General accounting
IV. 18. Revenue accounts and Capital accounts
Video
We reached the first fundamental document prepared at the end of an accounting cycle: the Trial balance (abbreviation: TB)
From this TB, we shall compute the Income Statement (IS) of the cycle, and the Balance Sheet (BS) at the end of the cycle.
The IS is a presentation of the sales and the corresponding costs (= charges = consumptions) during the period, in order to create these sales.
Accounting softwares enable you to post conveniently all the transactions during the accounting period, and compute automatically the TB.
The spreadsheet mini_accounting.xls is a rudimentary version of such a software.
Let's use it and modify a bit the journal from the past lessons, to see the impact on the TB.
Here is the new journal we shall work with:
The Trial balance (TB) is now this:
From the TB, in order to compute the Income Statement, we must extract the sales and the costs (= charges = consumptions) of the period, corresponding to the sales.
Next to the Sales account, some accounts record costs or consumptions or charges of the cycle to create the sales.
Let's mark them off with the letter R:
The Sales account and the other accounts recording costs are called the "Revenue accounts". That's why I marked them off with an R.
Their balances will form the Income Statement.
The other accounts record assets or liabilities. They are called the "Capital accounts".
Let's mark them off with the letter C:
The Bank account records money we have at the bank: it is an asset.
The Capital account records "receipts" we gave to the owners for the initial money they put into the firm. It is a special type of liability account, in the sense that this money is not, properly speaking, due. It doesn't have to be refunded. But it is classified as a liability, a part of the Capital accounts.
The Cash account records money in the till: it is an asset.
James is a supplier, and since we obtained a credit from him, it is a creditor. This account records a liability. At the end of the cycle, the TB tells us that we still owe James 1000€.
The Long term loan naturally is a liability. It records the promise to pay back 2000€ under the contract we gave a lender in exchange for the loan. Note that this contract also specifies that we will pay yearly interests, which at the outset do not appear in the accounting books. They will appear yearly in the income statements as charges of the year to have the use of the capital still borrowed.
Machinery is an asset.
Jules account, like James, is a liability.
The Purchases account is not an asset or a liability: it is the record of the purchases of goods to be sold. In traditional accounting when we purchase goods, we do not debit the inventory right away, we debit the Purchases account.
In the case we sold exactly these purchases during the accounting cycle, it would indeed be the cost of goods sold.
But since usually the goods purchased do not correspond exactly to the goods actually sold, this is one of the reasons why we shall have to make some adjustments to the TB before we can prepare the IS.
The Rent is clearly a cost.
Deirdre's account is a liability, like James's and Jules's.
Salaries are clearly a charge of the cycle. Remember, this account records the work consumed by the firm during the cycle.
Sales is Sales :-) It can be viewed as the most important account of the whole ledger. Remember, it is a special type of account created to compute conveniently, later on, the profit, in the Income Statement. The Sales account goes into the IS, so it is a Revenue account.
Sally is a customer, and a debtor. Her account records assets we hold (IOU due to us).
Shop expenses are a cost.
The Van account records an asset. Therefore it belongs to the "Capital accounts".
All the Capital accounts will form the Balance Sheet.
But before we can compute an exact IS and an exact BS, some more work is required.
We must "adjust" the Trial balance with some more entries.
It is the topic of next lesson.
