TIME TO DIG IN!

The next step, after entering your bank account transactions, is to output some basic reports, to see the effect of your entries.

If you are working in excel, the closest thing you will get to a report is a pivot table. However, you will need to have a structure in mind to guide your creation of the pivot table. If you are not familiar with the concepts behind basic financial reports and how they are supposed to be presented, I recommend that you do not use excel. Instead, use a bookkeeping software that creates the structure for the basic recommended reports.

Here are the two most basic financial reports:

• The Profit and Loss. This report may be referred to using various names. For our purposes, consider the following to be synonyms: “Profit and Loss Statement,” “Income statement,” “Statement of Revenues and Expenses,” “Statement of Operations.”
• The Balance Sheet. Again, known by various names, any of which are sufficient for our purposes: “Balance Sheet,” “Statement of Financial Position,” “Statement of Assets, Liabilities and Net Assets.”

The Profit and Loss is the report that is most familiar to people.

However, an accountant will usually spend their initial time looking at and fixing the Balance Sheet, not the Profit and Loss. The reason for this is that the Balance Sheet is a major way to proof the Profit and Loss.

The Balance Sheet has, as one of its components, the net income.  If your software program allows you to drill in on the line item “Net Income” on the balance sheet, you are in essence creating the Profit & Loss report.

Because a Balance Sheet has to, well, balance, a change in the balance of any one account (a bank balance, a loan balance, or owner’s equity) will affect the balances of the remaining accounts.

The Balance Sheet represents “The Basic Accounting Formula.”

Assets = Liabilities + Equity

Sometimes a Balance Sheet is presented in a side by side manner, to emulate the formula, and to emphasize that debits (which represent increases to asset accounts) are on the left and that credits (which represent increases to liability or equity accounts) are on the right.

(left side) Assets = (right side) Liabilities + Equity:

Note in the example Balance Sheet given above, that there is a negative number in one of the accounts (Current Liabilities). This is where an accountant usually frowns.

A negative number is contrary to what is expected. Sure, it is possible for a liability to be negative (for example, by overpaying a credit card), however, it is more likely that the balance is just plain wrong (why would anyone deliberately overpay a credit card?).

It is for this reason that an accountant usually asks the client for their year-end bank statements, loan statements, credit card statements, year-end inventory count, list of equipment on hand, etc. The accountant then looks at these items and compares them with the Balance Sheet.

Does the credit card company really agree that they owe you a refund for the overpayment? Or did you just forget to record some of your credit card purchases? Drilling in on the line item may uncover something like this:

Which shows that no credit card charges were entered after October 26, 2017. Were there really no credit card purchases after that date? Very unlikely, considering that a payment dated December 3^rd indicates there was probably a running balance of at least $4,513.04 in mid-November. More likely the bookkeeper went on holiday and didn’t enter the remaining credit card charges.

Once the bookkeeper does enter the remaining credit card charges for the year, the net income of the company will be affected by the additional expenses.

So the point here is to look at the Balance Sheet. If the Balance Sheet jives with what really is in the bank (factoring in checks and deposits in transit), what inventory and equipment really exists, what really is owed on credit cards and other loans, then it is fine to look at the Profit and Loss. On the other hand, if there are glaring negatives or out-of-the-ballpark figures on the Balance Sheet, then why even look at the Profit and Loss?

Now, this is not an attempt to teach you accounting. It is simply an attempt to get a handle on whether your entries are complete and reasonably accurate. Too often people get caught up in the details and don’t know the consequences of their details. Looking at basic reports and seeing if they reflect reality is the best way to learn whether you have been entering the details correctly.

Using this concept, the concept of looking at reports to see if your entries are correct, you can begin to organically learn accounting concepts. My first bookkeeping software in the late 1990’s was Peachtree, which had a button next to every entry that displayed the transaction in a text window showing what increased on the debit side and what increased on the credit side. It was like a mini report for any transaction that I entered. I had never been formally introduced to the concept of what a debit was and what a credit was, but this was a way to experiment and learn. See if your software has this feature (in QuickBooks there is something similar: if you are in a transaction you can go to the reports menu (or in some of the newer versions of QuickBooks there is a button in the reports tab in the transaction itself):

This should show you the debit and credit for the particular transaction:

If you notice, the Amex account is increasing on the right, since Amex is a liability. The insurance expense is increasing on the left, since an expense is an asset.

Of course, if you have any sense at all, you are not going to accept that an expense is an asset. Wrestle with it a little bit. Come up with arguments for and against it being an asset.

Isn’t insurance like an emergency fund, in a way? It sure is good to have when you need it. Supposedly, all expenses, assuming your goal is to make a profit, all expenses can be thought of as the subproducts and services that go into building and selling your own products to make income.

And when you convince yourself of that, then turn it around and think of examples that don’t fit. My favorite example was from the lecture I was listening to for my CPA Review. The instructor was trying to explain governmental accounting. A government decides to spend money on weapons. Is buying weapons going to bring in more revenue? “Not unless it points those weapons on the taxpayers to force them to pay their taxes.” Similarly, is spending on the elderly and disabled going to bring in more revenue? Are we creating assets with such expenditures? Or are we asking the wrong question. A government is not supposed to be a business, making profit for itself to the detriment of the people for which it is supposed to serve.

Which is why the ultimate definition of a debit and a credit is simply “debits are on the left, credits are on the right.” If assets happen to be on the left, then so be it. And if expenditures happen to be on the left along with assets, then it may or may not mean anything profound. Approach it like a scientist, see the results, experiment. When there is a concept that seems to be hard to accept, try to think about it in various ways.

Another example of a concept that throws newcomers off is that a bank account increases with debits. Pretty much all of us have received  a statement or message from the bank that our bank account has been “credited” with a deposit to it, and has been “debited” by a withdrawal from it. However, in the bookkeeping software, when you look at a deposit to the bank, your own software shows it as a debit, not a credit. And vice versa for a withdrawal.

Look:

See how, in the image above, the bookkeeping software indicates Deposits=Debits and Withdrawals=Credits.

Next to it is the bank website which indicates Deposits=Credits and Withdrawals=Debits.

The reason the bank treats your deposits and withdrawals in a backwards fashion is that the money is not their money. It is your money. So when you deposit money into the bank, their liability to you goes up (credit).

Now take the case where the bank loans you money, say, in a credit card.

Their statement will say that the payments are credits and the purchases are debits:

The bank, loaning you money, treats their loan to you as their asset (and assets increase with debits).

If you are anything like me, when I loan money to someone I definitely do not consider it an asset. I consider it a foolish waste of my hard-earned money, knowing that I will never see it again. It may take a while to see why anyone would think of a loan receivable as an asset.

To a bank, they still own the rights to that money and they feel relatively confident that most of their loans will get repaid.

Again, your gut instincts may be fine. How can it be an asset if you know you will never see that money again (when your whining relative guilts you into lending them money, trust me, you will never see it again. It is not an asset). This is what happened in the 2008 recession. All the banks had all these “assets” (after all, when they recorded the transaction and lent the money, their bookkeepers had to debit an asset called “mortgage receivable” to record the loan). By now we know what types of loans these were. They were kiss-your-money good-bye loans that the bank would never see come back. The financial collapse was magnified because the banks kept trying to present these loans as assets.

But I digress. The point is that the banks give you pages out of their company financials. They show you their own statements, where their loans to you are their assets, and your bank accounts with them are their liabilities. You have lent them money when you deposit money into the bank, so it is your asset increasing (as a debit in your own bookkeeping software) and is the bank’s liability increasing (as a credit in the bank’s bookkeeping software).

Just remember. Debits on the left. Credits on the right. And that right and left are relative depending on which direction you are facing.

Approach all bookkeeping software the same way, no matter the year, make and model of bookkeeping software you have (QuickBooks, Quicken, Accountedge, Peachtree, Microsoft Money, excel templates, etc).

Figure out how to open the right file.

The software is a program that allows you to view and edit a file. The software may be stored in one location (e.g. Program Files) while the file it is opening may be stored in a different location (e.g. My Documents).

The software is a program that theoretically allows you to open an infinite number of files, as long as those files are readable by the program.

For example, Microsoft excel is a program that allows you to open, view and edit excel files. Microsoft excel is also capable of viewing and editing plain text files and some other types of files.

The reason I mention this is because sometimes people get the program itself confused with the file the program is opening.

By convention, no matter what type of program you have, there is a File menu. If you click on the File menu, you will be able to either:

Create a new file

Or

Open an existing file

These choices may be presented in various ways, but the gist is the same:

If you create a new file, be sure to note where it is saved, so that you can open that file again later:

If you have many versions of the file (the file, not the program) saved on your computer or among your team you are liable to get into trouble. This happens when a file gets sent back and forth between people, or when someone sends themselves a copy of the file to work on a different computer or saves copies of a file for other reasons. Often what ends up happening is that nobody knows which is the working file and which file is the rough draft. My solution is to one have only ONE bookkeeping file on your computer. Trash all draft files except the working file. If it turns out that you trashed the wrong file, you can hopefully retrieve it from the trash.

Ok, enough already, by now you have performed the first step: opening the right file.

Once you are in the right file, figure out how to view the check register.

The learning curve in using any bookkeeping software is two-fold:

Understanding where the software hides its menu items

Understanding accounting principles

The reason to go straight for the check register is because this will put learning curve item #2 on hold (a check register is the most instinctively understood thing about accounting, so there are no real principles to learn), leaving only learning curve item #1 to tackle.

A check register looks like some variation on this:

An excel check register may look like this:

The point is, you will know it when you see it. When you are creating a new file for the first time, there will be no check register, or, if the software creates a skeletal structure, there will be an empty register:

In order to find where the program hides the check register, or how to create a bank account register, you have to google the instructions, or browse the help files. Each program is different, and each year companies that sell these software programs “improve” them by changing where the menu items are hidden. So it is up to you to poke around until you find how to create or open a check register. If you are using excel as your bookkeeping software and you don’t know how to create a check register, google the instructions. Somebody is bound to post instructions on any question you have.

Ok, once you have figured out how to get a check register in front of you, you now need to enter your first transaction into the register.

If you are taking over the bookkeeping file from a prior bookkeeper, then there already should be a bunch of transactions entered, and you just continue where the prior bookkeeper left off. This is the easiest scenario, since you can always use the prior bookkeeper’s style of entry as a model to figure out the gist of how to continue entering items.

If you are creating a company file from scratch, and creating a check register from scratch, and the bank account has newly been hatched at the bank, with a beginning balance of zero, then the first transaction will be the deposit into the bank that caused the bank account to be opened. The explanation of this amount could be any one of the following: from “income,” from “bank account xyz,” from “owner’s investment,” or from “loan.” If it is a loan, it is good to be clear whom the loan is from, so as to know whom to pay back (“loan from mafia” versus “loan from parents.”)

If you are creating a company file from scratch, and if you are entering a checking account that you have had for years, the beginning balance will be the balance on the last day of the prior year. You enter this amount as a deposit, and the explanation of this amount can be “opening balance.”

By now, you will have had all sorts of pop-up messages from the software, asking you to add names and accounts to its names list and accounts list. Humor the software by saying yes to add the names, but do not feel the need to fill out all the details about each name or account. Keep everything as minimal as possible. Do not worry about the effect of choosing the wrong name type or the wrong account type. Mistakes will be inevitable, your goal at this time is to just enter one transaction as best you can.

As an aside, if you really insist on a rule of thumb for a name type, choose “vendor.” And if you insist on a rule of thumb for an account type, choose “expense.” These are the safest choices to make when in doubt. Later, when you understand more about the program, you can at least find where you have created your objects and fish them out and correct them from there.

Ok, once you have figured out how to enter the first transaction, you now need to enter all the remaining transactions.

Watch the running balance in the register, to see if it is reasonably within range of the bank balance that shows up on the bank statement. If the balance drifts away from what the bank shows on the statement, then evaluate why it is at such variance. You may want to copy the bank statement line by line, to get a feel for the software’s ability to mimic the running balance exactly as the bank presents it to be.

As you get more sophisticated with the check register entry, you will find it much more useful to enter checks dated the day you actually write the check, rather than the date the check clears the bank. Realize that this will cause your running balance to differ temporarily with the bank’s running balance during the days that the checks are outstanding, but that the balance will eventually agree after the bank clears all the outstanding checks.

Do not do so much that you get allergic to bookkeeping. Now is a good time to take a break.