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Accounting Concepts and Principles

There are several principles and concepts used in accounting. When you understand these, you will be able to read financial information and make better decisions as a manager and owner of a company.  

The following articles are educational in nature and designed to teach the fundamentals of accounting.  They are written assuming the reader is a novice as it relates to accounting.  Please take your time and read to gain a better understanding of the accounting concepts and principles.

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FEATURE ARTICLES:

  • Accounting Principles

    Simply stated, accounting is the measurement of economic activity.  Its primary principle is to report information to the user so that (s)he can make informed decisions.  The primary reporting format is in the form of dollars.  There are two important reports used by pretty much 99% of all business operations to determine the status of ...
  • Depreciation – This is Weird Accounting

    In the world of accounting, there are two types of expenses on the reports widely misunderstood.  They are depreciation and amortization.  I will try to help the novice gain an understanding of depreciation in this article.  So if you can, clear your mind and let us begin: In business we buy all types of goods to get ...
  • What is ‘Cost of Goods Sold’?

    Grocery Store ShelfSimply put, ‘cost of goods sold’ equals the direct costs of materials, human resources, and equipment needed to produce the item sold.  However, this can be confusing because there are many marginal cost items that affect the real cost of producing and selling the item. From the utilities to the facility costs, all of these have ...
  • Small Business Tax Depreciation – Section 179

    irs bookThe Internal Revenue Service sets the depreciation allowance based on the Code as promulgated by Congress.  The most commonly referenced section is 179.  This is a form of accelerated depreciation allowing the small business owner the opportunity to take a large expense deduction and reduce their tax obligation immediately.  The maximum allowed deduction is $500,000.  ...
  • The Definition of Fixed Assets

    Any tangible item not consumed within one accounting cycle (typically a year) and providing long term utility is referred to as a Fixed Asset.  Traditional images include manufacturing equipment, tools, transportation vehicles, buildings and utility related systems (sewage systems, power grids, power plants and dams).  In accounting, these assets are recorded to the balance sheet ...
  • Liquidity – What Does This Mean?

    In business, liquidity is defined as the period of time it takes to turn assets into cash.  It takes 20 minutes to turn the balance in the checking account into cash.  You head on down to the bank and present a check.  You get cash.  But most businesses run on just more than the cash ...
  • What is Amortization?

    There are three methods of expensing an asset to the income statement.  The most common method is depreciation for fixed assets.  Mining, oil, and natural resource operations use depletion (amount removed versus the estimated volume on hand).  Non-physical assets are expensed to the income statement or profit and loss statement via a method called amortization.  It ...
  • Cash Flow – A Basic Definition

    Cash flow is the ability of a business to turn its product or service into cash.  It is generally measured in dollars or in dollars against a time period.  The simplest example I can think of is a child selling lemonade.  The child purchases the lemonade and sugar in the morning, starts selling in the ...
  • What is Accrual Accounting?

    Accrual accounting is the preferred method of accounting for all business operations.  Any publicly traded company must comply with the principles of accrual accounting.  Small business operations can choose between cash and accrual accounting for their records.  Although cash accounting is the easiest to work with as a small business operation, accrual accounting will provide ...
  • How is Cost of Goods Sold in Retail Determined?

    Each industry is different in determining costs of goods sold or cost of services rendered.  Retail uses two distinct methods to calculate costs of goods sold.  The first is called ‘Specific Identification’ whereby each item sold is specifically identified to its recorded cost.  The second method is referred to as ‘Inventory Adjustment’ format.  In this ...
  • The Various Forms of Depreciation

    depreciation definitionThere are various forms of depreciation used in the small business world.  In general, depreciation is not required but it is advisable.  So a small business owner should understand depreciation and the various forms of how to calculate the deduction.  Once you understand the reasoning behind depreciation you can better comprehend the different methods and ...
  • Format of the Profit and Loss Statement for Service Related Businesses

    Service related businesses require a different format than the traditional profit and loss statement AKA the income statement.  The traditional profit and loss focuses on sales of products and a corresponding cost of goods sold section to help the reader evaluate the gross margin.  But in service, the owner needs a profit and loss statement ...
  • An Explanation of Goodwill – Part I – Generating Goodwill

    Goodwill is essentially customer retention.  It’s the ability of a small business to retain and keep customers coming back.  I remember from my boyhood a hardware store my mother would go to and get parts for the house.  The owner was well into his 70’s and I was a boy of 7.  This was the ...
  • Definition of Contribution Margin

    Contribution margin is a core business concept and is often used in cost accounting to identify the amount of financial contribution a sold product provides to the company.  Simply put, contribution margin is the sales price less the direct costs (sometimes referred to as variable costs).  A parallel reporting format is the top two sections ...
  • Revenue and Sales – What is the Difference?

    Sales are a component of revenue.  Revenue encompasses several sources of income including sales.  Other sources of revenue include interest, trust monies, royalties, and fees.  In effect, revenue includes all sources of income, realized and unrealized.  Sales are divided into two levels, gross sales are all sales at the regular price; net sales are gross ...
  • Deferred (Unearned) Revenue – Definition and Accounting Procedures

    Deferred or unearned revenue is an advance payment made by a customer for a product or service that has not yet been rendered (delivered).  It is a very common economic transaction.  When you book and prepay for your airline ticket, the flight service records this as unearned revenue.  Once you board the plane and land ...
  • Quick Ratio – Definition, Explanation and Proper Use

    The quick ratio is a formula used in business to identify the ability of a business to pay its current liabilities.  It is also known as the ‘Acid Test’ formula (ratio).  In the large markets this formula is one of the financial industry ratios used to value the stock of a corporation.  In the arena ...
  • Fixed Costs – Explanation and Examples

    ‘Fixed costs’ is a business term used mostly in cost accounting.  It has several meanings based on its usage.  The most common definition associated with fixed costs is expenses that must be paid regardless of production or sales volume.  The best example is rent for a company.  It doesn’t matter whether you produce or sell ...
  • Various Sets of Accounting Books

    Accounting’s primary purpose is to measure economic activity.  There are several different methods to determine the economic value generated in your business each year.  In accounting this is referred to as sets of books.  There are four basic sets of accounting books.  Each has a different purpose and end goal.  This article is written to ...
  • Cost of Sales – Various Formats

    Many business owners misunderstand the use of term ‘Cost of Sales’ by restricting it to just simply ‘Cost of Goods Sold’.  Basically, most business entrepreneurs and even accountants don’t realize that it has several different names and presentation formats.  But it is essentially costs of sales.  Cost of Sales is the generic term used.  However, ...
  • Treasury Stock

    Those corporations doing well and flush with cash sometimes buy back stock from their investors. Once purchased back by the company the stock is called treasury stock. In large corporations the buy back often involves a small percentage of stockholders and rarely affects the voting rights or ownership structure.  However, in small business, buying back ...
  • Breakeven Analysis – Fundamentals

    Breakeven analysis is a managerial (cost) accounting tool used to examine the relationship of price to cost of a product.   It also considers various sales volumes and the effect on profit given the different relationships of price to cost.   The breakeven analysis is an essential tool in maximizing profit with the least amount of resources.   It ...
  • Amortization of Financing Costs

    When a business acquires a loan there are typically closing costs involved.   Generally Accepted Accounting Principles (GAAP) require these costs to be amortized (allocated) over the life of the loan.  There are several principles the reader needs to understand to properly calculate and assign these costs to the financial statements.  This lesson explains the basic ...
  • Gross and Net Sales

    Many of the business performance standards are measured against a baseline.  For the bulk of production and operation performance tools the baseline is net sales.  The key to an accurate performance standard is having an exact sales figure.  As an example, in a restaurant operation one of the prime costs is food.  So food consumption ...
  • Working Trial Balance

    The accounting profession uses various tools to generate accurate accounting information at the close of accounting cycles (monthly, quarterly and annually). The primary document is the working trial balance.  It is very similar to the traitional trial balance except there are additional columns used to identify various adjustments and the corresponding source documents (work papers).   The ...