Learn more about the Balance Sheet.  Also try our Free Interactive Puzzles on Balance Sheet and many more topics. 

One way to enter the transaction is to debit the current asset Prepaid Subscriptions for $24 and to credit Cash for $24. At the end of each month you would make an adjusting entry to debit Subscriptions Expense for $2 and to credit Prepaid Subscriptions for $2. This approach would obviously match the annual cost to each of the 12 periods benefiting from the subscription. However, this is not practical given the small amount involved.

Thanks to the accounting concept of materiality, accountants can ignore the matching principle when the amount is insignificant in relationship to the company’s size. Since no investor or lender would be misled if the entire $24 appeared as an expense in one month and $0 appeared in the other 11 months, the following entry would be more practical: debit Subscriptions Expense for $24 and credit Cash for $24 at the time of entering the invoice into the accounting records.

If the annual subscription was $8,400 for a trade journal and other membership services, a small company will likely find that amount to be significant and should not expense the entire amount in one month.

Learn more about Adjusting Entries.

For example, when a corporation issues shares of its common stock and receives more than the par value of the stock, two accounts are involved: 1) the account Common Stock is used to record the par value of the shares being issued, and 2) the amount that is greater than the par value is recorded in an account entitled Paid-in Capital in Excess of Par—Common Stock, or Premium on Common Stock.

Many years ago, the account Paid-in Capital in Excess of Par—Common Stock and the account Premium on Common Stock were referred to as capital surplus.

Learn more about Stockholders’ Equity.

Just as important as being able to take the CPA Exam is whether you can pass the CPA Exam. The CPA Exam is very rigorous and the pass rate is significantly lower than the pass rates for college accounting courses. Students having successfully completed 30 college credits in accounting courses (plus 120 credits of other college courses) find it very difficult to pass the CPA exam.  As a result, students with accounting degrees often enroll in CPA review courses to increase their likelihood of passing the CPA Exam. In other words, you need to ask yourself whether you have the accounting knowledge to pass the CPA exam in addition to meeting your state or jurisdiction’s educational requirement.

Our Helpful Links section has two links pertaining to the CPA Exam.

When a corporation issues shares of its stock for cash, the corporation’s current asset Cash will increase with the debit part of the entry, and the account Contributed Capital will increase with the credit part of the entry. If the corporation then uses some of its cash to purchase equipment, its current asset Cash will decrease and its non-current asset Equipment will increase.

If a corporation receives equipment in exchange for newly issued shares of stock, the non-current asset Equipment will increase and Contributed Capital will increase.

The effects of double entry accounting are illustrated under the topic Accounting Equation.

Let’s illustrate this by looking at the cost of property insurance. The cost of insuring the factory building is a fixed cost when the independent variable is the number of units produced within the factory. In other words, the factory’s property insurance might be $6,000 per year whether its output is 2 million units, 3 million units, or 5 million units. On the other hand, if the independent variable is the replacement cost of the factory buildings, the insurance cost will be a variable cost. The reason is the insurance cost on $12 million of factory buildings will be more than the insurance cost on $9 million of factory buildings, and less than the insurance premiums on $18 million of factory buildings.

In the case of worker compensation insurance, the cost will vary with the amount of payroll dollars (exluding overtime premium) in each class of workers. For example, if the worker comp premiums are $5 per $100 of factory labor cost, then the worker comp premiums will be variable with respect to the dollars of factory labor cost. If the units of output in the factory correlate with the direct labor costs, then the worker compensation cost will also be variable with respect to the number of units produced. On the other hand, the worker compensation cost for the office staff is usually a much smaller rate and that worker compensation cost will not be variable with respect to the number of units of output in the factory. However, the worker compensation cost of the office staff will be variable with respect to the amount of office staff salaries and wages.

As you have seen, determining which costs are fixed and which are variable can be a bit tricky.

A product’s manufacturing cost, consisting of direct materials, direct labor and manufacturing overhead, is used to report the cost of goods sold and also the cost of units in inventory. Therefore, if you look at the detail of a product’s inventory cost, you may see the manufacturing overhead being assigned or applied to the unit through a burden rate.

Learn more about Manufacturing Overhead.

Now for the reason companies often record purchases in a purchases account. Generally, companies will have a relatively stable amount of inventory and the cost of its annual purchases will be many times the cost of its inventory. This means that most of the cost of its purchases will appear as the cost of goods sold on its income statement. For the minor change in the cost of inventory from the beginning to the end of the accounting period, an adjustment can be made. For example, let’s assume that the cost of purchases during the year amounted to $560,000. Let’s also assume that the inventory at the end of the year has a cost of $70,000 compared to the inventory cost of $67,000 at the end of the previous accounting year. An adjustment will be entered to debit the Inventory account for $3,000 which will increase the Inventory account balance from $67,000 to $70,000. The credit portion of the entry of $3,000 will cause the cost of goods sold to be reported as $557,000 ($560,000 of debits in the Purchases account during the year minus the amount that increased the cost of inventory: $3,000). After this adjustment, the balance sheet will report the true cost of the ending inventory of $70,000 and the income statement will report the true cost of goods sold of $557,000.

Learn more about Inventory and Cost of Goods Sold.

It might be helpful to recall the bank reconciliation rule: Put it where it isn’t. The old check, which you had voided, is now on the bank statement, but it is not in the cash account. Therefore, you need to put the check amount into the general ledger.

Learn more about Bank Reconciliation.

States and jurisdictions have specific requirements that must be met before taking the CPA Exam. In the U.S. it is common for the requirements to include 150 college credits. The accounting material on AccountingCoach.com is perhaps the equivalent of 3 college credits of accounting, while students obtaining an accounting major will have 30 college credits in accounting courses alone.

Since AccountingCoach.com is free, you should learn and review all you can from the website. The website contains drills and puzzles that will give you immediate feedback on your accounting knowledge. For a small fee, you can download 640 accounting exam questions sorted into 16 accounting topics. The download file also contains an answer key. However, you need to keep in mind that these exams and the free material on the site cover the content in only the first one of 10 or 11 college accounting courses.

You should also know that even with 150 college credits, including 30 college credits in accounting, most people cannot pass the CPA Exam. If you wish to be successful, you will need an aptitude for accounting and business in order to master the complex material included on the CPA Exam.

Learn more about Getting Your Accounting Degree and Becoming a CPA.

For example, in the decision to replace equipment that has been used for the past six years, the original cost of the equipment does not have relevance. In other words, the original cost is irrelevant or is not relevant in the decision to replace the equipment. What will have relevance are the future amounts, such as the cost of the new equipment, and the savings that will occur when the old equipment is replaced.

Here’s another expression of relevance: Costs that will differ among alternatives. Costs that will not differ among alternatives do not have relevance.

In order to have relevance, accounting information must be timely. Financial statements issued three weeks after the accounting period ends will have more relevance than financial statements issued several months after the period ends. Having timeliness and relevance may mean sacrificing some precision or reliability.

Read more about relevance in paragraphs 46-57 of the Statement of Financial Accounting Concepts No. 2, Qualitative Characteristics of Accounting Information, issued by the Financial Accounting Standards Board. You may read it at no cost at www.FASB.org/st.

When the company earns interest on the loan, the interest should be credited to Interest Revenue or Interest Income and should be debited to Interest Receivable or Cash.

In the U.S., accountants often cite LIFO as the preferred method when products’ costs are changing. The reason is the matching of the latest costs of products with the sales revenues of the current period. U.S. tax  rules also allow for either FIFO or LIFO, but require that the same cost flow assumption be used on both the company’s tax return and on the company’s financial statements.

By using LIFO when the costs of products are increasing, the company will be matching the recent higher costs with the current period sales. This will provide not only the improved matching of costs with revenues, it will also result in lower taxable income.

Learn more about FIFO and LIFO.

My recommendation is to calculate the contribution margin and contribution margin ratio for each product (or service) that you offer. I suspect that some of your items have positive contribution margins, but the products with negative contribution margins are greater. You must get into the details.

You also need to look at each of your customers. Perhaps some customers are buying in huge quantities, but those sales are not profitable. See which customers have positive contribution margins.

By definition, the ways to eliminate the negative contribution margin are to 1) raise selling prices, 2) reduce variable costs, or 3) do some combination of the first two. If customers will not accept price increases in order for you to cover your variable costs, you are probably better off not having the sales. Remember that after covering the variable costs, those selling prices must then cover the fixed costs and expenses. A total negative contribution margin means your loss will be larger than the amount of the fixed costs and expenses.

When setting prices or bidding for new work, you must think of the bottom line—profits. Many people focus too much on the top line—sales. 

Learn more about Break-even Point.

Another reason for not valuing items in inventory at their selling prices is that inventory items cannot be sold without a sales effort. Until that effort is made and an item is actually sold, the company cannot report the $10 increase from $40 to $50. This is referred to as the revenue recognition principle. In other words, only after an item is actually sold can the company report the revenue of $50 minus the cost of $40 for a gross profit of $10.

There are some exceptions to cost. One exception is industries where no sales effort is required and the extensive effort of production has been completed. In these industries the inventory can be reported at its net realizable value, which is the sales value minus the costs to dispose of the items. The gold mining industry and certain other commodities are examples of this exception to cost.

Another exception can occur in any industry when a product will have to be sold for less than its cost. In that situation the item might be reported in inventory close to its net realizable value, provided it is less than the item’s cost. (U.S. income tax rules require conformity between tax and financial reporting. As a result, there are complexities involved.)

Learn more about Lower of Cost or Market.

The retailer can record the delivery surcharges in a separate operating revenue account. In other words the sales revenues account could be used to record the revenues excluding the surcharges and then another sales revenue account could be designated as the delivery surcharge revenues account. Those two accounts would then be added together to report total operating revenues.

If the amount of the Loss on Write-Down of Inventory is relatively small, it can be reported as part of the cost of goods sold. If the amount of the Loss on Write-Down of Inventory is significant, it should be reported as a separate line on the income statement.

Since the amount of the write-down of inventory reduces net income, it will also reduce the amount reported as owner’s or stockholders’ equity. Hence for the balance sheet and in the accounting equation, the asset inventory is reduced and the owner’s or stockholders’ equity is reduced.

Learn more about Inventory and Cost of Goods Sold.

1.  Social Security and Medicare taxes that were to be withheld plus your company’s matching of those taxes.

2. State and federal unemployment taxes. Your state can tell you the rate for your company and the wages to which the rate applies. For example, it might be 5% on the first $9,000 of annual wages and salaries. The federal rate is 0.8% on the first $7,000 of annual wages and salaries.

3. Check with your city, county, and state for any other payroll taxes.

In addition to the payroll taxes, you may have payroll related liabilities for worker compensation insurance, health insurance, 401-k contributions, pensions, vacations, and so on.  Your liabilities will also include other payroll withholdings that were to be remitted for the employee, but have not yet been remitted. 

Learn more about Payroll Accounting. In addition try our Crosswords and Word Scramble puzzles on payroll accounting.

Cost is defined as the cash or cash equivalent amount at the time of the transaction. This means that the asset’s cost is the cash amount plus the note’s present value at time that the asset is purchased.

To illustrate this, let’s assume that equipment is purchased by giving $50,000 of cash plus a promissory note of $100,000. If the note has an interest rate that is a fair rate considering the market rates and the riskiness of the party signing the note, then the present value of the note is $100,000. The equipment will then be recorded at its cost of $150,000. This cost of $150,000 will be depreciated over the equipment’s useful life.

If the note specifies zero interest, then the present value of the note is less than $100,000. Let’s assume that the note’s present value is computed to be $90,000. This means that the asset’s cost will be $140,000—the cash of $50,000 plus the note’s $90,000 of present value.  Assuming no salvage value, the total depreciation expense over the life of the equipment will equal $140,000. The $10,000 difference will be reported as interest expense over the life of the note.

Learn more about Present Value.

Let’s assume that the net cost of worker comp insurance after discounts and dividends is 5% of the wages and salaries of  direct and indirect manufacturing employees. If for the month of January the direct labor is $40,000, then $2,000 of the worker comp cost should be included as direct labor. If indirect labor for January is $60,000 then $3,000 of worker comp cost should be included as the cost of the indirect labor.

If the general office worker comp rates are 0.2% of the general office wages and salaries, then 0.2% of January’s general office wages and salaries will be expensed as worker comp insurance expense.

If the employer remits each month’s worker comp cost to its insurance company each accounting period, there will be no prepaid insurance nor will there be a liability for accrued worker comp expense.

If the employer remits worker comp premiums to the insurance company in advance of the cost associated with wages and salaries, the amount that is prepaid as of the balance sheet date should be reported as Prepaid Insurance, a current asset. If the employer has remitted less than the worker comp cost associated with the wages and salaries, the amount owed to the insurance company as of the balance sheet date is reported as a current liability such as Accrued Worker Comp Payable.

Learn more about accruals and deferrals under the topic Adjusting Entries.

I associate the term apportionment with a corporation’s taxable income that was earned in many states within the U.S. In that situation, the corporation’s taxable income must be allocated or apportioned to each of the states based upon certain accepted factors. In the past, the apportionment or allocation was often based on a corporation’s tangible property, employees, and sales in each of the states. More recently, apportionments seem to be based more on sales or receipts within each state.

Since accountingcoach.com does not cover income taxes, you should contact a tax professional for a more accurate and complete explanation.

The general ledger account has always been correct, because the amount of the check reduced the general ledger account balance at the time the check was written and recorded.

The problem was the previous bank statements. The bank statement balances were too high since the check had not yet cleared the bank checking account. That’s why we subtract the amount of the outstanding checks from the bank statement balance. Now that the bank statement balance has been reduced by the check clearing the bank account, there is no longer a need to further subtract the amount of the check as outstanding.

Learn more about Bank Reconciliation. Also see our crossword and word scramble puzzles on bank reconciliations.

If a sales tax is paid by the reseller and the sales tax could have been avoided, the sales tax would have to be expensed immediately. Costs that are not necessary cannot be recorded as assets.

If the sales tax could not have been avoided, then the sales tax would be part of the cost of the merchandise purchased. If the merchandise has not been sold, the entire cost will be reported as inventory, a current asset on the balance sheet. If the merchandise has been sold, then the entire cost will be reported on the income statement as the cost of goods sold.

Learn more about Accounting Principles. Work our interactive puzzles containing 1,900 terms.

The overhead rate is normally a predetermined rate—meaning that it was calculated prior to the start of the accounting year by using 1) the expected amount of overhead costs, and 2) the expected volume of production. Because of these two estimates, it is unlikely that the amount of overhead allocated, applied, assigned, or absorbed will be equal to the actual overhead costs incurred.

If the actual products manufactured are assigned or absorb more overhead through the overhead rate than the actual amount of overhead costs incurred, the products have overabsorbed the overhead costs.

At the end of the accounting year, the amount of the overapplied, overassigned, or overabsorbed overhead is often credited to the cost of goods sold. The reasons are 1) the overabsorbed amount is not significant, and 2) most of the products absorbing too much overhead costs have been sold. If the overabsorbed amount is significant, then the amount overabsorbed must be prorated or allocated as a reduction to the cost of the inventories and to the cost of goods sold based on where the overabsorbed overhead costs are residing at the end of the accounting year.

Learn more about Manufacturing Overhead and Standard Costing.

A company has a cost of $6,000 for property insurance covering the next six months. Initially the cost of $6,000 is reported as the current asset Prepaid Insurance. However, in each of the following six months, the company will report Insurance Expense of $1,000—the amount that is expiring each month. The unexpired portion of the cost will continue to be reported as the asset Prepaid Insurance.

The cost of equipment used in manufacturing is initially reported as the long lived asset Equipment. However, in each accounting period the company will report part of the asset’s cost as Depreciation Expense.

A retailer’s purchase of merchandise is initially reported as the current asset Inventory. When the merchandise is sold, the cost of the merchandise sold is removed from Inventory and is reported on the income statement as the expense entitled Cost of Goods Sold.

The matching principle guides accountants as to when a cost will be reported as an expense.

Learn more about this topic at Accounting Principles and Adjusting Entries.

The definition of a short term or current asset is cash and other assets that will turn to cash or will be used up or consumed within one year of the balance sheet date. If a company’s operating cycle is longer than one year, the definition allows for assets turning to cash, used up, or consumed during the operating cycle to be reported as a current asset.

Often companies are billed in advance for insurance premiums covering a one year period or less. Hence the prepaid amount is usually a current asset.

If a company would have to pay an insurance premium in advance for a period longer than one year, the portion of the prepayments that will not turn to cash within one year (or the operating cycle if it is longer than one year) would be reported as a long term asset.

To learn about adjusting the amount of prepaid insurance see Adjusting Entries.

Since the income statement reports only the expenses that match the revenues during the accounting period, the depreciation expense might be very small in the first accounting period compared to the amount spent for the machine. For example, if the machine is purchased half way into the accounting year and its cost was $300,000, the depreciation for that first accounting period might be only $15,000—assuming it has a 10 year life and no salvage value. In the next accounting period the depreciation expense will be $30,000 under the straight line method.

If the machine is used by a manufacturer, the depreciation, electricity, and maintenance of the machine will be recorded as manufacturing overhead. This overhead is then assigned to the products and will be held in inventory until the goods are sold. When the products are sold, these overhead costs will be reported on the income statement as part of the cost of goods sold.

Learn more about Depreciation. Also see our crossword and word scramble puzzles on depreciation.

We will demonstrate this with some amounts. Let’s assume that a company began on December 1, 2007. During the month of December it purchased or manufactured $100,000 of goods. At the end of December 31, the company reported that its ending inventory was $15,000. As a result, its balance sheet will report inventory of $15,000 and its income statement will report cost of goods sold of $85,000. In January 2008 it purchases $130,000 of goods and at the end of January 31 it reports inventory of $20,000. It will report January’s cost of goods sold as $125,000 (beginning inventory of $15,000 plus purchases of $130,000 minus ending inventory of $20,000).

Now let’s assume that only one error occurred and it involved the calculation of the December 31 ending inventory. Instead of the $15,000 that had been reported, the true amount of inventory was $19,000. That meant the December 31 balance sheet understated the true cost of inventory by $4,000. It also meant that the income statement’s cost of goods sold was not $85,000. Rather, the true cost of goods sold was $81,000 ($100,000 minus $19,000 of inventory). In January, the true cost of goods sold is $129,000 (beginning inventory of $19,000 plus the purchases of $130,000 minus the January 31 inventory of $20,000).

To recap, the December 31 balance sheet reported the incorrect ending inventory and the December and January income statements reported the incorrect cost of goods sold, and gross profit and net income. The true cost of goods sold for December was $81,000—not the $85,000 that was reported. The true cost of goods sold for January was $129,000—not the $125,000 that was reported. That one error in calculating the December 31 inventory cost resulted in December’s cost of goods sold being too high and January’s cost of goods sold being too low. That in turn meant that the reported gross profit for December was $4,000 too low and January’s reported profit was $4,000 too high.

Learn more about Inventory and Cost of Goods Sold. 

Here’s a brief explanation. If a company has a cost of goods available of $100,000 and it assigns too little of that cost to inventory, then too much of that cost will appear on the income statement as the cost of goods sold. Too much cost on the income statement will mean too little net income.

Another way to view this is through the accounting equation, Assets = Liabilities + Owner’s Equity. If you assign too little of the cost of goods available to Assets, then the amount of Owner’s Equity will be too little—caused by net income being too little.

Learn more about Inventory and Cost of Goods Sold.

AccountingCoach.com also has crossword and word scramble puzzles on inventory and cost of goods sold. 

For financial statements, you are guided by the matching principle. The objective is to match the cost of the asset to the accounting periods in which revenues were earned by using the asset. There are two estimates needed: 1) the number of years that the asset will be used, and 2) the salvage value at the end of the asset’s use. If an asset has a cost of $100,000 and is expected to be used for 10 years and then have no salvage value, most companies will depreciate the asset at the rate of $10,000 per year. This is known as the straight line method of depreciation.

For income tax purposes in the U.S., the Internal Revenue Service has determined the number of years that various assets will be useful and it assumes there will be no salvage value. The IRS also allows company’s to take larger depreciation deductions in the earlier years and smaller deductions in the later years of the assets’ lives. This is known as accelerated depreciation.

As you probably noted from the above information, in any one year the depreciation expense on the financial statements will be different from the depreciation expense on the income tax return. However, over the life of an asset, the total depreciation expense will be the same. Accountants refer to this as a timing difference.

Learn more about Depreciation Expense. You will also find Crossword Puzzles and Word Scramble Puzzles for depreciation on AccountingCoach.com.

Here’s an illustration. A company manufactures products in its 100,000 square foot plant. The company’s depreciation on the plant is $1,000,000 per year. The capacity of the plant is 500,000 units of output and its normal output is 400,000 units per year. When the company is manufacturing between 300,000 and 500,000 units, it needs salaried managers earning $400,000 per year. Below 300,000 units of output, some of the salaried manager positions would be eliminated. Above 500,000 units, the company will need to add plant space and managers.

For this example, the relevant range is between 300,000 units and 500,000 units of output per year. In that range the total of the two fixed costs is $1,400,000 per year. Below 300,000 units, the fixed costs will drop to less than $1,400,000 because some salaries will be eliminated and some of the space might be rented. When the volume exceeds 500,000 units per year, the company will need to add fixed costs because of the additional space and the additional managers.  Perhaps the total fixed costs will be $2,000,000 for output between 500,000 units and 700,000 units.

Product costs cling to the units of products purchased or manufactured. If a unit is unsold, the product costs will be reported as inventory, a current asset on the balance sheet. The product costs for a retailer will be the amount paid to the supplier plus any freight-in. Product costs for a manufacturer will be the direct materials, direct labor, and manufacturing overhead. Product costs will be reported on the income statement as the cost of goods sold expense in the period that the units of product are sold.

Period costs do not cling or attach to the units of product and will not be included in the cost of inventory. For example, the interest incurred by a retailer to finance its operations will be expensed in the period in which the interest occurs. Interest is not deferred by adding it to the cost of the units in inventory. Similarly, selling expenses and general administrative salaries are expensed in the period that the employees earn those salaries, the same period in which the company incurs the salaries expense. The insurance premiums that a company pays for nonmanufacturing protection will be expensed in the period in which the insurance premiums expire.  (Insurance premiums for the factory building will be included in the manufacturing overhead which will be part of the products’ cost.)

The accounting profession prefers the allowance method over the direct write off method because the accounts receivable will be presented on the balance sheet with a reduction called the allowance for doubtful accounts. This means the net amount of the accounts receivable will be lower and closer to the amount that will actually be collected. Bad debt expense is reported at the time that the allowance for doubtful accounts is created and adjusted. Hence, the bad debt expense is reported closer to the time of the credit sale.

It should be noted that the Internal Revenue Service requires the direct write off method. They prefer to see the tax deduction for bad debt expense only when an account receivable is actually written off—as opposed to allowing a deduction for an anticipated potential loss. 

In the case of earnings per share, earnings means a corporation’s net income after income tax expense. However, in another context the word earnings could me