A quickbooks accounting primer

A QUICKBOOKS ACCOUNTING PRIMERBy Jeanie R. Hoshor, M.S. Accounting

Introduction

Businesses run on information: information about the purchase of goods and services from their vendors, about the sale of goods and services to their customers, about their inventories of products, about their employees and the services they perform and the wages they earn, about all the things (cash, buildings, equipment, patents, supplies, etc.) they use to carry on their operations and activities. Most of this information deals with things that have a value that can be measured in dollars and cents; this is financial information. This course (OAS 120) and your textbook deal with the keeping of financial (accounting) records, using a software package for personal computers called QuickBooks (QB).

CHAPTER 1: BASIC CONCEPTS IN ACCOUNTING

The Two Main Financial Statements

The two main end products of accounting are the two financial statements which are presented to investors and creditors outside the business: the Balance Sheet and the Income Statement (which QB calls Profit & Loss). All the other reports you prepare in this course are for internal use by accountants and managers.

The Profit & Loss report shows the revenues (QB calls them income) the business earned by performing services or delivering goods to customers during a given period of time, together with the expenses incurred (what was used up) in the process of earning the revenues. Revenues and expenses are both part of owner equity, because the owner is responsible for whatever the business does. Revenues increase the owner’s equity and expenses decrease it; the owner hopes for a net increase in his equity (called a Net Income) but may suffer a net loss from the operation of the business during the period.

The Balance Sheet shows, as of a given point in time, the company’s assets and the interests (equities) in those assets. There are two kinds of equities: creditor equities, called liabilities, and owner equities. The equities record the sources of the assets: when they come from creditors, it creates creditor equity (liability); when they come from the owner or from the operation of the business which belongs to the owner, it creates owner equity. As the name Balance Sheet suggests, total assets must equal total equities.

On the next page is a sample of a Profit & Loss report done in QuickBooks (QB). The numbers on the left of the account names are account numbers. For example, 4010 is the number of the revenue account named “Web Page Design Fees.” Notice the date in the heading at the top of the report: June

A QUICKBOOKS ACCOUNTING PRIMER

2010. This report shows revenues earned and expenses incurred during the entire month of June. It does not include any revenues or expenses from any other time period. Each Profit & Loss report covers one specific period of time: one month, one quarter (three months), or one year. The fee income (revenue) shown on this report must come from services provided to customers during the month of June.

The customers may or may not have paid us cash for these services in June; it does not matter. The revenue (income) is recognized (included on the Profit & Loss report) when it is earned. Revenue is earned by delivering goods or providing services to customers. In most cases, service is provided on credit and cash will be received later, but the revenue is earned and recognized when we do the work, not when we collect the cash. This is called the accrual basis of accounting. The accrual basis also means that expenses will be recognized when they are incurred (consumed or used up) rather than when they are paid for in cash. For example, we may use up some office supplies as we prepare invoices and other documents (office supplies expense). We consume the labor service of our employees as they carry out our business operations (salaries and wages expense).

Why is Interest Expense given a special section at the bottom of the Profit & Loss report? All of the income, and all of the other expenses, are “ordinary”: they come from doing what we are in business to

By Jeanie R. Hoshor, M.S. Accounting of 34


do. In this case, we are in business to design web pages and give consultation on the internet. Interest expense comes from borrowing money. We are not in business to borrow money, so this is “Other.”

In summary, the Profit & Loss report shows revenues earned (increase in owner equity), expenses incurred (decrease in owner equity), and the resulting Net Income or Net Loss in owner equity from the operation of the business during one specific period of time. It is one of the two main financial statements presented to investors and creditors outside the business.

The other main financial statement is the Balance Sheet. What, exactly, is in balance on a Balance Sheet? Assets and equities are in balance. Recall that liabilities are also equities: the equities of the creditors of the business. So the equation in balance is: Total Assets = Total Equities, where the total equities include both creditor equities (liabilities) and owner equities.

Assets are what the business uses to carry on its operations and activities; they are anything expected to be of some benefit to the business in the future. In general, assets are one of two things: a physical object (inventory, supplies, equipment, vehicles, buildings, land, etc.) or a legal right. The right is most often a right to collect money (such as accounts receivable from customers) but may also be a right to do something (such as patents, which give you the right to make some patented product) or to receive a service (such as prepaid insurance, which gives us the right to insurance coverage). Cash is also an asset, as it has certain legal rights of exchange.

Liabilities are obligations to creditors who have given us money, goods, or services on credit. They are usually obligations to pay money (such as accounts payable to vendors), but may also be obligations to provide a service or to deliver goods for which money was collected in advance.

Owner Equity is the owner’s residual interest in the business; if the business is sold off, the creditors’ claims will be settled first, then the owner will get whatever is left over. For a business that is not a corporation, which is what your text deals with, it consists of a Capital account that will (eventually) include all transactions that affect the owner’s equity, a Drawings account that keeps track of the owner’s withdrawals of assets from the business for personal use during a given time period, and revenue (income) and expense accounts that keep track of revenues earned and expenses incurred by the business during a given time period. When the time period is over, the information in the temporary accounts is presented on the financial statements, and then their balances are cleared out and included in the Capital account.

Now let’s take a good look at the sample Balance Sheet on the next page (done in QuickBooks but processed through Excel to make the font larger). Notice the date in the report heading: “As of June 30, 2010.” The Balance Sheet is a snapshot of the business at one moment in time, on the one specific day given in the report heading. The amounts shown here have been accumulating in the various asset, liability, and owner equity accounts since the business began; they are the net result of all the increases



and decreases up through the Balance Sheet date. Check the totals: Total Assets = $43,575.00 and Total Liabilities & [Owner] Equity = $43,575.00. The Balance Sheet is in balance, as it must be,

OWS4 [Your Name] Olivia’s Web Solutions

BALANCE SHEET

As of June 30, 2010Jun 30,

10ASSETS

Current Assets

Checking/Savings

1010 · Cash-Operating 22,625.00

Total Checking/Savings 22,625.00

Accounts Receivable

1200 · Accounts Receivable 6,050.00

Total Accounts Receivable 6,050.00

Other Current Assets

1300 · Computer Supplies 350.00

1305 · Office Supplies 325.00

1410 · Prepaid Advertising 1,000.00

1420 · Prepaid Insurance 1,650.00

Total Other Current Assets 3,325.00

Total Current Assets 32,000.00

Fixed Assets

1700 · Computers

1725 · Computers, Cost 5,000.00

1750 · Accum. Dep., Computers -75.00

Total 1700 · Computers 4,925.00

1800 · Furniture

1825 · Furniture, Cost 3,200.00

1850 · Accum. Dep., Furniture -50.00

Total 1800 · Furniture 3,150.00

1900 · Software

1950 · Accum. Dep., Software -100.00

1900 · Software - Other 3,600.00

Total 1900 · Software 3,500.00

Total Fixed Assets 11,575.00

TOTAL ASSETS 43,575.00

LIABILITIES & EQUITY

Liabilities

Current Liabilities

Accounts Payable

2010 · Accounts Payable 5,225.00

Total Accounts Payable 5,225.00

Other Current Liabilities

2020 · Notes Payable 2,500.00

2030 · Interest Payable 25.00

Total Other Current Liabilities 2,525.00

Total Current Liabilities 7,750.00

Total Liabilities 7,750.00

Equity

3010 · Olivia Chen, Capital 27,500.00

3020 · Olivia Chen, Drawings -500.00

Net Income 8,825.00

Total Equity 35,825.00

TOTAL LIABILITIES & EQUITY 43,575.00



because the equities simply show us the source of the assets. Some portion of them came from creditors, giving rise to creditor equity or liability, and the rest came directly from the owner or from the operation of the business for which the owner is responsible, giving rise to owner equity.

Take another look at the Balance Sheet. The assets are divided into two groups: Current Assets and Fixed Assets. Current assets include cash and anything that will be collected in cash (receivables) or sold (inventories) or consumed (supplies, prepaid services) within one year of the Balance Sheet date. The key here is short life: one year or less. Fixed assets, on the other hand, have a long life, more than one year. Fixed assets include vehicles, equipment, machinery, buildings, and land. In accounting, they are also required to be physical objects and to be actively used in business operations and are called “Plant Assets”. QuickBooks has included computer software among Fixed Assets, even though it is not a physical object. We will follow QuickBooks for this course.

Liabilities also have two groups: current and long term. Only current liabilities are shown in the example above. Current liabilities must be paid or settled (by delivering goods or providing service) within one year of the Balance Sheet date. Long term liabilities are not due until more than a year in the future.

When you set up a new account in QuickBooks, you must tell QB what kind of account it is. If it is an asset, you have to choose either current asset or fixed asset. If it is a liability, you must choose either current liability or long term liability. If it is an expense, it may be an ordinary Expense (rent, salaries and wages, insurance, etc.) or it may be an Other Expense (interest).

QuickBooks includes the net effect of the current period’s revenues and expenses, the Net Income or Net Loss, in the Owner Equity section of the Balance Sheet. This Net Income or Net Loss will then become a part of the balance in the owner’s Capital account, and the next Balance Sheet will show the next period’s Net Income or Net Loss.

In summary, the Balance Sheet shows all of the assets the business owns and expects will provide some future benefit, and all of the equities (both creditor and owner, but NOT the separate income and expense accounts) in those assets, at one specific point in time. It is one of the two main financial statements presented to investors and creditors outside the business.

The amounts shown on the financial statements come from the balances in the named accounts. An account is a record of one particular item of interest for the business, showing all increases and decreases and the current balance. We have a Cash account to keep track of the business cash, an Accounts Receivable account to keep track of the amount owed to us by our customers, an Office Supplies account to keep track of our paper, pens, paper clips, etc., an Accounts Payable account to keep track of how much we owe to the vendors who sell us goods and services, and many, many more. The General Ledger (see next section) contains all of the accounts seen on the financial statements.



Before we prepare the financial statements, we make a list of all of the accounts in the General Ledger and the balance of each account. This list is called a Trial Balance.

Below is a sample of a Trial Balance done in QuickBooks. Notice that the amounts are listed in one of two columns: Debit (left) or Credit (right). Debits and credits are used in accounting (in internal records only, NOT on the financial statements) to make sure that the Balance Sheet equation (Assets = Liabilities + Owner Equity) will stay in balance when each transaction is recorded. The Trial Balance is an internal report, NOT a financial statement.

Note: The “Adjusted” in the report title above just means that this trial balance was prepared after adjusting journal entries (AJE) had been made. AJE are discussed later.

The Two Main Record Books

Every business we deal with in QuickBooks keeps two main books for financial records: a General Journal and a General Ledger. The Journal is organized by transaction, and the Ledger is organized by account, so they are useful for different purposes.



Information about business transactions is first entered in the form of Journal entries ; hence, the Journal is sometimes referred to as the book of original entry. The Journal records each transaction or event affecting the business accounts as one unit, in the time order in which they occur. A Journal entry shows for each transaction this information: the transaction date, the name of each account changed by the transaction and the amount by which it is changed, and sometimes a memo or explanation of the transaction. Increases and decreases are indicated by recording each amount in one of two columns: Debit (on the left) or Credit (on the right). The system of double-entry bookkeeping, which helps keep our books correct, uses debits and credits as a way to make sure the Balance Sheet will stay balanced with Assets = Equities (Liabilities + Owner Equity). It does this by recording every increase in an asset as a debit and every increase in an equity as a credit . Each transaction must have the same total debits as total credits.

At this point you may be confused, if you have ever used a bank statement in reconciling your personal checking account. You have just learned that Cash is an asset, and that assets are increased by debits and decreased by credits. Yet on your bank statement, increases in your cash held by the bank are listed as credits and decreases are listed as debits. There is no contradiction here, just a different point of view. When you put cash in the bank, it is still your money, your asset. When the bank accepts your money, it also accepts the obligation to pay that money out on your order when you write a check or make a transfer to another account. An obligation is a liability, so on the bank statement the bank is accounting for its liability to you. Meanwhile, on your own books, you are accounting for your Cash, an asset. So, both of you are following the same rules: debits to increase an asset, credits to increase a liability.

If assets increase, equity must increase by the same amount to make the Balance Sheet balance. If the increase in an asset gives us a debit and the corresponding increase in an equity gives us a credit, then making sure debits equal credits will also make sure that assets equal equities. Note that in this system, decreases in assets must be credits and decreases in equities must be debits. Asset: Cash increase = debit, Cash decrease = credit. Liability: Accounts Payable increase = credit, Accounts Payable decrease = debit. Revenues = credit (always, because they are an increase in Owner Equity), Expenses = debit (always, because they are a decrease in Owner Equity.

Note: Debits and credits are an internal tool used in the Journal and Ledger, and do NOT appear on the financial statements (i.e., they are NOT seen on the Profit & Loss report or the Balance Sheet).

In a manual system, Journal entries look like this:

DEBIT CREDITFeb. 1 Accounts Payable 600.00

Cash 600.00 to record payment of an account due



Here, we are paying to a vendor money owed for goods or services received earlier on credit. We give cash (asset, decrease = credit) to settle our account payable (liability, decrease = debit). In a manual journal, the debit is always listed first, and the credit is indented as shown above. The debit column is always on the left and the credit column on the right.

You may not make a formal journal entry in the first few chapters of the text, and the QB window for making general journal entries looks somewhat different from the manual form above, but it contains the same elements. However, from the moment you enter your first transaction into any activity window, QB will be creating journal entries behind the scenes to record what you have done. For example, if you enter a bill for utilities services (electric power from LI Power) in the Enter Bills window, QB will create this journal entry (though not in this format):

DEBIT CREDITAug. 21 Utility Expense 125.00

Accounts Payable – LI Power Company 125.00 to record bill for electric power (see Trans. #11 below)

Here is part of a Journal created by QuickBooks:



Every transaction you record, in any of the activities windows, produces an entry into the Journal. If you open the Reports menu, then the Accountants & Taxes category, and click on Journal, you can see all of the journal entries that QB has created for you. Note that each one includes the date, one or more accounts debited, and one or more accounts credited. They also have specific “real life” information such as reference numbers, and transactions involving vendors or customers have the name of the specific vendor or customer involved.

Each journal entry completely captures one transaction with all of its information and with equal debits and credits to ensure the Balance Sheet stays balanced, which is very useful for some purposes, but not so useful when it comes time to prepare financial statements or when the manager wants to know how much cash is on hand now. There may be hundreds of transactions in the journal involving increases or decreases in the Cash account; we need to put them all together in one place to figure out what the current balance of Cash is. That is what a Ledger is for. Each transaction recorded in the Journal is copied over into the Ledger, where it is entered into the separate accounts.

A Ledger contains all of the information that the Journal contains, but organizes the information by account rather than by transaction. Each account is a record of the effect on one item of all of the transactions that have increased or decreased that item. The Cash account, for example, is a record of all cash receipts and cash payments. A formal ledger account has three amount columns: debit, credit, and balance. A new balance is calculated after each transaction. A formal Ledger account in a manual system looks like this:

1010 Cash – Operating [the “1010” is the account number; accounts are usually numbered]Date Description Debit Credit Balance 2010Jan. 1 Owner invested to start business 5,000.00 5,000.00 2 Paid first and last month’s rent on office 1,600.00 3,400.00 3 Bought office supplies 120.00 3,280.00

When accounting students are making calculations for a homework problem, they often use an informal kind of ledger account called a T-account . This is what you will see in your text. It has just two columns, debit and credit, and the balance is taken manually after all the entries needed for the problem have been made.

Here is a T-account: ………………….………. 1010 Cash – Operating ………………………… Debit (Dr.) Credit (Cr.)

Jan. 1 5,000.00 Jan. 2 1,600.00Jan. 3 120.00

This is how you would 5,000.00 1,720.00



take the balance: 3,280.00

Let’s do a little review of the rules for debits and credits: Debits are always on the left, and credits are always on the right. Debits increase assets but decrease equities (liabilities and owner equity). Credits increase equities but decrease assets. Using T-account forms, this can be represented graphically on the next page:

…………. ASSETS …………………… = …………. LIABILITIES …………… + …………. OWNER EQUITY ……… Debit (Dr.) Credit (Cr.) Debit (Dr.) Credit (Cr.) Debit (Dr.) Credit (Cr.)

Increase Decrease Decrease Increase Decrease Increase

Asset rule is followed by: Liability rule is followed by: Owner Equity rule is followed by:Cash Accounts Payable Expenses RevenuesAccounts Receivable Interest Payable Prepaid Insurance Wages Payable Always AlwaysOffice Supplies Etc. Debit CreditFurniture Capital (usuallyEtc. Credited)

Drawings (always debited)

When this pattern is followed, as long as we make sure debits equal credits, we can be sure that total assets will equal total equities (the sum of liabilities and owner equity) on the Balance Sheet. As assets and equities move up together, the assets give us debits and the equities give us credits. When they fall together, assets give us credits and equities give us debits.

For every transaction you enter, in any activity window, QB creates a journal entry with debits and credits, and copies the information from that journal entry into the appropriate accounts in the General Ledger, which contains all of the accounts that appear on the financial statements. QB also copies any information about a vendor into that vendor’s account in the Vendor Center, and any information about a customer into that customer’s account in the Customer Center.

The Vendor Center and the Customer Center provide the necessary details supporting the balances in the Accounts Payable (Vendor) and Accounts Receivable (Customer) accounts in the General Ledger . The balance of Accounts Receivable, for example, may tell us that all of our customers together owe us $24,000 – but that is not much help when the time comes to try to collect it. We need to know exactly who each customer is, how much that customer owes us, and the specific transactions in which we provided the goods or services for which the money is owed, so that we can know if they pay what is



owed and take action against them if they don’t. All of these details are in the individual customer accounts in the Customer Center (it is organized by account), which is why it is like a subsidiary (supporting) ledger for the Accounts Receivable in the General Ledger . The Vendor Center is like a subsidiary ledger for the Accounts Payable account.

CHAPTER TWO: VENDOR TRANSACTIONS

The Three Main Types of Vendor Transactions

The three main types of vendor transactions you will handle in QuickBooks are:1. Bill Received for Purchase of Goods or Services on Credit 2. Payment of Bill Recorded Earlier 3. Purchase of Goods or Services for Immediate Cash Payment

Vendor Transactions: Bill Received for Purchase of Goods or Services on Credit

Let’s revisit that Aug. 21st transaction when a bill was received from a utilities company for service (electric power) we used up in an earlier month. This is something already used up in our business operations, not something that will benefit future operations, so it is clearly an expense. Also, we have an obligation to pay money to the utility company, and they have given us 30 days to pay, so this is a liability called an account payable. This is the journal entry required to record the transaction:

DEBIT CREDITAug. 21 Utilities Expense 125.00

Accounts Payable – LI Power 125.00 to record bill for utilities

You will not make this entry; QuickBooks (QB) will make it for you. In the Enter Bills window, you will enter the name of the vendor, the date, a reference number for the bill, the amount due, and a due date. You will also select an account from a drop-down list… just ONE account. But the entry above has two accounts; why do you select only one for this transaction? Because QB already knows that this entry needs a credit to Accounts Payable: the Enter Bills window is designed to create journal entries that credit Accounts Payable, and every transaction that you record in the Enter Bills window will automatically credit Accounts Payable, whether you want it to or not, so be sure you want it! Do not record any transaction into the Enter Bills window unless it involves a transaction in which you have purchased goods (computers, computer supplies, etc.) or services (electric power, rental occupancy, etc.) from a vendor on credit, with an obligation to pay some time later. QB will do the credit side of the journal entry, and all you have to do in the Enter Bills window is tell QB which account to debit. This account will be either an asset (future benefit in the form of a physical good or a right to service) or an expense (if you are paying for a service already used up). QB will record the proper journal entry.



Note: In a manual system, bills would be recorded in a special journal called a Purchases Journal. In QB, there are no special journals . The various activity windows capture transactions the way that special journals would do , and only the General Journal is used . The Enter Bills window is like the Purchases Journal because entries there are always credited to the Accounts Payable account , but different accounts can be debited.

Here is one more example: We receive a bill for the purchase 20 boxes of CDs for data storage for $200.00 on credit from CompuStore. In the Enter Bills window, select Computer Supplies as the account to be debited. QB debits Computer Supplies and credits Accounts Payable in a journal entry, then adds $200.00 to the balance of the asset account Computer Supplies and the liability account Accounts Payable in the General Ledger, and adds $200.00 to CompuStore’s account in the Vendor Center.

Vendor Transactions: Payment of Bill Recorded Earlier

When the due date for a bill arrives, it must be paid. We will settle our obligation to the vendor by paying cash. This will decrease our asset Cash (credit Cash account) and decrease our liability Accounts Payable (debit Accounts Payable). This is the required journal entry:

DEBIT CREDITSept. 20 Accounts Payable – LI Power 125.00

Cash 125.00 to record payment of electric bill

In QuickBooks (QB), payments to vendors for bills recorded earlier that are now due to be paid are entered into the Pay Bills window. This window shows all of the bills that are currently outstanding (exist and have not been paid yet). All you have to do is tell QB which bills you want to pay and the date that should be put on the check to make payment. You don’t select any account to be used in the journal entry QB will make for the transaction; QB already knows because when you use the Pay Bills window, the debit is always to Accounts Payable and the credit is always to Cash, so be sure that is what you want to do before you use the Pay Bills window. It doesn’t matter what you bought to create the debt – dump trucks or delivery service, advertising or angle wrenches – the debt is now in Accounts Payable, and that is what we are paying. QB will make the journal entry and copy the information into the General Ledger accounts (Cash and Accounts Payable), and also update the vendor’s account (APS) in the Vendor Center. How does QB know which vendor is involved? It takes the information from the bill you selected; remember that when you entered the bill, the first thing you did was choose the vendor’s name.

Vendor Transactions: Purchase of Goods or Services for Immediate Cash Payment



Sometimes when a bill is received, it is paid immediately in cash. The vendor has not offered us any credit terms to pay later, so it never becomes a debt, and does NOT go into Accounts Payable or a vendor account in the Vendor Center. This transaction CANNOT be recorded correctly using the Enter Bills window, because that would automatically credit Accounts Payable. We are paying cash now, and must credit the Cash account. To do this, we use the Write Checks window. The Write Checks window looks very much like a check in your personal checkbook (if you have a personal checking account), and you fill out the information in the Write Checks window much as you would in a personal check, and the result is much the same: cash is taken from the business’ bank account and paid to a vendor or other person or company. So every time you write a check, the asset Cash is decreased, and QB will automatically record a credit to Cash in its journal entry. You will have to tell QB what account or accounts should be debited to complete the entry.

For example, suppose a pest control company comes into your office each month to spray for insects. They don’t work on credit; as soon as they finish the job, they hand you a bill and you must write them a check to pay immediately. When you write the check, you still have to name the vendor (so they can cash the check), but QB will NOT copy the check information to that vendor’s account in the Vendor Center, because the Accounts Payable account is not involved. The journal entry will look like this:

DEBIT CREDITJune 5 Pest Control Expense 50.00

Cash 50.00 to record payment for pest spraying

Remember that every time you write a check in the Write Checks window, QB will create a journal entry that credits (decreases) the Cash account. Be sure that is what you want to do before you write a check!

Note: There is one small quirk in recording services that extend into the future. Technically, whenever you pay in advance for a future service, you have bought an asset (future benefit). However, as a practical matter, bookkeepers will debit expense when the service will be used up within the next month. This is because reports are done at the end of the month, and by that time the service will be used up and you will have an expense instead of an asset. Suppose our landlord, Boring Office Parks, sends us a bill on June 1st for the June rent on our office space, for which it wants immediate payment. In recording this payment, we will debit an expense (Rent Expense) rather than the more technically correct asset account (Prepaid Rent). If you pay rent for one month, you just debit Rent Expense; if you paid for six months or a year in advance, you would debit the asset account named Prepaid Rent. The same rule applies when you pay in advance for other services, such as advertising or insurance: if it is for one month, debit an expense account; if is for a longer period, debit an asset (prepaid) account.

SUMMARY OF VENDOR ACTIVITY WINDOWS:



Window Type of Transaction Account Debited Account CreditedEnter Bills Purchase goods or services on credit asset or expense Accounts PayablePay Bills Pay amount due on account to vendor Accounts Payable CashWrite Checks Purchase goods or services for cash asset or expense Cash

CHAPTER 3: CUSTOMER TRANSACTIONS

The Three Main Types of Customer Transactions

The three main types of customer transactions you will handle in QuickBooks are:1. Invoice Created for Sale of Goods or Services on Credit 2. Payment Received for Invoice Recorded Earlier 3. Sale of Goods or Services for Immediate Cash Receipt

Notice how these parallel the three types of vendor transactions; basically, we are looking at these exchange transactions from the other point of view. Sometimes we are the customer, buying from our vendors; and sometimes we are the vendor, selling to our customers. As with the vendors, the customer transactions are recorded in three different activity windows.

Customer Transactions: Invoice Created for Sale of Goods or Services on Credit

When we provide goods or services to our customers on credit, we earn revenue (increase in owner equity, credit) and create the right to collect money from the customer in the future (increase in asset, debit). For example, suppose we have completed monthly bookkeeping services for our client, Fantastic Fabrics, on credit. We must send them an invoice letting them know how much they owe us and when it must be paid (credit terms). In QuickBooks, an invoice is created using the Create Invoices window. Here, you will select the customer, enter the date and the invoice number, and select the credit terms and the service provided (which tells QB which revenue account to credit). In this example, you will select Bookkeeping Services as the service provided. You do not have to tell QB which account to debit: In the Create Invoices window, the debit account is always Accounts Receivable. Accounts Receivable is the name of the asset account in the General Ledger that keeps track of how much (in total) our customers owe us.

This is the journal entry QB will make using the information you have entered into the Create Invoices window:

DEBIT CREDITMay 2 Accounts Receivable – Fantastic Fabrics 150.00

Bookkeeping Services Revenue 150.00 to invoice customer for monthly bookkeeping



This information will be copied into the General Ledger accounts, increasing the asset Accounts Receivable and the owner equity account Bookkeeping Services Revenue. The debit will also be copied into the Fantastic Fabrics account in the Customer Center, so we can keep track of how much of the total Accounts Receivable is due from this particular customer.

Customer Transactions: Payment Received for Invoice Recorded Earlier

When the due date comes, the customer will pay our invoice, sending us actual money in place of the right to collect money, so one asset is increased (debit) and another is decreased (credit). This transaction is recorded in the Receive Payments window. For example, on June 1 we collect the $150.00 due from Fantastic Fabrics on our May 2 invoice. In the Receive Payments window, we select the customer, enter the date and the amount received and a reference number (usually the check number of the customer’s check, since most payments are by check), and select the invoice which is being paid. One customer may have more than one invoice unpaid at a given time. If you don’t choose one, QB will pay the oldest one first.The journal entry QB makes here may not be quite what you expect. QB will always credit Accounts Receivable when you use the Receive Payments window, and will always credit the customer’s account in the Customer Center, but even though we are receiving a cash payment, the debit may not be to Cash. That’s because payment is by check, and the check must be deposited into the bank for it to reach our Cash account, which is actually our bank account. Many businesses, including those in your QuickBooks textbook, use a special account called Undeposited Funds to keep track of customer checks received but not yet deposited into the bank. So, the journal entry QB makes to record the information in the Receive Payments window looks like this:

DEBIT CREDITJune 1 Undeposited Funds 150.00

Accounts Receivable – Fantastic Fabrics 150.00 to record receipt of payment for invoice

All checks collected on a given day are normally deposited together into the bank on that same day after the business has closed. This is recorded using the Make Deposits window, where you just select the payments to be deposited. QB will then make a journal entry that debits Cash and credits Undeposited Funds, so the checks received do end up in the Cash account where you would expect them to go.

Customer Transactions: Sale of Goods or Services for Immediate Cash Receipt

Just as we sometimes purchase goods or services (like the pest control) from our vendors for immediate cash payment, so our customers may purchase goods or services from us for which we receive immediate cash payment. These transactions do not involve credit terms, and must not go through Accounts Receivable or the customer’s account in the Customer Center, so they cannot be recorded in



the Create Invoices window. When a customer purchases goods or services from us for immediate cash payment, we have made a cash sale that must be recorded using the Enter Sales Receipts window. Of course, the “cash” will actually be a check written by the customer, so we will use the Undeposited Funds account for the debit. The credit will be to an appropriate revenue account.

Do not be misled by the fact that you start by selecting a customer in the Enter Sales Receipt window; this transaction does not go into the Customer Center, because no account receivable is created. The customer’s name is still important information on a cash sale, in case there is a question or a return, and to document the source of the revenue. Example: We have a delivery business with both regular and casual customers. The regular customers are invoiced monthly with credit terms, but the casual customers (special, one-time deliveries) must pay us immediately. On July 3, TheBest Hotel pays us $240.00 for a rush pickup and delivery of 20 cases of champagne; they are not a regular customer. In the Enter Sales Receipts window, you will select the customer’s name (you may have to set them up as a new customer first; the customer’s name is in the Customer Center, but the transaction amount will not go there), enter the date and the Sale Number (Confusingly, QB may refer to this as an Invoice number, but this is not an invoice. In the homework, if it says “received payment immediately” and gives an invoice number, use the invoice number as the Sale No. in the Enter Sales Receipts window. ) , and select the revenue account. For this transaction, QB will make this journal entry:

DEBIT CREDITJuly 3 Undeposited Funds 240.00

Delivery Service Revenue 240.00 to record cash sale to TheBest Hotel

QB will copy this information to the General Ledger, increasing the balances of the asset Undeposited Funds and the owner equity account Delivery Service Revenue. It will not copy it to TheBest Hotel’s account in the Customer Center, because it is not part of Accounts Receivable.

TheBest Hotel’s check, along with all other checks received on July 3, will be deposited into the bank after closing. This will be recorded in the Make Deposits window, as illustrated earlier.

SUMMARY OF CUSTOMER ACTIVITY WINDOWS:Window Type of Transaction Account Debited Account CreditedCreate Invoices Sell goods or services on credit Accounts Receivable Sales RevenueReceive Payments Collect amount due on account

from customerUndeposited Funds Accounts

ReceivableEnter Sales Receipts

Sell goods or services for cash received immediately

Undeposited Funds Sales Revenue

Make Deposits Deposit customer checks in bank Cash Undeposited Funds



CHAPTER 4: ADJUSTING THE ACCOUNTS BEFORE PREPARING FINANCIAL STATEMENTS

Suppose you are the world’s best bookkeeper, and never ever make an error when recording transactions. You started recording the transactions for a new business on January 1, 2010 . Every transaction you recorded was absolutely correct at the time you recorded it. Now it is the end of the month, and you must prepare the financial statements (Profit & Loss and Balance Sheet) to be presented to your business’ investors and creditors, especially the bank from which it hopes to borrow money. You print a Trial Balance report, which lists every account in the General Ledger (these are also all of the accounts that appear on both the financial statements) in the order in which they appear on the financial statements: first Assets, then Liabilities, then Owner Equity accounts (including income and expenses), together with the debit or credit balance of each account. This report is used by accountants to confirm that the ledger is in balance with total debits equal to total credits.

Can you now put these account balances on the financial statements? You must be very careful, because errors in the financial statements that mislead investors or creditors, especially errors that



overstate assets (claim more assets than the business really has) or understate liabilities (claim that debts are less than they actually are) can cause the business to be sued. They might even get you put in jail. You look carefully at the account balances and realize that many of them are NOT correct as of the Balance Sheet date, with many assets overstated and some liabilities missing . Yet you made no errors when you recorded the transactions that created these balances.

What happened? TIME happened. The passage of time affects the balances of assets, liabilities, and owner equity accounts. Suppose the business buys a machine for $6,000 which is expected to be used in the business, providing benefits, over the next five years. The $6,000 has bought a pool of usefulness, or future benefits, that will be gradually used up day by day as the machine is used. This is not like an exchange with a vendor or customer, and does not generate any paperwork that demands to be recorded immediately. No one actually cares about this change, because it is so gradual, until the time comes to prepare financial statements at the end of the month (or quarter, or year, whatever time period is used for reporting). Before we present the Balance Sheet, we must be sure that each asset’s balance shows only the benefits that remain for the future (after the Balance Sheet date). Before we present the Profit & Loss report, we must be sure that each expense account shows everything that has been used up during the period covered by that report. We must also make sure that every debt we owe is included in a liability account balance, and that all revenues earned during the period have been recorded.

To do this, we adjust the balance of every account that has been changed by the passage of time. We do this with a special set of journal entries called adjusting journal entries. These entries fall into one of four patterns:

1. Debit an expense account (decrease owner equity) and credit an asset account (decrease the asset) to show that some of the asset has been used up and an expense has been incurred. Examples: Many. This is the most common type of adjusting journal entry (AJE). We use up prepaid services (such as insurance and advertising), supplies (such as office or computer supplies), furniture, equipment, machinery, and buildings.

2. Debit an expense account (decrease owner equity) and credit a liability account (increase the liability) to show that we have used up a service for which we must pay cash at a later time. Examples: interest on debt, salaries and wages due to employees.

3. Debit an asset account (increase the asset) and credit a revenue account (increase owner equity) to show that we have been providing a service which earned revenue and the right to collect money in the future. Example: interest on investments.

4. Debit a liability account (decrease the liability) and credit a revenue account (increase owner equity) to show that we have been providing a service for which we collected money in the past, thus settling our obligation and earning revenue. Examples: landlords earning rent collected in advance, attorneys earning fees collected in advance.



Your textbook may use only the first two patterns, but in real life you could encounter any of the four, so it is a good idea to at least know the patterns. Look carefully at the four patterns; notice that every AJE pairs either an expense OR a revenue (from the Profit & Loss) with either an asset OR a liability (from the Balance Sheet). AJE always use one account from the P & L and one from the Balance Sheet.

An AJE will NEVER pair expense with revenue (both P & L), and NEVER pair asset with liability (both Balance Sheet). When the debit is to expense, the credit is either to an asset or to a liability. When the credit is to revenue, the debit is either to an asset or to a liability. Also, an AJE will NEVER involve the Cash account, because cash is changed only by actual cash receipts or payments, not by the mere passage of time. Here are a few examples of Adjusting Journal Entries (AJEs):

Pattern 1 (debit expense, credit asset): On January 1, we paid $3,000 for one year of insurance coverage on our office property. At the end of the month, 1/12th of that coverage has been used up. We must account for the expired coverage (Note: “Expired” is a word accountants like to say when an asset that is not a physical object is used up.) by decreasing the asset and recording an expense:

DEBIT CREDITJan. 31 Insurance Expense 250.00

Prepaid Insurance 250.00 to record one month of insurance coverage expired

Pattern 1 (debit expense, credit asset): On January 1, we bought office supplies costing $100. We bought more office supplies at a cost of $40 during the month, so the account ended the month with a balance of $140. A physical inventory done on January 31st shows that the supplies still on hand cost only $30, which means that $110 worth of supplies are gone (used up). Here is the AJE:

DEBIT CREDITJan. 31 Office Supplies Expense 110.00

Office Supplies 110.00 to record office supplies used up during January

Here is what the Office Supplies account will look like in the General Ledger:

1325 Office SuppliesDate Description Debit Credit Balance 2010 Jan. 1 Purchased envelopes, stationery, etc. 100.00 100.00



20 Purchased copy paper, paper clips, etc. 40.00 140.00 Jan. 31 AJE for supplies used up in January 110.00 30.00

Notice that the ending balance of $30.00, which we will include with Assets on the Balance Sheet for January 31, correctly states the supplies on hand at that date to benefit future operations. When the AJE was copied into the ledger account, it reduced the balance to the amount determined by the physical inventory count.

Pattern 1 (debit expense, credit asset) Special case: Fixed Assets

Assets that are physical objects with long lives that are actively used in the business (called “Fixed Assets” in QuickBooks; usually called Plant Assets or Property, Plant, & Equipment elsewhere) get special treatment in the accounts because their original cost is a very important and useful piece of information for investors and creditors. If the debit for the cost of buying the asset and the credits for using it up went into the same account, the original cost amount would soon be lost. Consider what happens in our Prepaid Insurance account in the General Ledger as the coverage expires over time and we reduce its balance:

1410 Prepaid InsuranceDate Description Debit Credit Balance 2010 Jan. 1 Bought one-year property insurance policy 3,000.00 3,000.00 31 One month of coverage expired 250.00 2750.00 Feb. 28 One month of coverage expired 250.00 2500.00

The January 31 Balance Sheet will just show Prepaid Insurance of $2,750.00, and the Feb. 28 Balance Sheet will show Prepaid Insurance of $2,500.00, and the reader will never know that it originally cost $3,000.00. This is fine for short-lived assets and intangible (non-physical) assets, but not enough for the long-lived physical assets. For them, the Fixed Assets, we keep two separate accounts, one for the original cost and another to show how much of its benefits have been used up. We then put these two amounts together on the Balance Sheet so the reader can see how big it was to start with and what portion of it has been used up so far. Consider, for example, two companies: A and B. Each has a factory building. Suppose all you saw on each Balance Sheet was “Factory Building… $50,000”. But what if A has a factory building that cost $900,000 and is now almost used up, and B has a factory building that only cost $90,000 but has more than half of its benefits left? Wouldn’t you learn a lot more, get a better picture of their operations, if you had the information about original cost? This is why we use the two separate accounts.

QuickBooks actually keeps three accounts for each Fixed Asset, although you use only two of them. The first account is called the parent account, and it will have just the name of the asset: “Office Furniture”, for example. The parent account has two subaccounts, which are the ones you use in



recording transactions and making adjustments. The two subaccounts for each fixed asset are Cost and Accumulated Depreciation. One is used to record the original cost when you buy the asset: “Office Furniture, Cost”, for example. The other is used to record the accumulated depreciation, the part of the asset’s benefits that have been used up. When a fixed asset is used up (its pool of usefulness has been reduced), the term for it is “depreciation.” As always, when something is used up in the business, an expense is created. This expense is Depreciation Expense (debit). The account that takes the credit entry that reduces the balance of the asset is Accumulated Depreciation (for example, “Accumulated Depreciation, Office Furniture”), so Accumulated Depreciation shows how much of the asset’s benefits have been used up in the past. When Accumulated Depreciation is subtracted from Cost, the balance shows what portion of the asset’s benefits remain for the future.

Example:

On January 1, we bought $7,200 worth of office furniture. This furniture is expected to be used for 8 years, or 96 months. This means we will use up 1/96th of the furniture’s future benefits each month, or $75 per month.

DEBIT CREDIT[Entry for original cost] Jan. 1 Office Furniture, Cost 7,200.00

Cash 7,200.00Bought desks and chairs for the office

[Adjusting journal entry]Jan. 31 Depreciation Expense, Office Furniture 75.00

Accumulated Depreciation, Office Furniture 75.00 to record one month’s depreciation of furniture

On the Balance Sheet for January 31, 2010, we can now report these two account balances and net them together to get the current balance for the asset:

Office Furniture, Cost $7,200.00Accumulated Depreciation, Office Furniture 75.00

Total Office Furniture 7,125.00

Each month, the balance of the Accumulated Depreciation account will increase, but the balance in the Cost account will stay the same, so the asset’s total balance will be reduced over time as its benefits are used up, but the reader will always know how much the asset cost when we bought it.

Note: Your text treats computer software like a Fixed Asset, with the two separate accounts for Cost and Accumulated Depreciation, even though it is not a physical asset. Traditional accountants will



“amortize” rather than “depreciate” non-physical assets, using only one account, but we will follow the text in this class.

Pattern 2 (debit expense, credit liability):Now let’s look at an example of the second pattern, which involves a debit to an expense account and a credit to a liability account. On Jan. 1, we borrowed $10,000 from the bank on a note due in three years with 6.0% annual interest. We won’t pay until the third year, but every month we are using the service of using someone else’s money, and the cost of this service is called interest. Here is the AJE we must make on January 31st:

DEBIT CREDITJan. 31 Interest Expense 50.00

Interest Payable 50.00 to record one month’s interest due on bank note(10,000 * .06 * 1/12)

Another example of Pattern 2 would be to debit Salaries and Wages Expense and credit Salaries and Wages Payable for salaries and wages due to employees for work performed but not yet paid. Most businesses pay after the fact, so if the month ends in the middle of a pay period there would be some work done that would not be paid for until the next month.

Pattern 3 (debit asset, credit revenue): Many businesses invest surplus cash in short-term investments so they can earn interest rather than letting the cash sit idle. This gives the third pattern of AJE, a debit to an asset account and a credit to a revenue (income) account: debit Short-Term Investments, credit Interest Income.

Pattern 4 (debit liability, credit revenue): This requires an original entry that creates a liability in the form of an obligation to provide service. For example, a landlord collects rent money in advance on a one-year lease. This creates a liability called Unearned Rent. Each month, a portion of the rent service is provided, so revenue is earned and part of the obligation is met. The AJE for this is to debit (reduce) the liability and credit a revenue (increase owner equity): debit Unearned Rent, credit Rent Revenue.

You are now “primed” and ready for the first four chapters of QuickBooks and for the exam on this Primer. The basic accounting concepts also apply to the later chapters, but most of these chapters have some new specific types of transactions and reports, new activity windows, and new lists to maintain.

CHAPTER 5: DEALING WITH PRODUCT INVENTORY

If our business deals with inventories of physical products (also called merchandise or goods) rather than (or in addition to) services, recording transactions with vendors and (especially) customers will be



a little different than in the earlier discussion of vendor transactions and customer transactions, though the basic concepts are the same. Furthermore, paying bills from vendors, collecting money (checks) from customers, and depositing customer checks in the bank are all done exactly the same way as discussed earlier. It doesn’t matter whether inventory products, other assets, or services are involved. The main difference between transactions with inventory products and transactions with other assets is that while assets we buy to use ourselves have only one value (their cost), inventory products have two different values: the COST at which we buy them from our vendors, and the SELLING PRICE at which we sell them to our customers. The difference between the two values is our profit.This difference means that whenever inventory products are SOLD, we must make TWO journal entries: (1) to record the COST of the asset used up (by giving it to the customer) and the expense incurred in making the sale, and (2) to record the revenue earned and the asset created (Accounts Receivable or Undeposited Funds) at the SELLING PRICE. The second entry is exactly like ones you have already seen in the section dealing with customer transactions, and is entered in the same windows: Create Invoices for credit sales, Enter Sales Receipts for cash sales. You do have to choose a different form of invoice in the Create Invoices window, one designed for sales of a product rather than a service, so it can handle the extra entry required. But in QuickBooks, you do not see the entries being made; you just see the activity window, which looks much the same as it always does. Behind the scenes, though, QuickBooks is making both the needed journal entries using the information you provide in the activity window.

The information you provide, whether in Create Invoices or in Enter Sales Receipts, includes only the Customer name, date, the name of the item sold, and the quantity sold. All the rest of the work is done by QuickBooks. How is this possible? QuickBooks will get all of the other information it needs from the item’s record in something called the Item List. This is a List window, not an activity window, and is like the Vendor Center or Customer Center. It has a record, a kind of account, for each separate inventory product you buy and sell, so the Item List is like a subsidiary ledger for inventory.

Before you buy or sell an inventory product, you set it up in an item record in the Item List. The product’s item record in the Item List contains all of the other information that is needed for the entries: the unit cost, the unit selling price, the inventory asset account to be debited when it is purchased, the Cost of Goods Sold (COGS) expense account to be debited when it is sold, and the sales revenue (income) account to be credited for the selling price when it is sold, and whether sales tax should be collected on the sale.

If the sale is on credit, you will use the Create Invoices window with the Product Invoice form rather than the Service Invoice form you used for sales of services. Accounts Receivable and the named customer’s account in the Customer Center will be debited for the selling price you entered in the Item window, and the income account you have chosen in the Item window will be credited for the



selling price. If the sale is for immediate cash, you will use the Enter Sales Receipts window, Undeposited Funds will be debited for the selling price, and the same income account will be credited.

(Note: Remember that Undeposited Funds become Cash when the customers’ checks are deposited into the business bank account using the Make Deposits window.)

Whether the sale is for cash or on credit, QuickBooks will make the same journal entry for the cost of the product. It will debit the COGS expense account you chose in the Item window, and credit the inventory asset account you chose there.

You must be very careful when setting up a new inventory product (which QuickBooks identifies by the Type “Inventory Part”), because the values you enter and the accounts you choose in the New Item window (a List window, not an activity window) will be used by QuickBooks every time this product is bought or sold. There are usually some “default” accounts already showing when you set up a new inventory item, and these accounts are rarely the ones you want, so be sure you check each of the three accounts (COGS, Asset, and Income) and make sure it is correct for your new item.

Let’s look at an example of a sale of an inventory product on credit . Suppose one of our products that we buy and sell is printers. Their inventory asset account is Inventory of Printers, their COGS account is Cost of Printers Sold, and their income account is Sale of Printers. Their unit cost is $80.00, and their unit selling price is $120.00. Suppose than on Nov. 9 we sell ten of these printers to a customer named Glendale Medical Clinic. In the Create Invoices window, in the Product Invoice form, we will give QuickBooks the customer name, the product name, and the quantity sold. QuickBooks will get the unit selling price from the item record, calculate and enter on the invoice the total selling price (ten units at $120.00 each = $1,200.00), and if the item is marked as taxable in its item record, calculate and add the sales tax on the invoice. Let’s ignore sales tax for now. This is all you will see on the invoice: customer, product, quantity, selling price, total sale amount, and sales tax (if any). But QuickBooks will pull all the other information it needs from the item record in the Item List: unit cost, COGS account, inventory asset account, and income account. Then it will make these two entries (which may be combined into one entry with two debits and two credits):

DEBIT CREDIT[Entry for COST] Nov. 9 Cost of Printers Sold 800.00

Inventory of Printers 800.00Sold ten printers

[Entry for SELLING PRICE]Nov. 9 Accounts Receivable - Glendale Medical Clinic 1,200.00

Sale of Printers 1,200.00



Sold ten printers

What is happening in each of these two entries? In the first entry, an asset is used up (given to a customer), so it is reduced (asset, decrease = credit), and an expense is incurred (owner equity, decrease = debit). In the second entry, revenue is earned (owner equity, increase = credit) and a new asset (the right to receive money from the customer, Accounts Receivable) is created (asset, increase = debit). Here is the pattern:

DEBIT CREDIT[Entry for COST] Nov. 9 Expense - COGS COST

Asset - inventory COSTSold inventory product

[Entry for SELLING PRICE]Nov. 9 Asset – receivable or Undep. Funds SELLING PRICE

Revenue - Sales SELLING PRICESold inventory product

Every sale of inventory products follows this same pattern, whether it is for cash or for credit. The only difference in a cash sale is that the asset debited for the selling price is Undeposited Funds rather than Accounts Receivable.

What about purchases of products for inventory? They are recorded in the same way, using the same activity windows as described in the earlier discussion of vendor transactions. There is one difference in the Enter Bills window. The Enter Bills window has two tabs: Expenses and Items. The one that is displayed when you bring up the window is the Expenses tab, which is what you used before when recording expenses and (strangely) assets that were purchased for use by the business in its own operations. The other tab, the Items tab in the Enter Bills window, is used for recording purchases of assets to be sold to customers (inventory products).

As soon as you enter the name of the product and the quantity, QuickBooks will complete the bill using the unit cost taken from the item record in the Item List. It will also make this journal entry:

DEBIT CREDIT[Date] Inventory of (product name) COST

Accounts Payable – Vendor Name COSTPurchased (product name) for inventory

The inventory account debited will again be taken from the item record in the Item List.



For example, suppose that the printers we sold on Nov. 9 had been purchased on Nov. 2 from BigTech Equipment. That entry would have been:

DEBIT CREDITNov. 2 Inventory of Printers 800.00

Accounts Payable – BigTech Equipment 800.00Purchased ten printers for inventory

If inventory is purchased for immediate cash payment (which rarely happens), use the Write Checks window. QuickBooks will pull the same information from the item record, and the only difference in the entry from that above will be a credit to Cash instead of Accounts Payable . SUMMARY: NEW PROCEDURES WHEN TRANSACTIONS INVOLVE INVENTORY PRODUCTS

1. Each inventory product must first be set up in the Item List using the New Item window. Its item record will include unit cost, unit selling price, inventory asset account, COGS account, and income account. All of this information can be used by QuickBooks whenever the product is bought or sold, so you don’t have to enter it into the activity window for the transaction.

2. When inventory products are purchased on credit , you use the Items tab instead of the Expenses tab in the Enter Bills window.

3. When inventory products are sold on credit , you use the Product Invoice form instead of the Service Invoice form in the Create Invoices window.

CHAPTER 6: SETTING UP A NEW COMPANY IN QUICKBOOKS

During your work in the QuickBooks (QB) text, you will be setting up a “new” company. The company is not really new; it is just new to QB. It has been in operation for some time, keeping its records manually. Now all of the balances from the manual ledger accounts, both General Ledger and subsidiary ledgers for customers, vendors, and inventory items, are to be set up in QB so that accounting for this business in the future can be done using QB.

You might think that you could make a Trial Balance from the manual General Ledger, listing each General Ledger account and its debit or credit balance, then just make one huge General Journal entry in QB with all of these account balances. If the Trial Balance is in balance, with total debits equal to total credits, then the journal entry will balance, and when the journal entry is copied over into the General Ledger in QB, you would be done. That is a good idea, and close to what you must actually do. It is not quite that simple, though. We do make one huge journal entry that will set up most of the account balances when it is copied into the General Ledger, but the procedure is complicated by the balances that must be established in the Customer Center, Vendor Center, and Item List. Sometimes the Cash account is also established separately when a banking account is set up.



The inventory and Cash accounts are the lesser problem. When you set up an inventory product with an existing balance in an item record in the Item List, QB will debit (increase) the inventory asset account (such as Inventory of Printers) and credit (increase) the owner’s Capital account. Similarly, when you set up a banking account during the process of setting up your company, QB debits a Cash account (asset, increase) and credits Capital (Owner Equity, increase). In each case, all you must do is adjust the amount for Capital in the major journal entry setting up the other accounts.

Setting up Accounts Receivable and Accounts Payable also cause the amount for Capital in the main journal entry setting up other accounts to differ from the balance shown in the manual General Ledger, but there is an extra step in each case.

Each time a new customer with an existing balance is created in the Customer Center, QB increases both the customer’s account and the Accounts Receivable balance in the General Ledger. The journal entry debits (increases) the asset Accounts Receivable and credits (increases) a special owner equity account called Uncategorized Income. Once all of the customer balances have been established, the balance of Uncategorized Income should equal the total Accounts Receivable shown in the manual General Ledger account. Suppose this is $12,500.00. It is then transferred over to the owner’s Capital account by this journal entry:

DEBIT CREDIT[Date] Uncategorized Income 12,500.00

Ima D. Owner, Capital 12,500.00To transfer balance of Uncat. Inc. to Capital

Note: Before you make this entry, be sure that all customer balances have been correctly entered into QuickBooks. If you display a Customer Balance Summary report at this time, it should show a total of $12,500.00 due from all customers, and that amount MUST equal the balance in the manual General Ledger account for Accounts Receivable. If not, something is wrong and must be fixed. In your homework, you don’t actually have the manual records, but you can check the total on your Customer Balance Summary against the amount shown in the solution key for the above entry.

Each time a new vendor with an existing balance is created in the Vendor Center, QB increases both the vendor’s account and the Accounts Payable balance in the General Ledger. The journal entry credits (increases) the liability Accounts Payable and debits (decreases) a special owner equity account called Uncategorized Expenses. Once all of the vendor balances have been established, the balance of Uncategorized Expenses should equal the total Accounts Payable shown in the manual General Ledger account. Suppose this is $9,000.00. It is then transferred over to the owner’s Capital account by this journal entry:

DEBIT CREDIT[Date] Ima D. Owner, Capital 9,000.00

Uncategorized Expenses 9,000.00To transfer balance of Uncateg. Exp. to Capital



Note: Before you make this entry, be sure that all vendor balances have been correctly entered into QuickBooks. If you display a Vendor Balance Summary report at this time, it should show a total of $9,000.00 due to all vendors, and that amount MUST equal the balance in the manual General Ledger account for Accounts Payable. If not, something is wrong and must be fixed. In your homework, you don’t actually have the manual records, but you can check the total on your Vendor Balance Summary against the amount shown in the solution key for the above entry.

ALL General Ledger account balances other than Accounts Receivable, Accounts Payable, Inventory, and (possibly) Cash are established in a single (very large) journal entry. The last line of this journal entry will be an entry to the owner’s Capital account. This is the ONLY account for which the amount will NOT match the amount in the manual General Ledger (or, in your homework, the only account for which the amount is not given in the textbook). The amount credited (or perhaps debited) to Capital here has to be adjusted because of separate entries to Capital caused by setting up Accounts Receivable, Accounts Payable, Inventory, and (possibly) Cash. You could work out the amount by T-account if you knew the original Capital balance in the manual records. In your homework, you will just let QB determine the amount needed to balance the journal entry. When you choose the owner’s Capital account as the last account in the journal entry, some balance will automatically appear for it as QB tries to make total debits equal total credits in the journal entry. Accept this amount to complete the entry. You can then check it against the amount shown for Capital in the journal entry on the solution key.

(Aside: Why doesn’t QB just use Capital for the other side of the Accounts Receivable and Accounts Payable entries in the first place, as it does with Cash and Inventory accounts? I have no idea; this is just a QB quirk, and we have to deal with it.)

CHAPTER 7: ACCOUNTING FOR PAYROLL TRANSACTIONS

Payroll is fairly simple in concept, but can be very messy in practice. One reason is the number of different items that can be deducted from an employee’s paycheck. If you have ever received a paycheck with a “stub” attached providing supporting details, you have surely noticed the large difference between what you have earned and what you are paid by the check. Amounts are “withheld” or “deducted” from your earnings for various reasons. Some are required by federal, state, or local law: income taxes, Social Security (sometimes called FICA), and Medicare . Some are voluntary, such as contributions for retirement savings or charity or medical insurance (thankfully, our text does not have any of these). In every case, the money that the company keeps back must be paid on your behalf to some other agency. In the case of our legally required withholdings, they must be paid by the company to the federal or state government. This is the EMPLOYEE’S MONEY, earned by the employee, not the company’s money. But the employee owes some of the money to the federal and state governments. The employee owes income taxes on his earnings, and is required to



contribute to his own Social Security and Medicare accounts. The company will make these payments to the government on behalf of the employee.

What is happening here, from the company’s viewpoint, is that they are incurring a payroll expense (decrease in owner equity) called Salary and Wages Expense at a certain rate as they use up the service of the employees’ labor, and they are creating an obligation (increasing a liability) to pay for this labor service. Most of what they owe will be paid in cash to the employees who earned the salaries and wages, but some of it will be paid instead to federal or state governments on behalf of the employees.

The payroll taxes charged to employees are part of the Salaries and Wages Expense the company incurs. But employees are not the only ones who bear the cost of payroll taxes. The second reason that payroll accounting is so messy is that several different payroll taxes are imposed on the company that employs the workers. Employers (companies) must match their employees’ contributions to Social Security and Medicare out of their own pockets, and must also pay a tax not borne by the employees: unemployment taxes. Employers pay both federal and state unemployment taxes. These payroll taxes are an expense to the company separate from and in addition to Salaries and Wages Expense. They are both part of Payroll Expenses for the company.

Before you begin accounting for payroll, all of the accounts that will be used in the journal entries for each pay period must be set up in your ledger. Accounts are added to the General Ledger in QB using the Chart of Accounts window. Your textbook will give you the opportunity to do this in the first payroll chapter.

Each actual payroll journal entry, done whenever the company has a pay period, will combine the two entries shown below. That’s a 14-line journal entry, even without any voluntary deductions. There will also be at least two more journal entries, not shown here and usually made only annually or quarterly, when the company pays the payroll tax liabilities due to the federal and state governments. These entries will just debit the payroll tax liability accounts (decrease liability) and credit Cash (decrease asset).

The basic pattern for the employee part of the payroll journal entry is:

DEBIT CREDIT[Date] Payroll Expense: Salaries and Wages Expense 10,000.00

Payroll Liability: Federal Income Tax Payable 2,000.00 Payroll Liability: State Income Tax Payable 300.00 Payroll Liability: Social Security Tax Payable 620.00 Payroll Liability: Medicare Tax Payable 145.00 Cash 6,935.00To record salaries, wages, and withholdings for the pay period



In your text, the account names will be somewhat different; for example, they will use the abbreviations FIT and SIT for federal and state income taxes, and the order of the accounts may differ. But this is the pattern used.

The basic pattern for the company part of the payroll journal entry is:

DEBIT CREDIT[Date] Payroll Expense: Social Security Company 620.00 Payroll Expense: Medicare Company 145.00 Payroll Expense: Federal Unemployment 70.00 Payroll Expense: State Unemployment 230.00

Payroll Liability: Social Security Company 620.00 Payroll Liability: Medicare Company 145.00 Payroll Liability: Federal Unemployment 70.00 Payroll Liability: State Unemployment 230.00To record company payroll taxes for the pay period

Again, the names will differ somewhat in your text (such as FUTA for federal unemployment tax and SUI for the state unemployment tax), and QB will pair each expense with its related liability in its journal entry rather than grouping expenses and liabilities as we do in a manual entry, but the effect will be the same.

QuickBooks makes this process as easy as possible in your text, but payroll accounting is never really simple. One very important thing the TEXTBOOK does is to give you the amounts for the payroll deductions for income taxes, Social Security, and Medicare, as well as the amounts due for unemployment taxes. In real life, you must either calculate these amounts manually or you must pay for a service to do them for you. The calculations are not simple (there are all sorts of rules for base amounts, annual limits on earnings that can be taxed, and tax rates, and the rates and limits keep changing). When you pay the taxes, you must also file payroll tax returns, and the forms for reporting to the federal government when you make payments are difficult to understand and complete correctly. We will not make the calculations or fill out the forms in this course, but you should be aware that they must be done and have some idea of what is involved.

One thing the QuickBooks PROGRAM always does to make your payroll accounting easier is to use a Payroll Item List (in real life as well as in your text). Just as QB uses the Item List to get information for journal entries involving inventory so you don’t have to enter the same information over and over in the activity windows, so QB uses the Payroll item List to get much of the information needed for payroll journal entries. Of course, you must first set up the information in the Payroll Item List.



What information is included in the Payroll Item List? Among other things, this is where you tell QB which expense and liability accounts to use for each payroll tax, for both employee and employer (company) payroll taxes. You also tell QB the accounts (expense and liability) to use for salaries and wages. QB already knows the annual limits on earnings that are taxed and the tax rates for federal payroll taxes, but you will have to give it these numbers for your state payroll taxes.

When you are creating paychecks for individual employees, QB will require additional information. Much of this information will come from the Employee Center. Before you start to process payroll, you will have to set up each employee in the Employee Center . Besides personal information such as name and address, each employee record in the Employee Center will have needed payroll information such as whether the employee gets an annual salary or an hourly wage, the rate at which the employee is paid, and which payroll taxes must be deducted from the employee’s pay. QB will draw on this information when processing pay checks each pay period.

SUMMARY: PROCESSING THE PAYROLL1. Set up payroll accounts in General Ledger2. Set up salary, wage, and payroll tax items in Payroll Item List3. Set up employee information in employee records in Employee Center4. At the end of each pay period, prepare a paycheck for each employee. This requires the

calculation of each payroll tax amount to be withheld from the employee’s check and of each payroll tax imposed on the company for that employee.

5. QuickBooks takes information from the Payroll Item List, Employee Center, and individual paychecks to create journal entries recording each paycheck. (Note: It can also summarize the entire payroll for the pay period in other reports.) These entries are copied over into the General Ledger accounts.

6. At appropriate times, annually or quarterly, prepare payroll tax return forms and submit them to the federal or state government with cash payment for all of the payroll taxes due from both the employees and the company.

CHAPTER 8: BANK RECONCILIATIONS

When financial statements are prepared, the Balance Sheet must show the correct amount for each asset at the Balance Sheet date. This includes our Cash asset. Suppose we need to present a Balance Sheet at January 31, 2010. At January 31, 2010, our books (General Ledger) will show a certain balance for the Cash account. We will also get a statement from the bank where we have the checking account that holds our cash. This bank statement will also show a certain balance in our checking account at January 31, 2010. The two balances will not match. Which is the correct amount to put on our Balance Sheet? NEITHER one is correct.



At this point, neither our books nor the bank statement show the correct amount of our Cash asset, because each has some information that the other does not have. To get the correct balance of Cash for the Balance Sheet, we must combine the information from the books and the bank statement through a process called “bank reconciliation”.

What do the books “know” that the bank statement does not? Usually, there are two main items: outstanding checks and deposits in transit. The first, and most important, are outstanding checks. When we write a check to pay a vendor, we immediately record an entry crediting the Cash account, reducing the balance of our Cash account in the General Ledger (on our books). But the check must be delivered to the vendor (called the “payee” of the check), and the vendor must deliver it to our bank, and our bank must process it before it will show up on the bank statement. There can be quite some time lag between the writing of the check and its processing by the bank, and during this time our books have recorded the check but the bank statement has not. This is what is called an “outstanding check,” and it is one reason the bank statement balance is not the true balance of our cash.

The second item is deposits in transit. Recall that when we collect payment on account from our customers or when we make a “cash” sale, we get checks from our customers. We debit Undeposited Funds when we get the checks, then at the close of business we take all the checks received that day and deposit them in the bank by putting them in the night depository. We record the deposit immediately in the Make Deposits window, debiting Cash, so on our books the deposit is included in the balance of our Cash account. The bank won’t process them until the next day. When the bank statement is prepared, it may not include a deposit that was made the night of the Balance Sheet date. This would be a “deposit in transit” (in transit between the company and the bank), and it will cause the bank statement balance to differ from the true balance of our cash at Balance Sheet date.

But the bank statement also contains some information that the books do not yet include. There are three main items in this category: bank service charges, interest earned on the balance in our bank account, and NSF checks from our customers. Every month, the bank charges us a fee for any services they have done, and this fee is taken out of our bank account. These bank service charges are an expense that we don’t record until we see the amount on the bank statement. Also, most banks pay at least a small amount of interest each month for the use of our money that is held by the bank. The bank adds this amount to our bank account. This is interest income to us, but again, we don’t record it until we see the amount on the bank statement. Both of these items cause the book balance to differ from the correct balance until we get the bank statement and record them in our journal and ledger.

When you start a bank reconciliation in QB, the Begin Reconciliation window comes up. This is where you will enter the ending balance from the bank statement, the bank service charge, and the interest earned on the bank account. You will also choose the expense account to be debited for the bank service charge and the income account to be credited for the interest earned; the other side of each entry will be Cash. QB will automatically make journal entries to record these two transactions .



The other item is not a regular monthly item, but may sometimes occur. An NSF check from a customer is a check that could not be deposited because the customer did not have enough money (had “Not Sufficient Funds”) in its bank account to pay the check. When we got the check, we thought it was good, and recorded it as an increase in our Cash account before we took it to the bank. Now we see from the bank statement that it was just a worthless piece of paper, so the customer still owes us some real money. We have to take this amount out of our Cash account and put it back into the receivable account in order to correct our books. QB will not make this entry automatically. You will have to open the Create Invoices window and enter the amount of the bad check with an Item Code of NSF. Recall that the Create Invoices window usually makes a journal entry that debits Accounts Receivable and credits Sales Revenue. That is not appropriate here, because it would count the revenue twice. The special Item Code “NSF” causes the journal entry to credit Cash instead of Sales Revenue, so Cash is reduced and the Account Receivable is restored.

When you read the bank statement, remember that it is prepared from the bank’s point of view. To the bank, your company’s checking account is a liability – they have an obligation to pay out the money in your account when you write a check or make a transfer order. This means that the bank follows the rule for liabilities, showing deposits and other increases as credits (increase in liability) and checks and other decreases as debits (decrease in liability). You, however, are accounting for an asset, the company’s Cash (asset) account in the General Ledger, where increases are debits and decreases are credits. Since you are recording from the company’s point of view, be sure you follow the asset rule when you make any adjustments to the Cash account for items found on the bank statement that are not yet recorded on the books.

QB will use the bank statement balance and the information we provide about outstanding checks and deposits in transit (by checking off the ones that ARE included on the bank statement so QB knows the others are not included) to calculate the correct balance of cash and compare it to the balance recorded in our Cash account. Once we have adjusted our Cash account for any items on the bank statement that were not yet included in our Cash balance, our Cash account should have the correct balance for cash and the reconciliation should be complete. In the Reconcile Cash window, this is indicated by a Difference amount of zero. In your textbook problems, this will always work.

In real life, you may find that the difference between your adjusted Cash balance and what QB has calculated for the correct balance will not be zero. Either your company or (rarely) the bank could have made an error in recording transactions. For example, you may have recorded the wrong amount for the bank service charge or for the interest income. The bank may have paid a different amount than what you wrote on a check. Any such errors discovered during the reconciliation process must be corrected before the reconciliation is complete.

CONCLUSION



There are other topic areas in your textbook, but this primer gives you enough to get started and to understand new material as you encounter it. The basic concepts of assets, liabilities, and owner equity, of journal and ledger, of debits and credits, apply in all of accounting and all the work you do in QuickBooks. You have studied the main List, Center, and activity windows, seen how they interact and how they affect the accounts. The activity windows that are introduced in one chapter will be used again in later chapters. For example, in one chapter of the text you will learn how to keep track of work done by your company’s personnel by specific customer and job, and how to charge customers for the work when you invoice them. But this will mean using the same payroll windows and invoice window you used when recording other payroll and customer transactions. Once you have mastered this material, you are “primed” and ready to tackle the QuickBooks textbook.


A quickbooks accounting primer

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