A Few Important Details
There are a few more details of the wires and gears behind the scenes that we should mention before we close the chapter.
Compound Entries and Split Accounts
Sometimes, we write one check for several items. This requires a more complex entry: our accounts still balance, but they are spread out over several transactions, not just two.
We’ll illustrate this with a general journal entry for a check that was written to an office supply store. Let’s say we bought a printer, ink cartridges, and supplies for the annual Christmas party.
The PR column stands for posting reference. We use a checkmark in the PR column to indicate that the item has been entered on the separate accounting page in our ledger for that particular account and that it has been checked.
This simple example illustrates the advantages of an accounting system over trying to run a business on a checkbook. Imagine seeing a check for $600 for office supplies six months later and wondering, “What in the world did I spend all that money on?” You start digging. With your accountant’s help (at $50/hour) you find the receipt. You discover what you paid
for. Your accountant says, “Gee, I wish I’d seen this before we did your taxes. We treated it all as expenses, but the computer printer really is an asset.” And you’re wondering, “What in the world was I thinking, spending $300 on an office party!”
Long experience has led to a standardized chart of accounts for many businesses.
All the accounting software packages come with a built-in chart of accounts, often several.
You may only need to put in the name of your bank for the cash account. Make adjustments as necessary so that your accounting system returns the information you need to make effective decisions. The bookkeeping system is a tool. It should not be your master.
Cash vs. Accrual
As you can see, an accounting system offers a great deal more than a simple checkbook. There are two basic approaches to accounting; you’ll want to choose one for your business. The two approaches are accrual basis and cash basis.
In this chapter, our example used accrual accounting. You can recognize accrual accounting
because you see an asset category called accounts receivable and you see short-term liabilities for bills you need to pay. You can see how valuable accrual accounting is for the internal management of your business. It keeps you from being fooled by a big balance in your checking account when you have lots of bills to pay. It also lets you know when business is starting to pick up, as accounts receivable goes up even before the money comes in, and it helps you with collections. In addition, accrual accounting gives you a special report of accounts receivable called the aging report that shows you who owes you money— and how late they are in paying it.
At this point you may feel a bit like you’ve been “rode hard and put up wet,” as we say in South Texas. I just wanted to get past the fear factor as quickly as possible. We’ll look at these concepts further as we navigate through the other general concepts of accounting, financial and management accounting, taxes, accounting systems, financial ratio analysis, and auditing. But that should not be difficult, since you now understand the basics. Believe me, you’ve got it licked. It’s all downhill from here.