QuickBooks 2011: The Missing Manual

Accounting Basics—The Important Stuff

Intuit claims that you don’t need to understand most accounting concepts to use QuickBooks. However, you’ll be more productive and have more accurate books if you understand the following concepts and terms:

• Double-entry accounting is the standard method for tracking where your money comes from and where it goes. Following the old saw that money doesn’t grow on trees, money always comes from somewhere when you use double-entry accounting. For example, as shown in Table 1, when you sell something to a customer, the money on your invoice comes in as income and goes into your Accounts Receivable account. Then, when you deposit the payment, the money comes out of the Accounts Receivable account and goes into your checking account. (See Chapter 16 for more about double-entry accounting and journal entries.)

  Note

  Each side of a double-entry transaction has a name: debit or credit. As you can see in Table 1, when you sell products or services, you credit your income account (since you increase your income when you sell something), but debit the Accounts Receivable account (because selling something also increases how much customers owe you). You’ll see examples throughout the book of how transactions translate to account debits and credits.

  Table 1. Following the money through accounts

  Transaction	Account	Debit	Credit
  Sell products or services	Service Income		$1,000
  Sell products or services	Accounts Receivable	$1,000
  Receive payment	Accounts Receivable		$1,000
  Receive payment	Checking Account	$1,000
  Pay for expense	Checking Account		$500
  Pay for expense	Office Supplies	$500

• Chart of Accounts. In bookkeeping, an account is a place to store money, just like your checking account is a place to store your ready cash. The difference is that you need an account for each kind of income, expense, asset, and liability you have. (See Chapter 3 to learn about all the different types of accounts you might use.) The chart of accounts is simply a list of all the accounts you use to keep track of money in your company.

• Cash vs. Accrual Accounting. Cash and accrual are the two different ways companies can document how much they make and spend. Cash accounting is the choice of many small companies because it’s easy: You don’t show income until you’ve received a payment (regardless of when that happens), and you don’t show expenses until you’ve paid your bills.

  The accrual method, on the other hand, follows something known as the matching principle, which matches revenue with the corresponding expenses. This approach keeps income and expenses linked to the period in which they happened, no matter when cash comes in or goes out. The advantage of this accrual method is that it provides a better picture of profitability because income and its corresponding expenses appear in the same period. With accrual accounting, you recognize income as soon as you record an invoice, even if you’ll receive payment during the next fiscal year. For example, if you pay employees in January for work they did in December, those wages are part of the previous fiscal year.

• Financial Reports. You need three reports to evaluate the health of your company (described in detail in Chapter 17):

  • The income statement, which QuickBooks calls a Profit & Loss report, shows how much income you’ve brought in and how much you’ve spent over a period of time. This QuickBooks report gets its name from the difference between the income and expenses, which results in your profit (or loss) for that period.

  • The balance sheet is a snapshot of how much you own and how much you owe. Assets are things you own that have value, such as buildings, equipment, and brand names. Liabilities consist of the money you owe to others (like money you borrowed to buy one of your assets, say). The difference between your assets and liabilities is the equity in the company—like the equity you have in your house when the house is worth more than you owe on the mortgage.

  • The Statement of Cash Flows tells you how much hard cash you have. You might think that the Profit & Loss report would tell you that, but noncash transactions—such as depreciation—prevent it from doing so. The statement of cash flows removes all noncash transactions and shows the money generated or spent operating the company, investing in the company, or financing.