Stephen L. Nelson - QuickBooks 2022 All-in-One For Dummies

One other important point: Income statements summarize revenue, expenses, and profits for a particular period. Some managers and entrepreneurs, for example, may want to prepare income statements on a daily basis. Public companies are required to prepare income statements on a quarterly and annual basis. And taxing authorities, such as the Internal Revenue Service (IRS), require tax return preparation both quarterly and annually.

Technically speaking, the quarterly statements required by the IRS don’t need to report revenue. The IRS requires quarterly statements only of wages paid to employees. Only the annual income statements required by the IRS report both revenue and expenses. These income statements are produced to prepare an annual income tax return.

The second-most-important financial statement that an accounting system produces is a balance sheet. A balance sheet reports on a business’s assets, liabilities, and owner contributions of capital at a particular point in time:

The assets shown in a balance sheet are those items that are owned by the business, which have value and for which money was paid.

The liabilities shown in a balance sheet are those amounts that a business owes to other people, businesses, and government agencies.

The owner contributions of capital are the amounts that owners, partners, or shareholders have paid into the business in the form of investment or have reinvested in the business by leaving profits inside the company.

As long as you understand what assets and liabilities are, a balance sheet is easy to understand and interpret. Table 1-4, for example, shows a simple balance sheet. Pretend that this balance sheet shows the condition of the hot dog stand at the beginning of the day, before any hot dogs have been sold. The first portion of the balance sheet shows and totals the two assets of the business: the $1,000 cash in the cash register in a box under the counter and the $3,000 worth of hot dogs and buns that you’ve purchased to sell during the day.

TABLE 1-4A Simple Balance Sheet

Balance sheets can use several other categories to report assets: accounts receivable (amounts that customers owe), investments, fixtures, equipment, and long-term investments. In the case of a small owner-operated business, not all these asset categories show up. But if you look at the balance sheet of a very large business — say, one of the 100 largest businesses in the United States — you see these other categories.

The liabilities section of the balance sheet shows the amounts that the firm owes to other people and businesses. The balance sheet in Table 1-4shows $2,000 of accounts payable and a $1,000 loan payable. Presumably, the $2,000 of accounts payable is the money that you owe to the vendors who supplied your hot dogs and buns. The $1,000 loan payable represents some loan you’ve taken out — perhaps from some well-meaning and naive relative.

The owner’s equity section shows the amount that the owner, the partners, or shareholders have contributed to the business in the form of original funds invested or profits reinvested. One important point about the balance sheet shown in Table 1-4: This balance sheet shows how owner’s equity looks when the business is a sole proprietorship. In the case of a sole proprietor, only one line is reported in the owner’s equity section of the balance sheet. This line combines all contributions made by the proprietor — both amounts originally invested and amounts reinvested.

I talk a bit more about owner’s equity accounting later in this chapter because the owner’s equity sections look different for partnerships and corporations. Before I get into that discussion, however, let me make two important observations about the balance sheet shown in Table 1-4:

A balance sheet needs to balance. This means that the total assets must equal the total liabilities and owner’s equity. In the balance sheet shown in Table 1-4, for example, total assets show as $4,000. Total liabilities and owner’s equity also show as $4,000. This equality is no coincidence. If an accounting system works right, and the accountants and bookkeepers entering information into this system do their jobs right, the balance sheet balances.

A balance sheet provides a snapshot of a business’s financial condition at a particular point in time. I mention in the introductory remarks related to Table 1-4that the balance sheet in this table shows the financial condition of the business immediately before the day’s business activities begin.

You can prepare a balance sheet for any point in time. It’s key that you understand that a balance sheet is prepared for a particular point in time.

By convention, businesses prepare balance sheets to show the financial condition at the end of the period of time for which an income statement is prepared. A business typically prepares an income statement on an annual basis. In this orthodox situation, a firm also prepares a balance sheet at the very end of the year.

At this point, I return to something that I allude to earlier in the chapter: the fact that the owner’s equity section of a balance sheet looks different for different types of businesses.

Table 1-5shows how the owner’s equity section of a balance sheet looks for a partnership. In Table 1-5, I show how the owner’s equity section of the business appears if, instead of having a sole proprietor named S. Nelson running the hot dog stand, the business is actually owned and operated by three partners named Tom, Dick, and Harry. In this case, the partners’ equity section shows the amounts originally invested and any amounts reinvested by the partners. As is the case with sole proprietorships, each partner’s contributions and reinvested profits appear on a single line.

TABLE 1-5Owner’s Equity for a Partnership

Go ahead and take a look at Table 1-6, which shows how the owner’s equity section looks for a corporation.

TABLE 1-6Owner’s Equity for a Corporation

This next part is a little bit weird. For a corporation, the amounts that appear in the owner’s equity or shareholders’ equity section actually fall into two major categories: retained earnings and contributed capital. Retained earnings represent profits that the shareholders have left in the business. Contributed capital is the money originally contributed by the shareholders to the corporation.