Make Accounting Software Count β Part 2
Feb 1, 1999 12:00 PM, By Mark Lamendola, Technical Editor
What principles do you need to know to get the most out of your accounting software?
In Part 1, we discussed the importance of data entry methods. Now, we'll take an in-depth look at the accounting process itself. This overview will help you evaluate your present accounting practices and make any necessary adjustments. One problem many businesses run into is they have accounting software but don't understand what it really does or how to incorporate it into their specific activities.
The first item to address is your system of internal control. This will determine if your accounting system produces accurate and reliable information. The sidebar (top, right) shows the purposes of a system of internal control. Through the judicious use of passwords and administrative policies, you can create an excellent system of internal control with any accounting software package. For example, a basic principle of internal control is no one person handles all phases of a transaction from beginning to end. Accounting software lets you set up a password for your accounts payable (AP) module and a different password for your check-issuing module. This prevents an employee from creating fake vendor payables and then issuing funds to pay them, without the collusion of another employee. Relying on a multiple signature system for cut checks won't stop this, unless a clear pattern emerges. By then, the damage may be significant. You can also use this very same mechanism to prevent pilfering from the petty cash fund.
Your accounting system will produce, among other types of reports, a balance sheet. The purpose of this sheet is to show the financial condition of your business at a particular date. Most packages allow you to customize the look of this sheet, but you should decide on one format and stick with it for your whole fiscal year. The balance sheet simply shows assets in one column and liabilities and equity in the other. The totals of each column must match to the penny (the sidebar, bottom, right). If they're off, you have an inaccurate statement. Finding the problem can be a nightmare, which is one reason your methodology of data entry is so critical. You should view the balance sheet at regular intervals and reconcile any differences. Producing a balance sheet used to require several hours, but today you can complete this task with a mouse click. So, you may want your data entry procedure to include checking the balance sheet after each entry. Then, if there's a problem, you won't have to sift through a month's worth of entries to find it.
Assets are the economic resources your business owns and that you expect to benefit future operations. According to Generally Accepted Accounting Principles (GAAP), you value these at cost rather than appraised market values. There are four reasons for this: The Cost Principle, The Ongoing Concern Assumption, The Objectivity Principle, and The Stable Dollar Assumption. All have fairly lengthy explanations you can sum up this way: According to GAAP, this cost valuation method is not open to debate.
Tangible assets include land, buildings, merchandise, and equipment. Intangible assets include legal claims or rights, amounts due from customers (accounts receivable), purchased tradenames, and investments in government bonds. Liabilities are debts, and all businesses have them. An account payable (AP) is a liability arising from the purchase of goods and services you owe to a creditor. An AP carries no interest payments or formal promise to the creditor; it is debt incurred in the normal course of conducting business. Examples include invoices, wages, and supplier accounts. Some accounting packages provide separate entries for delinquent APs, because these begin to accrue interest. A note payable is a longer-term loan, usually for a specific purpose that allows business expansion. Notes require a formal written agreement and interest payments. They usually appear ahead of APs on a balance sheet and any financial report that would include APs and notes.
When you subtract your liabilities from your assets, you have your equity. Equity can increase in only two ways: investment by the owner or earnings from profitable operation of the business. Profit goes up when costs go down or revenue goes up. If neither is happening and there is no new money coming into the business, then the equity will not increase. Equity can decrease only through withdrawals by the owner or through losses from unprofitable operation.
Software packages make it unnecessary to fill out the intermediate forms involved in bookkeeping, and to manage the several types of journals manual methods require. However, you still must follow the principle of double-entry accounting, so you don't violate the accounting equation. For every change on the balance sheet's left hand side (assets), you must have an equal change on the right hand side (either liabilities or equity). Remember the criteria for entering changes in liability. Fortunately, the better accounting packages lead you through this or automate it completely. For example, if you write a check for $895 to account #Vend123, Invoice #99-0345, the program will automatically find Invoice #99-0345, reconcile it, and then reduce your AP amount by $895. While it's at it, the program will number and arrange all transactions in financial statement order, and update your balance sheet. If the program can't find an invoice, it'll prompt you for further information. This example shows you the power and importance of entering information completely and correctly.
What we have just seen, in this example, is completion of the accounting cycle, which consists of the four steps shown in the sidebar (below). This is just an overview of how to make your accounting system work well. There will be times when you need to adjust your entries. You'll need to apportion costs among accounts, apportion unearned revenue, correct for unrecorded revenue, and correct for unrecorded expenses. However, if you pay attention to the principles outlined in this article, making those adjustments should be a breeze.
Sidebar: Purpose of an Internal Control System
1. Ensure accuracy and reliability in accounting and operating data.
2. Evaluate the level of performance in all your groups, divisions, or operations.
3. Protect your resources against waste, theft, fraud, and inefficiency.
4. Secure and ensure compliance with company policies.
5. Secure and ensure compliance with federal, state, and local regulations in regard to financial reporting.
Sidebar: The Accounting Cycle
1. Record transactions in the journal. Software integrates the journals, so all you have to do is know the type of transaction, and let the software guide you on where to enter it.
2. Post to ledger accounts. Software now handles this internally, but you may have to respond to prompts to help it along.
3. Prepare a trial balance. You don't need to do this step anymore:the software does it on the fly and alerts you if there is a problem. Usually, the problem is one of posting inaccuracy:you put in the wrong amount or entered it in the wrong place. You need to check that your ledger accounts balance, but now you can rely on the software to do it for you.
4. Prepare financial statements. This is how you determine your financial position, whether for internal use or presentation to outside parties. Regulators, lenders, taxing authorities, and investors all need financial statements from you.