Accounting-Step by Step

Let’s do some simple transactions to see how accounting works. First, let’s add $20,000 in cash to the business as our investment in the business. The transaction would look like this:

Our Balance Sheet now looks like this:

Showing a Negative Number as a Positive

Notice that we show Common Stock, which has a Credit balance, as a positive number. If credits are negatives, why show Credit balances as positives? Because the Credit appears where we expect to see Credit Balances. It is an ancient tradition among accountants that when Credit balances appear on the Credit side of the Balance Sheet (or the Profit & Loss), they are shown as positive numbers. This might seem confusing, but once you get used to it, it’s easy, just like the rest of accounting. All you have to do is remember the chart on the prior page and where Debit and Credit balances are typically found.

If an Account that is expected to have a Debit balance actually has a Credit balance, it would show up on our Balance Sheet as a negative number. For instance, if Cash were overdrawn by $1,000, it would show up as (-1,000). Likewise, an Account that is expected to have a Credit balance that has a Debit balance would show as a negative number. For example, if there were a $433 loss so far this year, Year-to-Date Earnings would show (-433).

Now, let’s purchase a used Trenching Machine for $5,000. We write a check for $1,000 for a down payment and promise to pay the $4,000 balance at $1,000 per month:

Our Balance Sheet now looks like this:

Cash went down by $1,000 because of the check we wrote. Fixtures & Equipment went up by a $5,000 purchase, but we still owe $4,000 in Accounts Payable.

What we are looking at is known as the General Ledger. This is where all transactions are summarized. The transaction was actually entered and processed through a Transaction Entry Screen in the Accounts Payable "Journal" of this accounting system. The Accounts Payable Journal is where all of the details for Accounts Payable are kept. This process actually duplicates the way accounting was done when physical "Books" and "Journals" were used.

Professional accounting software is usually designed to match the traditional method of doing accounting because it is a practical system that works very well, it is logical, and it is easy to follow.

Individual Journals (such as Accounts Payable) are used to track details while summaries of transactions are kept in the General Ledger. What does this mean to us as accountants? We can see transaction amounts on the General Ledger, but if we need to know: Who we owe, How much we owe, the Invoice Number, its Date and When it’s due, we have to go to the Accounts Payable Journal. The same goes for Accounts Receivable, Payroll and Job Costing. Each has their own Journal where the details are kept.

To demonstrate the value of this process, consider looking up a scripture in the Bible. What if there were no individual "Books" to refer to. Instead of Genesis or Proverbs, we had one book that held everything. Having the "General" Bible broken down into separate "Journals" makes it much easier to find what we are after.

Now, Let’s pay the $500 Rent for the month:

Now, we have an item that hits both the Profit & Loss and the Balance Sheet, so they look like this:

Cash went down when Rent went up. The transaction balances. Notice that we now have a loss of $500 in Year-to-Date Earnings. That’s because our expenses exceed our income---so far. In fact, we have no income. Isn’t this the way a business starts?

We note again that the actual transaction was entered using the Accounts Payable Journal Entry Screen and this accounting system, Posted the transaction to the Accounts Payable Journal, the Job Cost Ledger and the General Ledger.

Posting is the process of transferring accounting transactions from a temporary "Batch" (such as in the Accounts Payable Journal Entry Screen) to permanent records (the Accounts Payable Journal and the General Ledger). Temporary transactions are accumulated in Batches as we enter them, so they can be proof read (edited) and corrected before they are posted into our permanent accounting history. When the temporary information in the Batch is approved as accurate, it is transferred from the temporary Batch into the various permanent files. This final transfer is called Posting.

Now, let’s do some construction work on Job 100 and bill a customer for $12,000:

Accounts Receivable went up $12,000, the same as Construction Revenue.

Now, we have a profit of $11,500 showing in Year-to-Date Earnings. That’s what we are in business for. If you are not in business to make a profit, according to the IRS, you have a hobby. We know that we must be profitable to succeed.

Note that even though we have a profit, our Cash balance is unchanged. Profit does not necessarily mean Cash Flow. (We will explain this great accounting mystery later.)

Remember that when we have any transactions that affect the Income Statement (profitability), we have to update the Year-to-Date Earnings on the Balance Sheet. If you are using an advanced Job Cost Accounting System such as this one, this recalculation is automatically done for you. It happens every time you do a transaction.

The transaction we just did was actually entered in the Accounts Receivable Journal Entry Screen where it was then posted to the Accounts Receivable Journal, Job Costing Ledger and the General Ledger. All of this was done automatically by our accounting software.

Now, let’s account for a $1,000 Invoice for Materials on Job 100 that just came in the mail today. For obvious reasons, we verified that this was in fact delivered to the job. We’ll actually pay it later, when it is due:

Accounts Payable went up 1,000, the same amount as Material Expense.

Again, this transaction was entered through the Accounts Payable Journal, but it was saved in Accounts Payable, General Ledger, and Job Costing.

When we accounted for the Expense, it reduced the Profit. Our accounting software, the accounting program automatically recalculated our profit (Year-to-Date Earnings) when we did the transaction and saved the numbers in all the places we needed them.

Now that we have timesheets from our employees for work on Job 100, let’s account for the $1,500 payroll for the last week of last month. We’re not actually paying the payroll yet, we are just accounting for it. This is referred to as making an Accrual. An Accrual is how we account for the expense in the month it occurred even though we haven’t paid it. We do the same thing for income, accounting for it in the month we earned it, even though we haven’t received it. We’ll explain Accrual Accounting in great detail in the next section.

We will actually print our payroll checks later. In the meantime, we have to account for the payroll expense in the right month. (With taxes, withholdings and everything else. An actual payroll accrual is a little more complicated than this. All of the details are handled automatically by this advanced accounting software program.) What we have is:

Accrued Expenses and taxes went up by $1,500, the same as Labor Expense. Now that we have accounted for the labor that went into Job 100, we are closer to getting a handle on the actual cost for the job. When we have it all, we’ll know if we made money.

As with all transactions, in the process of doing our payroll accrual, the accounting software has automatically updated our Year-to-Date Earnings.

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