide on the Classifications of the accounts involved. (for Example, Equipment is something the business owes, and it's a liability; Rent is an Expense.
4. After recording the transaction, make sure the accounting equation is in balance.

The Five Classification

Accounts Category      Normal Balance           Increase              Decrease

1. ASSETS                         DEBIT                         DEBIT                 CREDIT

2. LIABILITIES                    CREDIT                      CREDIT               DEBIT 

3. OWNER'S EQUITY

    CAPITAL                        CREDIT                      CREDIT               DEBIT

    WITHDRAWALS           DEBIT                         DEBIT                  CREDIT

4. REVENUE                     CREDIT                      CREDIT               DEBIT

5. EXPENSES                   DEBIT                         DEBIT                  CREDIT 

STEPS IN THE ACCOUNTING PROCESS

1. Record the transactions of a business in a JOURNAL book of original entry - the day - by day record of the transactions of a firm). Entry should be based on some source document or evidence that a transaction has occurred, such as an invoice, a receipt, or a check.

2. Post entries to the accounts in the LEDGER. Transfer the amounts from the JOURNAL to the Debit or Credit column of the specified accounts in the LEDGER. Use a cross reference system. Accounts are placed in the LEDGER according to the account numbersassigned to them in the 

CHART OF ACCOUNT.

3. Prepare a TRIAL BALANCE. Record the balances of the LEDGER accounts in the appropriate Debit or Credit column of the Trial balances form. Prove that the total of the debit balances equals the total of the credit balances.

RECORDING BUSINESS TRANSACTION

To repeat Business transactions are events that have a direct effect on the operations of an economic unit or enterprise and are expressed in terms of money. Each business transaction must be recorded in the accounting records. As one records business transactions, one has to change the amounts listed under the headings Assets, Liabilities, and Owners Equity. However, the total of one side of the fundamental accounting equation should always equal the total of the other side.

SUMMARY OF TRANSACTIONS

Summarizing each individual ledger account and listing these accounts and their balances to test for accuracy in recording the transactions.

1. Name of the company

2. Title

3. Date

4. Account Name (In order - Chart of Account)

5. Two Column Debit - Credit

CHART OF ACCOUNTS

A numbering system of accounts that list account titles and accounts numbers to be used by a company.

Before recording transactions for new business, the accountant must first think of all the possible types of transactions that the company will carry out. Based on this variety of possible transactions, the company's accountant makes a list of account titles to be use to record the company's transactions.

Chart of Account - Is the official list of the ledger accounts in which transactions of a business are to be recorded. Assets are listed, Liabilities, Owners Equity, Revenue, and Expenses.

Accounting Theory

Accounting Theory is to provide a logical framework for accounting practice. The basic assumptions, definitions, principles and concepts and how we derive them. It is concerned with improving financial accounting and reporting broad perspective, it includes a conceptual framework, accounting legislation, concepts, valuation models, and hypotheses and theories that allow researchers to analyze accounting in order to explain or predict phenomena related to accounting, such as how users employ accounting data or how preparers choose accounting methods.

The Early History of Accounting

Accounting records dating back several thousand years have been found in various parts of the world. These records indicate that all levels of development people desire information about their efforts and accomplishments.

According to Hain, "The Zenon papyri give evidence of a surprisingly elaborate accounting system which had been used in Greece since the fifth century B.C. and which, in the wake of Greek trade or conquest, gradually spread throughout the Eastern Mediterranean and Middle East." Zenon's accounting system contained provisions for responsibility accounting, a written record of all transactions, a personal account for wages paid to employees, inventory records, and all records of asset acquisitions and disposals. In addition, there is evidence that all the accounts were audited.

There were no organized professions or standards of qualifications, and accountant were trained through an apprenticeship system. Later, private commercial colleges began to emerge as the training grounds for accountants.

These institutions emphasized the quality of value, and discussions of the nature of value in accounting education. Subsequently, widespread speculation in the securities markets, watered stocks, and large monopolies that controlled segments of the U.S. economy resulted in the establishment of the progressive movement at the end on the nineteenth century.

Although most accountants did not necessarily subscribe to the desirability of the progressive reforms, the progressive movement conferred specific social obligations on accountants.

Accountants generally came to accept three general levels of progressiveness:

1. A fundamental faith in democracy, a concern for morality and justice, and a broad acceptance of the democracy, a concern for morality and justice, and a broad acceptance of the efficiency of education as a major tool in social amelioration;
2. An increased awareness of the idea of the social obligation of all segments of society and introduction of the idea of the public accountability of business and political leaders; and
3. An acceptance of pragmatism as the most relevant operative philosophy of the day.

During the period 1900-1915, the concept of income determination was not well developed. There was, however, a debate over which financial statement should be viewed as more important, the balance sheet or the income statement.

The 1904 International Congress of Accountants marked the initial development of the organized accounting profession in the United States, although there had been earlier attempts to organize and several states had state societies. At this meeting, the American Association of Public Accountants was formed as the professional organization of accountants in the United States.

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Accounting Methods and Periods

There are two major methods of accounting: the cash methods and the accrual methods, both of which are described below. The vast majority of taxpayers use the cash method. Also, taxpayers may file their tax returns using the calendar year or a fiscal year. The vast majority use the calendar year. Thus, in this courses, you may assume all information is based on the cash method of accounting and the calendar year unless otherwise specified.

Cash Method of Accounting

When the cash method of accounting is used, income is reported in the tax year it is constructively or actually received, and deductions are claimed in the tax year paid. Constructively received means that the income is available to the taxpayer, regardless of whether it is actually in his possession. Constructively received income includes income credited to an account, income and reinvested by an agent of the taxpayer, a check or other payment received before the end of the year even if not deposited or converted to cash, and income for which the date of receipt is controlled by the taxpayer (for example, income due and payable from an activity owned or controlled by the tax payer who elects to defer receipt).

Example: Shehgarlynn had $150 interest credited to her savings account by her bank during 2007. Shehgarlynn left the $150 on deposit. Even though she did not use the money, Shehgarlynn constructively received the interest during 2007 and must report it on her 2007 tax return.

Calendar Year

The calendar year is January 1 through December 31.The normal due date for filing a calendar-year tax return (including the final return of a taxpayer who died during the tax year) is April 15 following the end of the tax year. Taxpayers may receive an automatic extension until August 15 filing Form 4868 by April 15. If April 15 falls on a Saturday, Sunday, or legal holiday, the due date is extended to the next business day.

Other Accounting Methods And Periods 

Accrual Method of Accounting

When the accrual method of accounting is used, income is reported in the tax year earned, whether or not received. Deductions are claimed in the tax year incurred, whether or not paid.

Example:

Shehgarlynn, an accrual-basis taxpayer, earned $750 for services performed on December 28, 2007. She was not paid until January 10, 2008. Shehgarlynn must report the 750 on her 2007 return.

Hybrid Method of Accounting

A hybrid accounting method is a combination of methods, usually of the accrual and cash methods. Business often use a hybrid method because the accrual method is required on tax returns for inventory accounting, but the cash method is more convenient for operating expenses.

Fiscal Year

Instead of the calendar year, a few tax-payers report their income using a fiscal year. A fiscal year may end on the last day of any month except December.

Once a taxpayer chooses an accountingmethod and an accounting period, he cannot change either one without the consent of the IRS. Taxpayers may use a different accounting method for each separate and distinct business. A married couple may use different accounting methods and still file a joint return, but they must use the same accounting period.

What is Income?

Generally speaking, income is financial gain derived from labor (work), capital (money) or a combination of the two. Unless specifically exempt or excluded by law, all income is subject to income tax and is reported on the tax return.

Gross income is total worldwide income received in the form of money, property, or services that is subject to the tax. There are two types of gross income:

• Earned income is received for services performed. Some examples are wages, commissions, tips, and generally, farming and other business income.
• Unearned income is taxable income that does not meet the definition of earned income. It includes money received for the investment of money or other property, such as interest, dividends, and royalties. It also includes pension, alimony, unemployment compensation, and other income that is not from performing service.

Non taxable income is by law exempt from tax. Exempt income includes child support, municipal bond interest, welfare benefits, VA benefits, various military allowances, workers' compensation, gifts, and life insurance proceeds paid to the death of the insured.

Gross Income

There are two aspects to determining gross income:

1. Who owns the income, and
2. What income should be reported on a tax return.

Ownership of income is determined by state law. The laws regarding the ownership of income and property in most states are based on British common law. These states are called separate property states. In separate property states, income belongs to the person who earned it or who owns the property that produced the income.

Nine states are community property states. With the exception of Wisconsin, the laws of community property states are based on Spanish civil law. Generally, in community property states, income received by a married couple for services performed is considered to belong half to the husband and half to the wife regardless of which of them earned the income. The laws regarding the ownership of income from property vary among these states. The nine community property states are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Generally, ownership of the income of a married couple needs to be determined only if they file separate returns.

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Filing Requirements

The first step in completing an income tax return is to determine if the taxpayer needs to file a return in the first place. In this section, you'll study the filing requirements for federal income tax purposes.

Individuals who had income tax withheld from their wages or who are eligible for certain credits, which you'll learn about later in this course, should file a tax return, even if not required to do so.

Special filing requirements apply to taxpayers who may be claimed as dependents on another taxpayer's return. First, we'll discuss taxpayers who are not dependents; then we'll look at those who are dependents.

Non dependent Taxpayers

In order to determine if a taxpayer is required to file an income tax return, you need to know his marital status, age, and gross income. You need to know the marital status and whether the taxpayer is age 65 or older because these facts help you determine how much gross income the taxpayer may have before being required to file. Once marital status is determined, you need to know whether a married couple will file a joint return or separate returns because this choice also affects filing requirements with respect to income.

Marital Status

Marital status (married or unmarried) is determined by the taxpayer's status of a person who died during the year, as well as that of his surviving spouse, is determined as of the date of death.

Example:

Maricar and Mario were wed on December 31, 2007. They are considered married for the 2007 tax year.

Rey and Ani's divorce decree became final on December 31, 2007. They are considered unmarried for the 2007 tax year. Arding and Remy were married on the day Arding died, March 27, 2007. Both Arding and Remy are considered married for the year 2007 tax.

Common Law Marriage

A taxpayer is considered married if, at the end of the tax year, he is in a common law marriage that is recognized in the state where the couple is residing, or was at the time recognized by the state where the common law marriage began.

AGE

Taxpayers are considered to be age 65 on the day before 65th birthdays.

Example:

Jacob Martin's 65th birthday is January 1, 2007; for tax purposes, he is considered age 65 for the 2006 tax year.

The age of a person who dies during the year is determined as of the date of death.

For federal income tax purposes, there are five filing statuses:

1. Single;
2. Married filing jointly;
3. Married filing separately;
4. Head of household; and
5. Qualifying widow(er)

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Retirement Benefits

Everyone wants a financially secure retirement, and most people take some steps to provide for their later years. Almost all employed and self-employed Americans are required to contribute to the social security system. In addition, many people belong to retirement plans where they work, contribute to individual retirement arrangements (IRAs), or buy annuities.

SOCIAL SECURITY AND EQUIVALENT RAILROAD RETIREMENT BENEFITS

Many taxpayers who are retired, disabled, or whose spouses or parents are deceased may receive social security or equivalent tier 1 rail road retirement benefits. The maximum benefit amount for 1999 is $1,373 per month. Some of these benefits may be taxable, depending upon the taxpayer's circumstances. Taxpayers above a certain income level will pay tax on a portion  of their social security income, while lower income taxpayers will enjoy tax-free social security benefits.

Note: For purposes of this section, the term "benefits" applies only to those payments made under the Old-Age, Survivors, and Disability Insurance program (OASDI), which is funded through the social security payroll tax and based on prior earnings. Social security benefits do not include SSI (Suplemental Security Income), which is federally funded program of income assistance based on financial need for the aged, blind, and disabled. The Social Security Administration administers both programs, but SSI benefits are not taxable. 

For 1999, up to 85 percent of a taxpayer's social security and equivalent tier 1 railroad retirement benefits may be taxable. Generally, however, if these benefits are the only source of a taxpayer's income, they won't be taxable. This also holds true if the taxpayer's other income is small.

Forms SSA-1099 (for social security) and RBB-1099 (for railroad retirement) are used to notify the taxpayer of total benefits received during the year. Also indicated is the amount of repayment of benefits the taxpayer made, if any.

Each individual recipient of social security and tier 1 railroad retirement of social security and tier 1 railroad retirement receives Form SSA-1099 or RRB-1099. For example, if a widowed parent receives one monthly benefits check that includes benefits for that parent as well as two minor children, each of them will receive a separate Form 1099 reporting his share of the year's benefits.

Computing Taxable Benefits

The amount of a taxpayer's social security or tier 1 railroad retirement benefits that is subject to federal income tax varies from zero to 85 percent of the taxpayer's benefits, depending on the taxpayer's income level and filing status. None of the benefits are taxable unless the taxpayer's modified adjusted gross income (defined below) plus half the taxpayer's benefits exceeds $32,000 (MFJ), $25,000 (S.HH, QW, or MFS and the taxpayer didn't live with his spouse at any time during the year), or $0 (MFS and the taxpayer lived with his spouse at any time during the year).

Note: the above amount is subject to change.(The amount it depend of current year stated)

Social security and equivalent railroad retirement benefits may be nontaxable or partially taxable, depending on the taxpayer's other income and filing status. 

PENSION AND ANNUITIES

Contribution - When a person puts money into retirement plan.

Distribution -When a person takes or receives money from a retirement plan.

When a taxpayer receives a distribution from a pension or annuity, he must sometimes determine how much of the amount he receives is taxable and how much is not.

If the taxpayer made no contribution to the pension plan or annuity (for example, his employer paid all the costs), or if the taxpayer made only pre-tax contributions to a plan such as a 401(K) plan, the entire amount received during the year is taxable.

If the taxpayer did make after-tax contributions to the pension plan or to the cost of the annuity, part of the amount received is a return of his cost (investment) and is nontaxable. The balance represents a return of his employer's cost and and amounts earned from the investment of the pension plan's funds.

Simplified and Special Averaging Methods

Simplified Method

The simplified method may be used to compute the taxable portion of a pension or annuity with a starting date after July1, 1986. The pension or annuity must meet the following three conditions:

• The payments are for either the annuitant's life or the joint lives of the annuitant and a beneficiary;
• The payments must be from a qualified pension, profit-sharing, or stock bonus plan; a qualified employee annuity plan; or a tax-sheltered annuity; and
• The annuitant must be under 75 years of age when the payments begin, or if 75 or older, there must be fewer than five years of guaranteed payments.

Pension and annuity income is fully taxable if the taxpayer did not contribute after-tax money to the cost of the pension or annuity or, in some cases, if the taxpayer has recovered his entire cost  in previous years. Use of the simplified method for computing the taxable portion of a pension or annuity is generally mandatory for pensions starting after November 18, 1996. 

SPECIAL AVERAGING METHODS

When a taxpayer receives a lump-sum distribution he has some choices to make. He may choose to roll over all or part of the distribution into a traditional IRA or other eligible retirement plan within 60 days. Any amount the taxpayer rolls over isn't currently taxable.

Ten-Year Averaging

Ten-year averaging may be used to compute the tax on a lump-sum distribution only if the emplyee or self-employed person

1. Was born before January 1, 1936, and
2. Was an active participant in a qualified plan for at least five full years (except in the case of death) before the year of the distribution. If the distribution was made due to the death of the plan participant, the beneficiary may use special 10-year averaging if the distribution otherwise qualifies.

Qualified higher education expenses

The expenses must be paid for the taxpayer, his spouse, or the child or grandchild of the taxpayer or spouse.

Qualified first-time home-buying expenses

For the purpose of exception 9, are any costs of acquiring or construction a principal residence for a firs-time homebuyer. The term first-time homebuyer is misleading; what it really means is someone who has not owned a home during the two-year period prior to the acquisition of the home to which this exception applies.

The distribution must be used to pay qualified expenses within 120 days of the date of distribution. The expenses must be paid for the taxpayer, his spouse, child, or grandchild, or parent or grandparent.

SIMPLE Distributions

Early withdrawals from a SIMPLE IRA are generally subject to the usual 10-percent penalty, but a 25  percent penalty applies to withdrawals made during the first two years in which an employee participates in the plan.

Rollovers can be made from one SIMPLE IRA to another. Rollovers to traditional IRAs are permitted at the end of two years of participation in the plan.

See: Self-employment income

CREDIT FOR THE ELDERLY OR THE DISABLED

The credit for the elderly or the disabled is a nonrefundable credit available to low-income taxpayers who are age 65 or older or who are permanently and totally disabled at the end of the tax year. This credit has not been adjusted for inflation since 1983. Due to the numbers involved, nowadays it is a fairly rare occurrence when a taxpayer actually gets the credits, but we'll discuss it briefly for your awareness.

To be eligible for the credit, a taxpayer must be:

• A qualified individual (define below);
• A U.S. citizen or resident for the entire year (or a nonresident alien who is married to and filing a joint return with a U.S. citizen or resident); and
• Filing a joint return if married at the end of the tax year, unless the taxpayer and his spouse did not live together at any time during the tax year or the taxpayer qualifies to be considered unmarried.

A qualified individual is one who is 65 or older; or, if under age 65

1. is retired because of permanent and total disability,
2. had not reached the mandatory retirement age for his employer's retirement program at the beginning of the tax year, and
3. has received taxable disability benefits during the year.

 Disability Pensions

If a taxpayer under 65 is retired because of a disability and received a taxable disability pension due to this disability during the year from an employer-funded disability plan or a disability provision of a retirement plan, he is eligible to claim the credit for the elderly or disabled if he was permanently and totally disabled at the time he retired and is still permanently and totally disabled.