Accounting Corner: Getting Back to Basics

By Efrem Litwin

This is the first of what will become a regular column in the WebFOCUS Newsletter about helping companies alleviate the pain they often endure during their financial reporting and financial analysis processes.

Let’s start at the very beginning. What is financial reporting all about and why is it any different from sales and marketing reporting or manufacturing reporting? Well, financial reporting deals with the production of specific types of reports. Income statements, balance sheets and cash flows are types of reports typically involved in a financial reporting process.

In a sales and marketing report, a developer would lay out the columns to appear on the report. The rows would be printed in the sort order of the report. But in a financial report, the developer would not only lay out the columns but also the specific rows and order of rows that are to appear on the report. The rows reported on within a financial report, such as a balance sheet or income statement, are called general ledger accounts. The columns of the report could be “Time Periods,” “Actual Dollars,” “Planned Dollars,” or “Forecast Dollars.” I will cover planning and forecasting in a future article.

Each of the general ledger accounts has a type associated with it. Revenue, expenses, cost of goods sold, assets, liabilities, and equity are examples of account types. Revenues, cost of goods sold, and expenses would be part of an income statement. Assets, liabilities, and equity would be part of a balance sheet.

Here are some simple formulas to remember:

	Gross margin = revenue ­ cost of goods sold
	Net income before taxes = gross margin ­ expenses
	Assets = liabilities + equity

Most of you should be familiar with the terms debit and credit. But, for those of you not familiar with these terms, here is a brief explanation. When you make a deposit to your checking account, you also make an entry in a register to keep track of the deposits you have made to your bank account and to obtain an estimated account balance.

This entry would be made to the right column of the register just before the account balance column. An entry of this type (right-side entry) is called a credit. When you write a check against your checking account, you also make an entry to that same register to keep track of checks you have written and to obtain an estimated account balance. This entry would be made to the left column of the register. An entry of this type (left-side entry) is called a debit.

The way debits and credits work in relation to your bank statement or your credit card statement is exactly the opposite to the way you would make entries in your own general ledger system. Your bank or credit card statement looks at entries from the perspective of the bank’s accounting system. When making entries for your own company, you are looking at things from a perspective of your company’s accounting system.

Let’s take a look at some examples of general ledger accounts and how a general ledger entry would be made for each. Revenues, liabilities and equity usually contain credit balances, whereas assets, cost of goods sold and expenses usually contain debit balances.

An example of a revenue account would be sales. As you make sales, the revenue account gets credits. This account should contain a credit balance.

An example of a liability account would be mortgage payable. If you buy a building by taking out a mortgage, the money you owe on your mortgage would be a credit entry to this account. This account should contain a credit balance.

An example of an equity account would be retained earnings. The net income you make as per your income statement is reflected in this account. Assuming your company is profitable, retained earnings will be credited at month’s end with the net income amount. This account should contain a credit balance.

An example of an asset account would be a building. If you bought a building, the amount of money you paid for the building would be recorded as a debit entry to this account. This account should contain a debit balance.

An example of a cost of goods sold account would be material cost. If you’re a manufacturer, the cost of all the materials that go into making a product is reflected as a debit on this account. This account should contain a debit balance.

An example of an expense account would be rent expense. If you are leasing office space for your company, you would have to keep track of how much money you paid for rent. When you pay the rent, you would make a debit entry to this account. The rent expense account should contain a debit balance.

In most general ledger systems, revenues, liabilities, and equity are stored as negative values. Assets, cost of goods sold and expenses are stored as positive numbers. Therefore, assets + liabilities + equity should equal zero. If they don’t, there is a balancing problem in your general ledger system.

In accounting, a general ledger transaction is defined as a combination of debit and credit entries for particular general ledger accounts whose sum of debit amounts equals the sum of credit amounts.

Let me give you an example. Let’s say I own a real estate company and I bought a building. The building costs $1 million, of which I will pay $200,000 out of my own pocket and take out a mortgage for the remaining $800,000. The amount of money I paid for the building would be recorded in the building account (asset). The $200,000 I paid out of my own pocket would be recorded as a reduction of my cash account (asset). The $800,000 I took out for a mortgage would be recorded as a liability.

The General Ledger transaction for this example would be as follows:

Account	Debit	Credit
Building	$1,000,000
Cash		$200,000
Mortgage Payable		$800,000

Notice: The sum of the debits equals the sum of the credits.

WebFOCUS Developer Studio gives you the ability to create financial reports. The ability to lay out the general ledger accounts on a page and perform calculations, not only on columns but also on rows, are part of this tool and a requirement for Financial Reporting.

Screen 1 shows an income statement being created with the Financial Report Painter within Developer Studio. Notice that the report line Mail Order and Internet Sales is a calculation at report time. Profit in Canadian dollars is also a calculation at report time. The order of the report lines would be laid out in the matrix. Also notice that notes can appear anywhere in the Financial Report. Without the Financial Report Painter, notes can be inserted into a report only through the use of HEADING, FOOTING, SUBHEAD, or SUBFOOT.

Screen 1

Screen 2 shows the output of the report from Screen 1. Notice the lines appear exactly as I laid them out in the painter. Also notice the results of the calculated report lines.

In my next column I will address financial data consolidation.