Please Note: This article is part of a series of articles titled Accounting and Bookkeeping Principles for Contractors
Written by James R. Leichter
Accounting Journals and Ledgers
In a manual accounting system, the debits and credits for each transaction are first entered in a book called a journal. The journal record for each transaction is called a journal entry or entry. Later in the accounting process, the journal entries are copied, or posted, to another book called the ledger. A journal lists the transactions in the order in which they occur, while the ledger contains a page for each account. In a manual system, the journal tells the bookkeeper which accounts are to be debited and which accounts are to be credited and by what amounts. The bookkeeper carries out these instructions by posting journal entries to the ledger.
Fortunately, computerized accounting is more convenience, accurate, and efficient than a manual accounting system. Good accounting software, such as Aptora’s Total Office Manager, does the posting and processing for you. In the electronic journal, merely decide which accounts to debit or credit and for how much. For an example of the types of accounts listed in an accounting software program, see Sample Chart of Accounts on page 26.
Cash Disbursements Journal
When you write a check, the cash payment is recorded in a Cash Disbursements Journal, Cash is credited, and one of three types of accounts is debited:
- A liability account
- An asset account
- An expense account
Debits to liability accounts are straightforward. If the check pays off a bank loan or installment loan, for example, then the Notes Payable liability account is debited for the amount. Entries to asset and expense accounts, however, can be more complex because the distinction between assets and expenses may not be clear.
Distinction Between Assets and Expenses
In a Cash Disbursements Journal, assets and expenses can be distinguished from one another as follows:
- If the cash disbursement buys something that benefits the business during future periods, then the debit part of the entry is to an asset account that appears on the Balance Sheet as of the end of the period. Land, buildings, furniture, equipment, automobiles, inventory, prepaid rent, prepaid insurance, and other items that are paid for in advance of the period in which they provide benefits are considered assets.
- If the cash disbursement purchased items that were used up within the purchase period, then the debit part of the entry is to an expense account. Salaries and wages, telephone, electricity, and other services used in the current period are expenses.
The debit rules for assets and expenses are not always followed in a Cash Disbursements Journal. Some items that should be recorded as assets are debited to expense accounts. If they had been debited to an asset account, additional bookkeeping would be required later to debit the item to an expense account during the period(s) in which it is used up. According to the accrual principle on page 14, for example, paper is an asset that must be debited to an asset account when the paper is purchased and then debited to an expense account in each month the paper is used. This extra work can be avoided if the cost of the paper is debited to an expense account when it is purchased. Furthermore, if the amount of supplies purchased monthly tends to be consistent, then the effect of debiting an expense account immediately is about the same as the alternative of first debiting an asset account and later transferring the asset to an expense.
Supplies, small tools, and similar items are usually debited to expense accounts when they are purchased. Property taxes and insurance payments may also be debited to an expense account in the period that they are charged or purchased. Whether or not the business abides by the accrual principle or uses the bookkeeping shortcut is up the individual doing the accounting.
The materiality principle states that a business can depart from the accrual principle if the effect of doing so does not mislead the user of accounting information (referred to as not material). In most cases, it is more practical to utilize a shortcut that provides a good approximation of business information while reducing bookkeeping. The only exception is the application of the materiality principle to chunky disbursements.
Chunky disbursements are expenses that occur at infrequent intervals. If insurance premiums or property tax payments, for example, are recorded as expenses in the month of their payment, then the income reported for that period will be artificially low and the income in the other months will be artificially high.
The materiality principle applies particularly well to asset acquisition costs, employee costs, and accounts payable items.
Asset Acquisition Costs
If the debit part of a credit to Cash is applied to an asset account, then the amount of the asset should be the sum of all the costs incurred in making the asset ready for its intended use. For example: The cost of goods purchased for inventory should include the invoiced cost of the goods plus freight and handling costs; the cost of a building should include the costs of constructing or purchasing the building, including demolition of an existing building on the site, legal and appraisal fees, permit and inspection fees, and interest on any funds tied up during the construction period (interest stops being added to the cost when the building is ready for use); and the cost of equipment should include the cost of installation.
By applying the materiality principle to inventoried goods, however, you can treat the freight, postage, or other costs of handling the goods as expenses as long as the amount reported is accurate.
The cost of each period of work performed by an employee should include the earned salary, any fringe benefits, and the business’ portion of FICA taxes (social security taxes). To remove the need for the tedious tracking of each of these amounts, all employee costs can be lumped together in accordance with the materiality principle into a separate expense account called Employee Benefits.
An employee’s actual cost is typically about 25 percent above the cost of their salary. Since part of their salary is withheld as an advance payment on their income taxes, they do not receive cash equal to the amount they earn. Employers are responsible for remitting income tax to the Internal Revenue Service and for deducting the employees’ contribution to social security and any health plans, union dues, and pensions. The expense to the business is what an employee earns, not what they are paid.
When an employee is not paid for work performed during a month, there is an accrued liability at the end of the month that requires time-consuming calculations. By utilizing the materiality principle, the amount earned by employees in the pay periods in which cash disbursements were made can be recorded as an expense.
Accounts Payable Items
Accounts payable is money that a business owes other people—usually vendors and suppliers. According to the accrual principle, assets are recorded when they are acquired and expenses are recorded when they are incurred even if payment is not made until a later date. In accordance with the materiality principle, the accrual principle for accounts payable items may be disregarded if the effect on income is not material.
Telephone bills and other utility bills, for example, are not received until after the end of the month to which they apply. Since the amount of the bills tends to be approximately the same from one month to the next, the amount of the bills can be debited to an expense account in the month the bill is received and paid. The same shortcut can be applied to supplies, similar assets, and expenses for repairs or maintenance.
A cash receipt, also known as cash on delivery or COD, is a transaction in which the customer pays cash upon delivery of goods or services. Cash can take the form of a check, a credit card, or something else of value. Cash receipts from sales (Cash debits and Sales Revenue credits) are recorded in the Cash Sales Journal and other cash receipts (Cash debits and other account credits), such as a receipt for a customer’s payment to their accounts receivable account, are recorded in the Cash Receipts Journal.
Most businesses must collect sales tax from customers on labor sales, material sales, or both. Where a business resides, where it sells, what it sells, and how it sells determines its sales tax rate and how the tax is collected. Sales tax is not revenue: The business acts as a collection agent for the government, crediting a Sales Taxes Payable account with collected tax and equally debiting a Cash or Accounts Receivable account. Since equity is unaffected by sales tax transactions, there is no revenue.
Some businesses seek to save time by including sales tax in sales revenue. This shortcut is acceptable as long as the sales tax liability is recorded and remitted to the government.
Accounts Payable Journal
An Accounts Payable (AP) Journal tracks the amounts and due dates of vendor bills. Accounting software, such as Aptora’s Total Office Manager™, provides an Accounts Payable module that permits the easy entry of AP information. Credits entered into the electronic AP Journal are automatically debited to the appropriate asset or expense account that corresponds to the vendor’s invoice.
Smaller businesses that do not have a large number of outstanding invoices may decide to file invoices by due date instead of recording them as an entry in the AP Journal. When the invoice is paid, an entry is made in the Cash Disbursements Journal. If the invoices are not paid until the following month, the amount owed at the end of the current month is found by totaling the unpaid invoices. This amount is credited to Accounts Payable and debited to the proper asset and expense accounts. This process, called an adjusting entry, is described on page 22.
If the invoice amounts are small, then it is sufficient to hold the invoices until they are paid instead of entering an AP amount. If the invoice amounts are large, however, omitting the AP amount will result in an inaccurate record of the business’ financial status.
Accounts Receivable Journal
An Accounts Receivable (AR) Journal tracks the amounts and due dates of money owed to a business for previously delivered goods and/or rendered services. Total Office Manager and other accounting programs provide an Accounts Receivable module that permits the easy entry of AR data, maintains and updates customer records, and reports customer information such as year-to-date purchases, credit terms and limits, current and past due bills, and more. The electronic AR module can be used to prepare customer statements and dunning notices. It also calculates and adds any finance charges and prints several different customer information summary reports.
When sales are made on credit, AR is debited and Sales Revenue and Sales Tax Liability (if applicable) are credited. Upon receiving payment from a credit customer, Cash is debited and AR is credited. If the customer paid a finance charge, then Finance Charge Revenue is credited.
Please read Accounting Journal Entries next.