Friday, February 1, 2008

A New Month

A lot of business scramble at the end of a month or the beginning of the next one to "close the books". What exactly does that mean? In accounting, before computers, the records of a business were literally kept in books called ledgers. The ledgers related to income and expense have to be closed each period, which means they have to be brought to a zero balance. Entries to close income look like this:

---------------------------------Debit ----------------Credit
Income -------------------------[balance in income]
--------Retained earnings ----------------------------[same amount]

The reason the amount is the same on both sides is that accounting entries always have to balance. The retained earnings account is a long term measure of the earnings of a business that have not been distributed to owners.

The entries to close expense accounts look reversed:

Retained earnings-------------- [balance in expense]
------------------Expense -----------------------------[same amount]

The reason the entry is reversed is because expenses reduce retained earnings (which have a "credit" balance. All accounting is done with debits and credits, and no, that does not refer to debit cards or credit cards. Here's a lesson in what those two words actually mean: debit means "left" and credit means "right" and they refer to the left and right of the ledger. The reason for credit and debit cards being called what they are is how they are accounted for at a bank - a credit card increases a debt, which is a liability account; liability accounts have "credit" or right side balances. A debit card comes directly out of an cash account, which is an asset; assets have "debit" or left side balances.

The beginning of a new month seemed like a good time to explain those terms. Thankfully, I don't have to close the books, because my Quickbooks software does all of that work for me. I just have to handle a payroll this morning, which is also made much easier thanks to software.

-- Robert


Julie Pippert said...

In my business I have to account not only to the state for taxes, to myself and so forth, but also to my authors and illustrators. I pay royalties, and must give them a full and open accounting of accounts along with their royalty check.

We got invited to test out new accounting and tax software. They'll even pay a little bit.

Robert said...

I definitely was simplifying how closing the books works. The reason it is so time consuming - if you still have to do it - is because there are so many accounts to close.

In my opinion, if you are using good software, accounting to various agencies becomes far simpler. My business pays well over a hundred vendors a year, but it's fast and easy in each case thanks to Quickbooks. I preach the glory of Quickbooks to any business or business person. If you have a small business (and now they market to medium size businesses from Intuit direct sales with some nice packages) there is just no better software package, whether or not you know any accounting.

The creator of Quicken (the precursor of Quickbooks) wrote it for his wife because she kept complaining she could never balance her checkbook. Several billion dollars later, it's the best personal accounting software I've ever seen. Quickbooks is more robust and perhaps slightly more confusing because of it, but it is powerful and user-friendly. No, I don't own Intuit stock or get royalties from sales of Quickbooks.