Accounting 101 - Part 4

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Introduction:

Each Tuesday, our new series ‘Accounting Tips Tuesday’, brought to you by Zoho Books, will present articles that fit into one of two categories. First, the theory behind basic, and even not so basic, accounting concepts with practical applications including the old ‘debits and credits’ appropriate to the situation. Second, we will go beyond the practical theory and actually cover fundamental software use in the proper recording of these types of transactions using Zoho Books.

Today's Part 4 in our Accounting 101 mini-series will cover the fundamentals of revenue transactional postings impacting the financial statements. While we will focus on use of Zoho Books, the concepts within this article apply regardless of the accounting software you may be using. 

Highlights from Part 1 - We applied the following scenario to the fundamental accounting equation: "Let’s assume you manufacture ‘dongles’ (don’t ask me what a ‘dongle’ is, I just like the sound of it.) You decide to go into business by opening a checking account with $1000.00 in cash from your personal savings.  You now purchase one dongle-maker at a cost of $1000.00, but you don’t want to use all of your cash, so you pay for half of the dongle-maker, and the maker of the dongle-maker gives you an interest-free loan for the remaining $500.00.  You also spend $250.00 on the materials you need to manufacture your first run of dongles. At the end of the first month you actually have sold $2500.00 worth of dongles and so your bank balance has $2750.00 in it. Since you haven’t made another payment on the dongle-maker at month’s close, your liabilities are $500.00, and your Owner’s Equity is $1000.00. Your total equity also includes the value or your revenue $2500.00, less the expenses (your costs of materials) of $250.00."

And then posted both an ‘old fashioned’ journal entry for the Owner’s Equity portion of the scenario, as well as a Zoho Books entry (both shown below)

Highlights from Part 2 - We learned two different ways to post transactions (like the one below) impacting Balance Sheet accounts like Fixed Assets, Loans (secured against those Fixed Assets) and Cash. We also learned the steps to produce a Balance Sheet in Zoho Books.

Highlights from Part 3 – We learned about Cost-of-Goods Sold-Materials in production, and identified the steps to post an expense from the bank account in Zoho Books to purchase COGS.

We also examined the steps to run a Zoho Books Profit & Loss report.

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Part 4 - What about revenues?

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In today’s Part 4 we are going to look at how revenue transactions associated with our scenario impact the Income portion and bottom line of the Profit & Loss statement for our new Dongle-making business. We actually did pretty well with our new business, the scenario says we "actually have sold $2500.00 worth of dongles" (at the end of our first month of operation.)  As it happens we quickly found a new customer (Dongle Distributors) to buy our dongles, in fact not only did they purchase $2500 worth of dongles, but they intend to buy another $2500 worth of dongles each month we can meet their demand.

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Invoicing Revenues

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We sold 500 dongles at $5.00 each, so our total revenues were $2500.00, and we can see the invoice we created in Zoho Books below, but before we look too far into the 'software' side of the equation let us not forget the fundamental accounting behind creating an invoice.

An invoice records an ‘accrual accounting entry’ to an account called “Accounts Receivable.”  This Balance Sheet ‘Asset’ account records legally enforceable claims for payment held by a business against its customers for goods supplied and/or services rendered.  When we create an invoice we post a ‘debit’ to Accounts Receivable, and a ‘credit’ to some Income account on our Profit & Loss.  Our old fashioned journal entry reflecting the posting of the Invoice would look like this:

In a bit, when we get around to posting the payment, we will see how this accrual entry will get off-set.  But right now let's look at our beautiful 'first invoice' for dongles.

Here are the steps to creating a New Invoice in Zoho Books:

1) Navigate to the Sales tab and click on the + icon either next to the Invoices or the icon placed on top of the invoice list to create a new invoice.

A new invoice creation form (like the one above) will open up for entering the details for creating a new invoice.

2) Pick your customers from the list you have already created or you can add a new customer by selecting the New Customer option.

The invoice number is an unique Id which generates by default. If you wish to enter an order number as a reference to this invoice, it can be added.

3) The Invoice Date will default to the current date, but you can change it if you need to.

4) You can set the Due Date of the invoice by selecting one of the options in the terms drop down.

5) In the Item Detail section of the New Invoice form (shown below), select an Item from the list of items shown in the drop down.

6) Enter the number of items to be billed on the invoice within the Quantity field.

7) Verify, or enter, the sales price for each unit quantity under the Rate field.

Note: Discounts can be applied to the invoice either at the item level or at the invoice level.

8) Apply the Tax Rate to the item (if applicable). You can also choose the Non-Taxable option from the Tax drop-down.

9) Other charges such as Shipping or Invoice adjustments, maybe posted.

10) Select the payment option(s) that should be used for charging the customer, or for the customer to make payment for the invoice.

11) Now click on Save as Draft to create the new invoice and save it in draft state for further review before sending it to the customer, or

12) Click on Save and Send to send (based on customer settings) the created invoice directly to the customer.

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Receiving Payments

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But sending an Invoice to our customer is only half of the revenue process, we need to collect payments as well. If you remember we entered an 'accrual' accounts receivable that posted our invoice and the income we received, so you maybe asking yourself "how do I post a payment and not duplicate income?" When we post the payment we are essentially reversing the Accounts Receivable (A/R) side of the equation via use of a 'credit' to A/R, and we will off-set that to 'cash' (via a debit) by depositing it into our Bank account. So here is the journal entry, the old-fashioned way:

In effect we cleared-out the A/R balance from the Invoice and posted the same $2500 to our Bank Account. In order to accomplish this we simply had to record our customer's payment for the invoice, so here it is, our scenario customer's payment, a check for $2500.00 paid at the time they picked up their merchandise.

Because our customer paid in person (instead of using any of the online methods) at the time they picked-up their merchandise, we recorded a payment for their invoice manually in Zoho Books. In order to do this we:

1) Opened the customers invoice against which we intended to record the payment.

2) We then clicked on the Record Payment button.

3) We proceeded to fill in the required details: Amount Received, Payment Date, Deposit to (account).

4) We option to post the payment method, the customers check # as the reference, and to also post a note that this payment paid Invoice # 1 at the time of pick-up of their merchandise.

5) We then clicked the Record Payment button to save the record.

So here is our End-of-Month (May, 2016) Profit & Loss Report for our New Dongle Business.

And our End-of-the-month Balance Sheet for May 2016 is perfectly in line with the conclusion of our 'scenario', "at month’s close, your liabilities are $500.00, and your Owner’s Equity is $1000.00. Your total equity also includes the value or your revenue $2500.00, less the expenses (your costs of materials) of $250.00." [Current Year Earnings = $2250.00.]

Can you believe it, we have posted our entire first month, and we are perfectly in balance?  Of course, I always knew we would be, because we followed 'Accounting 101.'