Accounting & Bookkeeping

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# Accounting & Bookkeeping Knowledge Pack

## Double-Entry Bookkeeping

### The Fundamental Equation
Assets = Liabilities + OE. Every transaction must maintain this equation. Double-entry means every transaction affects at least two accts: one DR and one CR. DRs must always equal CRs.

### DR and CR Rules
- **Assets**: DR increases, CR decreases. Normal balance: DR
- **Liabilities**: CR increases, DR decreases. Normal balance: CR
- **OE/Revenue**: CR increases, DR decreases. Normal balance: CR
- **Expenses**: DR increases, CR decreases. Normal balance: DR
- **Dividends/Draws**: DR increases, CR decreases. Normal balance: DR

Memory aid: DEALER — Dividends, Expenses, Assets are DR-normal. Liabilities, Equity, Revenue are CR-normal.

### Common JEs

**Purchase inventory on credit:**
DR Inventory (asset up) $5,000
CR AP (liability up) $5,000

**Record a sale:**
DR AR (asset up) $3,000
CR Sales Revenue (revenue up) $3,000
DR COGS (expense up) $1,800
CR Inventory (asset down) $1,800

**Receive payment from customer:**
DR Cash (asset up) $3,000
CR AR (asset down) $3,000

**Pay supplier:**
DR AP (liability down) $5,000
CR Cash (asset down) $5,000

**Record dep:**
DR Dep Expense $500
CR Accumulated Dep $500
(Accumulated dep is a contra-asset — CR normal balance, reduces asset value on BS)

**Payroll entry:**
DR Salary Expense $10,000
CR Federal Tax Payable $1,500
CR State Tax Payable $500
CR FICA Payable $765
CR Cash (net pay) $7,235

### COA Structure
Organized by acct type with numbering system:
- 1000-1999: Assets (1000 Cash, 1100 AR, 1200 Inventory, 1500 PP&E)
- 2000-2999: Liabilities (2000 AP, 2100 Accrued Liabilities, 2500 Long-term Debt)
- 3000-3999: Equity (3000 Common Stock, 3100 RE)
- 4000-4999: Revenue (4000 Sales Revenue, 4100 Service Revenue)
- 5000-5999: COGS
- 6000-6999: Operating Expenses (6100 Rent, 6200 Utilities, 6300 Salaries)
- 7000-7999: Other Income/Expense (7000 Interest Income, 7100 Interest Expense)

## Financial Statements

### IS (Profit & Loss)
Reports financial perf over a period (month, QTR, FY).

Structure:
- Revenue (Net Sales)
- Less: COGS
- = GP (gross margin = GP / Revenue)
- Less: Operating Expenses (SG&A: salaries, rent, utilities, marketing, dep)
- = Operating Income (EBIT)
- Less: Interest Expense
- +/- Other Income/Expense
- = Income Before Tax
- Less: Income Tax Expense
- = NI (bottom line)

Key ratios: Gross margin (GP/Revenue), Operating margin (EBIT/Revenue), Net margin (NI/Revenue). Compare to industry benchmarks and prior periods.

### BS (Statement of Financial Position)
Reports financial position at a specific point in time (snapshot).

Structure:
**Assets (what you own):**
- Current Assets (convertible to cash within 1 year): Cash, AR, Inventory, Prepaid Expenses
- Non-Current Assets: PP&E (less accumulated dep), Intangible Assets (less accumulated amort), Long-term Investments
- Total Assets

**Liabilities (what you owe):**
- Current Liabilities (due within 1 year): AP, Accrued Expenses, Current Portion of Long-term Debt, Unearned Revenue
- Non-Current Liabilities: Long-term Debt, Deferred Tax Liabilities
- Total Liabilities

**OE (residual interest):**
- Common Stock (par value + additional paid-in capital)
- RE (cumulative NI minus cumulative dividends)
- Total OE
- Total Liabilities + OE = Total Assets

Key ratios: Current ratio (Current Assets / Current Liabilities; healthy > 1.5), Quick ratio ((Current Assets - Inventory) / Current Liabilities), Debt-to-equity (Total Liabilities / Total OE).

### CF Statement
Reports cash inflows and outflows over a period. Three sections:

1. **Operating Activities** (indirect method, most common):
   Start with NI, then adj for non-cash items (add back dep/amort), then adj for changes in working capital (increase in AR = cash decrease, increase in AP = cash increase, increase in inventory = cash decrease)

2. **Investing Activities**: Purchase/sale of PP&E, purchase/sale of investments, loans to others

3. **Financing Activities**: Proceeds from debt, repayment of debt, issuance of stock, dividends paid, stock buybacks

Net change in cash = Operating + Investing + Financing. This must reconcile to the change in cash on the BS.

**CRITICAL**: A profitable company can go bankrupt with poor cash flow. NI includes non-cash items (dep, accruals). Always monitor CF from operations — negative operating CF is a red flag even with positive NI.

## Tax Basics

### Business Entity Tax Treatment
- **Sole proprietorship**: Schedule C on personal return. Self-employment tax (15.3% on first $168,600 for 2024, 2.9% thereafter)
- **Partnership/LLC (multi-member)**: Form 1065, K-1 to each partner. Pass-through — income taxed on partners' individual returns
- **S-Corp**: Form 1120-S, K-1 to shareholders. Pass-through but allows reasonable salary + distributions (distributions avoid self-employment tax — major advantage). Must pay reasonable comp to avoid IRS scrutiny
- **C-Corp**: Form 1120. Corporate tax rate 21% (flat, federal). Distributions to shareholders taxed again as dividends (double taxation). Retained earnings avoid double taxation until distributed

### Key Tax Deadlines
- March 15: S-Corp and Partnership returns (or extension)
- April 15: Individual and C-Corp returns (or extension)
- Extensions give 6 extra months to FILE but NOT to PAY — estimated taxes still due on original deadline
- Quarterly estimated taxes: April 15, June 15, September 15, January 15
- Payroll: Form 941 quarterly, Form 940 (FUTA) annually, W-2s by January 31
- 1099-NEC for contractors ($600+ payments): due January 31

### Common Deductions
- Ordinary and necessary business expenses (Section 162)
- Dep: Section 179 immediate expensing (up to $1.16M for 2024), bonus dep (60% for 2024, phasing down), or MACRS over useful life
- Home office: simplified method ($5/sqft, max 300 sqft) or actual expense method (% of home used)
- Vehicle: standard mileage (67 cents/mile for 2024) or actual expenses. Keep a mileage log
- Meals: 50% deductible if business purpose (100% pre-2026 for restaurant meals expired)
- Health insurance premiums: deductible for self-employed on personal return

## AP and AR Management

### AP Process
1. **Receive invoice**: match to purchase order and receiving report (three-way match). Discrepancies trigger hold for investigation
2. **Code and approve**: assign GL acct codes, route to budget owner for approval. Separation of duties: person approving should not be person paying
3. **Schedule payment**: pay within terms to capture early payment discounts. "2/10 net 30" = 2% discount if paid within 10 days, otherwise full amount due in 30. That 2% discount = ~36% annualized return — almost always take it
4. **Process payment**: check, ACH, wire, or credit card. Record payment JE (DR AP, CR Cash)
5. **Filing**: maintain invoice + payment documentation. Digital preferred for searchability

### AR Process
1. **Invoice generation**: issue promptly after delivery of goods/svcs. Include payment terms, due date, accepted payment methods
2. **Aging tracking**: categorize outstanding AR by age — Current, 1-30 days past due, 31-60, 61-90, 90+. Review weekly
3. **Collections**: systematic follow-up. Friendly reminder at due date, phone call at 15 days past due, formal demand at 30 days, collections agency or legal action at 90+ days
4. **Bad debt**: when collection unlikely, write off. DR Bad Debt Expense, CR AR (direct write-off method) or DR Bad Debt Expense, CR Allowance for Doubtful Accts (allowance method — required under GAAP for material amounts). Estimate allowance using aging method (% of each aging bucket based on historical collection rates)

### Days Sales Outstanding (DSO)
DSO = (AR / Total Credit Sales) x Number of Days. Measures average collection period. Lower is better. Industry benchmarks vary but 30-45 days is typical. Rising DSO signals collection problems.

## Recon Process

### Bank Recon
Perform monthly, within 5 business days of statement date.

Process:
1. Start with bank statement ending balance
2. Add deposits in transit (recorded in books, not yet on bank statement)
3. Subtract outstanding checks (issued but not yet cleared)
4. Adj for bank errors (rare but possible)
5. = Adjusted bank balance
6. Start with book (GL) cash balance
7. Add items on bank statement not in books: interest earned, direct deposits
8. Subtract items on bank statement not in books: bank fees, returned checks (NSF)
9. Adj for book errors (transposition errors, missed entries)
10. = Adjusted book balance
11. Adjusted bank balance MUST equal adjusted book balance
12. Record JEs for all book-side adj items identified in steps 7-9

### Other Recons
- **AR recon**: customer statements vs GL sub-ledger. Investigate discrepancies (unapplied payments, disputed invoices)
- **AP recon**: vendor statements vs GL sub-ledger. Watch for duplicate payments
- **Intercompany recon**: eliminate intercompany balances for consolidated reporting
- **Credit card recon**: match receipts to statement charges monthly. Code to proper GL accts
- **Payroll recon**: quarterly — verify 941 filings match payroll register totals and GL balances

### Month-End Close Process
1. Post all transactions for the period (invoices, payments, JEs)
2. Run bank recon, credit card recon, AR/AP recons
3. Record adj JEs: accruals (expenses incurred but not yet invoiced), deferrals (prepaid expenses recognized), dep
4. Review GL for unusual balances or errors
5. Generate TB — verify DR = CR
6. Prepare financial statements (IS, BS, CF)
7. Variance analysis: compare to budget and prior period. Investigate material variances (>5-10%)
8. Management review and sign-off

Target: close books within 5-10 business days of month end for small business, 3-5 days for larger organizations. Faster close = earlier insight for decision-making.

[DECODE] DR=debit|CR=credit|AP=accounts payable|AR=accounts receivable|GL=general ledger|TB=trial balance|BS=balance sheet|IS=income statement|CF=cash flow statement|RE=retained earnings|COGS=cost of goods sold|GAAP=Generally Accepted Accounting Principles|FY=fiscal year|QTR=quarter|YTD=year to date|JE=journal entry|COA=chart of accounts|NI=net income|GP=gross profit|OE=owner's equity|PP&E=property plant and equipment|dep=depreciation|amort=amortization|acct=account|recon=reconciliation|adj=adjusting