CORPORATIONS

CORPORATIONS

CORPORATIONS

INTRODUCTION TO CORPORATIONS

A corporation is an legal entity created by state law. It has a distinct and separate existence from the individuals who created it, and those who control its operations. Corporations are commonly classified as profit or nonprofit, and public or nonpublic. A profit corporation's survival depends upon its ability to make profits. A not-for-profit corporation relies on donations and grants. Public corporations issue stock that is widely held and traded. Shares of a nonpublic corporation are usually held by a small number of individuals. Regardless of the form or purpose of corporations, all must be created according to either state or federal statutes.

CHARACTERISTICS OF A CORPORATION

A corporation has the ability to enter into contracts, incur liabilities, and buy, sell, or own assets in its corporate name. These provisions can be found in the charter or articles of incorporation. Ownership of a corporation is divided into shares of stock. Stocks can be issued in different classes. All shares of stock in the same class have identical rights and privileges. The buying and selling of shares does not effect the business activities of the corporation. Shareholders' liability is limited to the amount they invested.

CHARACTERISTICS OF A CORPORATION

The corporation is subject to considerable more regulation than other forms of business organization. Corporations are also subject to greater taxes. Earnings are taxed before they are distributed to shareholders, and again when shareholders report them on their individual tax returns. The IRS does under certain conditions allow a corporation to be taxed in a manner similar to a partnership, provided it has a small number of shareholders. All corporations are subject to federal income taxes. The payment of state income taxes depends upon where the corporation was incorporated and in which states it conducts business.

ORGANIZATION OF A CORPORATION ORGANIZATIONAL STRUCTURE OF A CORPORATION

1) Shareholders of a corporation elect the board of directors.

2) The board of directors are responsible for determining corporate policies and electing officers.

3) Officers are responsible for operations and hiring employees. When shareholders are not pleased with the performance of the board of directors, they can elect new directors.

ADVANTAGES/DISADVANTAGES OF CORPORATIONS

The major advantages of corporations as a form of business are:

1- limited liability of shareholders,

2- large capital formation,

3- ease of transfer of ownership,

4- continuity of existence.

The disadvantages of corporations are:

1- double taxation of profits,

2- possible conflicts between management and shareholders,

3- government regulations.

SHAREHOLDERS' EQUITY

The shareholders' equity (that is, owners' equity of a corporation) consists of primarily paid-in capital and retained earnings. Paid-in capital represents the funds paid for shares of stock. When more than one class of stock is issued, separate paid-in capital accounts are maintained. The retained earnings account should normally have a credit balance, and it represents past net income that has been accumulated by the corporation. Dividends are paid out of retained earnings resulting in debit to retained earnings account. If the retained earnings account balance is itself a debit, a deficit has been incurred by the corporation, i.e. losses in excess of profits.

CHARACTERISTICS OF STOCK

The number of shares of stock a corporation may issue is stated in the articles of incorporation. Shares can be issued with or without par. A par value does not reflect the true value of the stock, it is merely an arbitrary monetary figure. The par value of a stock can be found on the stock certificate which also serves as evidence of ownership. Most states require that a stock be assigned a stated value. It is the responsibility of the board of directors to either assign a par or stated value to shares of stock.

CHARACTERISTICS OF STOCKS

Shares of ownership in a corporation are capital stock. Shares owned by shareholders are referred to as stock outstanding. The creditors of a corporation have no legal claim against shareholders. The law requires, however, that a specific minimum contribution of shareholders be held by the corporation as protection for creditors. The percentage is determined by state laws, and is known as legal capital. The percentage of investment held as legal capital tends to be low, similar to the par or stated value of the stock.

CLASSES OF STOCK

All shareholders of a corporation are entitled to basic rights. These rights differ according to classes of stock. Common stock possesses most of the voting powers, while preferred stock has preferential rights to a share in the distribution of earnings, and often has first claim to assets in the event of liquidation. Each common stoch shareholder also has a preemptive right to any new issue. The specific rights of a stock are found in either the charter or the stock certificate. The board of directors decides if earnings should be distributed to shareholders as dividends. Distribution of dividends is not guaranteed, and the decision is usually based upon the needs of a corporation.

TYPES OF PREFERRED STOCK

Preferred shareholders are assured of receiving dividends before any common shareholder. When preferred stock is participating, preferred shareholders can share in excess profits with common shareholders. Nonparticipating preferred stock is limited to a fixed dividend. When a preferred stock is cumulative, the preferred shareholder is entitled to all dividend payments in arrears before any common shareholder can be paid a dividend. A preferred stock that is both cumulative and participating is the most attractive to investors.

ISSUANCE OF STOCK

The entries to record investments of shareholders are similar to most other forms of business. A cash or an asset account is debited, and a capital account is credited. A corporation must keep detailed records of shareholders investments if it plans to pay the correct amount of dividends to the appropriate individuals. It also uses these records to sent shareholders financial reports and proxy forms. When corporations issue stock, it rarely sells at its par value. The price of a stock is influenced by many factors.

PREMIUMS AND DISCOUNTS ON STOCK

When stock is issued at a higher value than par, a premium on stock account is credited. If a stock is issued below par, a discount on stock account is debited. Under certain circumstances, a corporation may decide to return a premium as a dividend at a later date. When a stock is issued at a discount, shareholders may be liable up to the amount of the discount in the event of a liquidation. The discount on capital account is classified as a contra paid-in capital account, and is subtracted from other capital accounts when determining the total shareholders' equity.

STOCK SUBSCRIPTION

When a corporation does not want to sell its own shares, it can sell its stock to an underwriter who resells it at a higher price to earn a profit. The advantages of issuing stock through an underwriter are that it relieves a company from marketing tasks, and the company may even receive funds before shares are sold. Stock can be subscribed at par, below par, or above par.

STOCK SUBSCRIPTION

When a company sells its stock directly to investors, a Stock Subscription Receivable account is debited for each sale. A Stock Subscribed account is credited upon the initial offering of the subscription. When a subscription has been paid in full, Stock Subsdcribed account is debited and the appropriate stock account credited. At the same time the stock certificates are issued to shareholders. To keep track of subscription payments a subscribers ledger shows individual accounts. Paper stock certificates are currently phased out and replaced by computerized entries.

TREASURY STOCK

Treasury stock represents stock that has been issued, subscribed in the past, and later repurchased from shareholders. Motives for repurchasing shares may be to provide employees with stock bonuses, use these stocks for employee savings plans, or to boost the market value of the stock. If treasury stock is reissued or cancelled, it is no longer treasury stock. The accounting method most commonly employed to record the purchase and sale of treasury stock is the cost basis. The purchase or sale price is used to record the entry with no consideration given to par value or original issue price. When the stock is resold a Paid-In Capital from Sale of Treasury Stock account is used to record any premiums or discounts on sales.

EQUITY PER SHARE

Equity per share represents the book value of a share (not its market value). Equity per share is calculated by dividing total shareholders' equity by the number of shares outstanding. In the event more than one type of stock has been issued, the equity must be allocated among the different types. The presence of preferred stock reduces the amount of equity available to common stock shareholders. The equity per share has an insignificant influence on the market price of a stock: earnings per share, dividend payments, and future expectations are far more influential.

ORGANIZATION COSTS

Any expenditure incurred when the corporation is formed, is charged to the Organization Costs account. This account is an intangible asset that has no value in the event the corporation is liquidated. The Internal Revenue Code allows Organization Costs to be amortized, but this must be done within five years. Organization Costs are usually not large, and their amortization has little effect on net income.

CORPORATIONS

CORPORATIONS

INTRODUCTION TO CORPORATIONS

A corporation is an legal entity created by state law. It has a distinct and separate existence from the individuals who created it, and those who control its operations. Corporations are commonly classified as profit or nonprofit, and public or nonpublic. A profit corporation's survival depends upon its ability to make profits. A not-for-profit corporation relies on donations and grants. Public corporations issue stock that is widely held and traded. Shares of a nonpublic corporation are usually held by a small number of individuals. Regardless of the form or purpose of corporations, all must be created according to either state or federal statutes.

CHARACTERISTICS OF A CORPORATION

A corporation has the ability to enter into contracts, incur liabilities, and buy, sell, or own assets in its corporate name. These provisions can be found in the charter or articles of incorporation. Ownership of a corporation is divided into shares of stock. Stocks can be issued in different classes. All shares of stock in the same class have identical rights and privileges. The buying and selling of shares does not effect the business activities of the corporation. Shareholders' liability is limited to the amount they invested.

CHARACTERISTICS OF A CORPORATION

The corporation is subject to considerable more regulation than other forms of business organization. Corporations are also subject to greater taxes. Earnings are taxed before they are distributed to shareholders, and again when shareholders report them on their individual tax returns. The IRS does under certain conditions allow a corporation to be taxed in a manner similar to a partnership, provided it has a small number of shareholders. All corporations are subject to federal income taxes. The payment of state income taxes depends upon where the corporation was incorporated and in which states it conducts business.

ORGANIZATION OF A CORPORATION ORGANIZATIONAL STRUCTURE OF A CORPORATION

1) Shareholders of a corporation elect the board of directors.

2) The board of directors are responsible for determining corporate policies and electing officers.

3) Officers are responsible for operations and hiring employees. When shareholders are not pleased with the performance of the board of directors, they can elect new directors.

ADVANTAGES/DISADVANTAGES OF CORPORATIONS

The major advantages of corporations as a form of business are:

1- limited liability of shareholders,

2- large capital formation,

3- ease of transfer of ownership,

4- continuity of existence.

The disadvantages of corporations are:

1- double taxation of profits,

2- possible conflicts between management and shareholders,

3- government regulations.

SHAREHOLDERS' EQUITY

The shareholders' equity (that is, owners' equity of a corporation) consists of primarily paid-in capital and retained earnings. Paid-in capital represents the funds paid for shares of stock. When more than one class of stock is issued, separate paid-in capital accounts are maintained. The retained earnings account should normally have a credit balance, and it represents past net income that has been accumulated by the corporation. Dividends are paid out of retained earnings resulting in debit to retained earnings account. If the retained earnings account balance is itself a debit, a deficit has been incurred by the corporation, i.e. losses in excess of profits.

CHARACTERISTICS OF STOCK

The number of shares of stock a corporation may issue is stated in the articles of incorporation. Shares can be issued with or without par. A par value does not reflect the true value of the stock, it is merely an arbitrary monetary figure. The par value of a stock can be found on the stock certificate which also serves as evidence of ownership. Most states require that a stock be assigned a stated value. It is the responsibility of the board of directors to either assign a par or stated value to shares of stock.

CHARACTERISTICS OF STOCKS

Shares of ownership in a corporation are capital stock. Shares owned by shareholders are referred to as stock outstanding. The creditors of a corporation have no legal claim against shareholders. The law requires, however, that a specific minimum contribution of shareholders be held by the corporation as protection for creditors. The percentage is determined by state laws, and is known as legal capital. The percentage of investment held as legal capital tends to be low, similar to the par or stated value of the stock.

CLASSES OF STOCK

All shareholders of a corporation are entitled to basic rights. These rights differ according to classes of stock. Common stock possesses most of the voting powers, while preferred stock has preferential rights to a share in the distribution of earnings, and often has first claim to assets in the event of liquidation. Each common stoch shareholder also has a preemptive right to any new issue. The specific rights of a stock are found in either the charter or the stock certificate. The board of directors decides if earnings should be distributed to shareholders as dividends. Distribution of dividends is not guaranteed, and the decision is usually based upon the needs of a corporation.

TYPES OF PREFERRED STOCK

Preferred shareholders are assured of receiving dividends before any common shareholder. When preferred stock is participating, preferred shareholders can share in excess profits with common shareholders. Nonparticipating preferred stock is limited to a fixed dividend. When a preferred stock is cumulative, the preferred shareholder is entitled to all dividend payments in arrears before any common shareholder can be paid a dividend. A preferred stock that is both cumulative and participating is the most attractive to investors.

ISSUANCE OF STOCK

The entries to record investments of shareholders are similar to most other forms of business. A cash or an asset account is debited, and a capital account is credited. A corporation must keep detailed records of shareholders investments if it plans to pay the correct amount of dividends to the appropriate individuals. It also uses these records to sent shareholders financial reports and proxy forms. When corporations issue stock, it rarely sells at its par value. The price of a stock is influenced by many factors.

PREMIUMS AND DISCOUNTS ON STOCK

When stock is issued at a higher value than par, a premium on stock account is credited. If a stock is issued below par, a discount on stock account is debited. Under certain circumstances, a corporation may decide to return a premium as a dividend at a later date. When a stock is issued at a discount, shareholders may be liable up to the amount of the discount in the event of a liquidation. The discount on capital account is classified as a contra paid-in capital account, and is subtracted from other capital accounts when determining the total shareholders' equity.

STOCK SUBSCRIPTION

When a corporation does not want to sell its own shares, it can sell its stock to an underwriter who resells it at a higher price to earn a profit. The advantages of issuing stock through an underwriter are that it relieves a company from marketing tasks, and the company may even receive funds before shares are sold. Stock can be subscribed at par, below par, or above par.

STOCK SUBSCRIPTION

When a company sells its stock directly to investors, a Stock Subscription Receivable account is debited for each sale. A Stock Subscribed account is credited upon the initial offering of the subscription. When a subscription has been paid in full, Stock Subsdcribed account is debited and the appropriate stock account credited. At the same time the stock certificates are issued to shareholders. To keep track of subscription payments a subscribers ledger shows individual accounts. Paper stock certificates are currently phased out and replaced by computerized entries.

TREASURY STOCK

Treasury stock represents stock that has been issued, subscribed in the past, and later repurchased from shareholders. Motives for repurchasing shares may be to provide employees with stock bonuses, use these stocks for employee savings plans, or to boost the market value of the stock. If treasury stock is reissued or cancelled, it is no longer treasury stock. The accounting method most commonly employed to record the purchase and sale of treasury stock is the cost basis. The purchase or sale price is used to record the entry with no consideration given to par value or original issue price. When the stock is resold a Paid-In Capital from Sale of Treasury Stock account is used to record any premiums or discounts on sales.

EQUITY PER SHARE

Equity per share represents the book value of a share (not its market value). Equity per share is calculated by dividing total shareholders' equity by the number of shares outstanding. In the event more than one type of stock has been issued, the equity must be allocated among the different types. The presence of preferred stock reduces the amount of equity available to common stock shareholders. The equity per share has an insignificant influence on the market price of a stock: earnings per share, dividend payments, and future expectations are far more influential.

ORGANIZATION COSTS

Any expenditure incurred when the corporation is formed, is charged to the Organization Costs account. This account is an intangible asset that has no value in the event the corporation is liquidated. The Internal Revenue Code allows Organization Costs to be amortized, but this must be done within five years. Organization Costs are usually not large, and their amortization has little effect on net income.

CONSOLIDATION

CONSOLIDATION

CONSOLIDATION

STOCK INVESTMENTS INFORMATION THAT CAN BE FOUND IN THE FINANCIAL PAGES OF A NEWSPAPER ON STOCK

1) The high and low price for the past year.

2) The volume of sales for the day.

3) The low, high, and closing price for the day.

4) The current annual dividend and dividend yield.

5) The price-earnings ratio. Stocks of companies which are

unprofitable will not have P-E ratios.

SELLING LONG-TERM STOCK INVESTMENTS GAINS FROM THE SALE OF LONG-TERM INVESTMENTS IN STOCK

Example: A corporation purchases $50,000 of XYZ company stock, and sells it for $65,000 five years later. The brokerage fee is equal to $750, and another $250 is used for administrative expenses. What entry is necessary to record this transaction?

Entry: debit - Cash 64,000

credit - Investment in XYZ Company Stock 50,000

- Gain on Sale of Investments 14,000

SELLING LONG-TERM STOCK INVESTMENTS LOSSES FROM THE SALE OF LONG-TERM INVESTMENTS IN STOCK

Example: A corporation purchases $50,000 of XYZ company common stock, and sells it for $35,000 five years later. A brokerage fee of $500 is incurred as a result. What entry is necessary to record this transaction?

Entry: debit - Cash 34,500

- Loss on Sale of Investment 15,500

credit - Investment in XYZ Company Stock 50,000

BUSINESS COMBINATIONS MERGERS

When one company purchases all the properties of another company, and as a result the latter ceases to exist; a merger has taken place. The acquiring company takes over all assets and all liabilities. The acquiring company can make payment in the form of cash, assets, debt obligations, or capital stock. Mergers can produce legal, accounting, managerial, and financial problems. The most difficult task is deciding upon the correct value of the assets of the company being taken over. Besides the value of assets, the market price of both companies securities and their future earnings prospects must be taken into consideration.

CONSOLIDATED FINANCIAL STATEMENTS EXAMPLES OF INTERCOMPANY ITEMS THAT MUST BE ELIMINATED BEFORE A CONSOLIDATED FINANCIAL STATEMENT IS PREPARED

1) accounts payable and accounts receivable

2) notes payable and notes receivable

3) interest payable and interest receivable

4) sales and purchases

5) loans between companies

6) ownership of each other's stock

CONSOLIDATION

CONSOLIDATION

STOCK INVESTMENTS INFORMATION THAT CAN BE FOUND IN THE FINANCIAL PAGES OF A NEWSPAPER ON STOCK

1) The high and low price for the past year.

2) The volume of sales for the day.

3) The low, high, and closing price for the day.

4) The current annual dividend and dividend yield.

5) The price-earnings ratio. Stocks of companies which are

unprofitable will not have P-E ratios.

SELLING LONG-TERM STOCK INVESTMENTS GAINS FROM THE SALE OF LONG-TERM INVESTMENTS IN STOCK

Example: A corporation purchases $50,000 of XYZ company stock, and sells it for $65,000 five years later. The brokerage fee is equal to $750, and another $250 is used for administrative expenses. What entry is necessary to record this transaction?

Entry: debit - Cash 64,000

credit - Investment in XYZ Company Stock 50,000

- Gain on Sale of Investments 14,000

SELLING LONG-TERM STOCK INVESTMENTS LOSSES FROM THE SALE OF LONG-TERM INVESTMENTS IN STOCK

Example: A corporation purchases $50,000 of XYZ company common stock, and sells it for $35,000 five years later. A brokerage fee of $500 is incurred as a result. What entry is necessary to record this transaction?

Entry: debit - Cash 34,500

- Loss on Sale of Investment 15,500

credit - Investment in XYZ Company Stock 50,000

BUSINESS COMBINATIONS MERGERS

When one company purchases all the properties of another company, and as a result the latter ceases to exist; a merger has taken place. The acquiring company takes over all assets and all liabilities. The acquiring company can make payment in the form of cash, assets, debt obligations, or capital stock. Mergers can produce legal, accounting, managerial, and financial problems. The most difficult task is deciding upon the correct value of the assets of the company being taken over. Besides the value of assets, the market price of both companies securities and their future earnings prospects must be taken into consideration.

CONSOLIDATED FINANCIAL STATEMENTS EXAMPLES OF INTERCOMPANY ITEMS THAT MUST BE ELIMINATED BEFORE A CONSOLIDATED FINANCIAL STATEMENT IS PREPARED

1) accounts payable and accounts receivable

2) notes payable and notes receivable

3) interest payable and interest receivable

4) sales and purchases

5) loans between companies

6) ownership of each other's stock

Bank Reconciliation

Bank Reconciliation

Bank Reconciliation

Introduction to Bank Reconciliation

A company's general ledger account Cash contains a record of the transactions (checks written, receipts from customers, etc.) that involve its checking account. The bank also creates a record of the company's checking account when it processes the company's checks, deposits, service charges, and other items. Soon after each month ends the bank usually mails a bank statement to the company. The bank statement lists the activity in the bank account during the recent month as well as the balance in the bank account.

When the company receives its bank statement, the company should verify that the amounts on the bank statement are consistent or compatible with the amounts in the company's Cash account in its general ledger and vice versa. This process of confirming the amounts is referred to as reconciling the bank statement, bank statement reconciliation, bank reconciliation, or doing a "bank rec." The benefit of reconciling the bank statement is knowing that the amount of Cash reported by the company (company's books) is consistent with the amount of cash shown in the bank's records.

Because most companies write hundreds of checks each month and make many deposits, reconciling the amounts on the company's books with the amounts on the bank statement can be time consuming. The process is complicated because some items appear in the company's Cash account in one month, but appear on the bank statement in a different month. For example, checks written near the end of August are deducted immediately on the company's books, but those checks will likely clear the bank account in early September. Sometimes the bank decreases the company's bank account without informing the company of the amount. For example, a bank service charge might be deducted on the bank statement on August 31, but the company will not learn of the amount until the company receives the bank statement in early September. From these two examples, you can understand why there will likely be a difference in the balance on the bank statement vs. the balance in the Cash account on the company's books. It is also possible (perhaps likely) that neither balance is the true balance. Both balances may need adjustment in order to report the true amount of cash.

After you adjust the balance per bank to be the true balance and after you adjust the balance per books to also be the same true balance, you have reconciled the bank statement. Most accountants would simply say that you have done the bank reconciliation or the bank rec.

In addition to the following explanation of the bank reconciliation, we have developed a visual tutorial, business forms, and exam questions to help you reinforce your understanding. They are part of

Bank Reconciliation Process

Step 1. Adjusting the Balance per Bank

We will demonstrate the bank reconciliation process in several steps. The first step is to adjust the balance on the bank statement to the true, adjusted, or corrected balance. The items necessary for this step are listed in the following schedule:

13X-table-01

Deposits in transit are amounts already received and recorded by the company, but are not yet recorded by the bank. For example, a retail store deposits its cash receipts of August 31 into the bank's night depository at 10:00 p.m. on August 31. The bank will process this deposit on the morning of September 1. As of August 31 (the bank statement date) this is a deposit in transit.

Because deposits in transit are already included in the company's Cash account, there is no need to adjust the company's records. However, deposits in transit are not yet on the bank statement. Therefore, they need to be listed on the bank reconciliation as an increase to the balance per bank in order to report the true amount of cash.

A helpful rule of thumb is "put it where it isn't." A deposit in transit is on the company's books, but it isn't on the bank statement. Put it where it isn't: as an adjustment to the balance on the bank statement.

Outstanding checks are checks that have been written and recorded in the company's Cash account, but have not yet cleared the bank account. Checks written during the last few days of the month plus a few older checks are likely to be among the outstanding checks.

Because all checks that have been written are immediately recorded in the company's Cash account, there is no need to adjust the company's records for the outstanding checks. However, the outstanding checks have not yet reached the bank and the bank statement. Therefore, outstanding checks are listed on the bank reconciliation as a decrease in the balance per bank.

Recall the helpful tip "put it where it isn't." An outstanding check is on the company's books, but it isn't on the bank statement. Put it where it isn't: as an adjustment to the balance on the bank statement.

Bank errors are mistakes made by the bank. Bank errors could include the bank recording an incorrect amount, entering an amount that does not belong on a company's bank statement, or omitting an amount from a company's bank statement. The company should notify the bank of its errors. Depending on the error, the correction could increase or decrease the balance shown on the bank statement. (Since the company did not make the error, the company's records are not changed.)

Step 2. Adjusting the Balance per Books

The second step of the bank reconciliation is to adjust the balance in the company's Cash account so that it is the true, adjusted, or corrected balance. Examples of the items involved are shown in the following schedule:

13X-table-02

Bank service charges are fees deducted from the bank statement for the bank's processing of the checking account activity (accepting deposits, posting checks, mailing the bank statement, etc.) Other types of bank service charges include the fee charged when a company overdraws its checking account and the bank fee for processing a stop payment order on a company's check. The bank might deduct these charges or fees on the bank statement without notifying the company. When that occurs the company usually learns of the amounts only after receiving its bank statement.

Because the bank service charges have already been deducted on the bank statement, there is no adjustment to the balance per bank. However, the service charges will have to be entered as an adjustment to the company's books. The company's Cash account will need to be decreased by the amount of the service charges.

Recall the helpful tip "put it where it isn't." A bank service charge is already listed on the bank statement, but it isn't on the company's books. Put it where it isn't: as an adjustment to the Cash account on the company's books.

An NSF check is a check that was not honored by the bank of the person or company writing the check because that account did not have a sufficient balance. As a result, the check is returned without being honored or paid. (NSF is the acronym for not sufficient funds. Often the bank describes the returned check as a return item. Others refer to the NSF check as a "rubber check" because the check "bounced" back from the bank on which it was written.) When the NSF check comes back to the bank in which it was deposited, the bank will decrease the checking account of the company that had deposited the check. The amount charged will be the amount of the check plus a bank fee.

Because the NSF check and the related bank fee have already been deducted on the bank statement, there is no need to adjust the balance per the bank. However, if the company has not yet decreased its Cash account balance for the returned check and the bank fee, the company must decrease the balance per books in order to reconcile.

Check printing charges occur when a company arranges for its bank to handle the reordering of its checks. The cost of the printed checks will automatically be deducted from the company's checking account.

Because the check printing charges have already been deducted on the bank statement, there is no adjustment to the balance per bank. However, the check printing charges need to be an adjustment on the company's books. They will be a deduction to the company's Cash account.

Recall the general rule, "put it where it isn't." A check printing charge is on the bank statement, but it isn't on the company's books. Put it where it isn't: as an adjustment to the Cash account on the company's books.

Interest earned will appear on the bank statement when a bank gives a company interest on its account balances. The amount is added to the checking account balance and is automatically on the bank statement. Hence there is no need to adjust the balance per the bank statement. However, the amount of interest earned will increase the balance in the company's Cash account on its books.

Recall "put it where it isn't." Interest received from the bank is on the bank statement, but it isn't on the company's books. Put it where it isn't: as an adjustment to the Cash account on the company's books.

Notes Receivable are assets of a company. When notes come due, the company might ask its bank to collect the notes receivable. For this service the bank will charge a fee. The bank will increase the company's checking account for the amount it collected (principal and interest) and will decrease the account by the collection fee it charges.Since these amounts are already on the bank statement, the company must be certain that the amounts appear on the company's books in its Cash account.

Recall the tip "put it where it isn't." The amounts collected by the bank and the bank's fees are on the bank statement, but they are not on the company's books. Put them where they aren't: as adjustments to the Cash account on the company's books.

Errors in the company's Cash account result from the company entering an incorrect amount, entering a transaction that does not belong in the account, or omitting a transaction that should be in the account. Since the company made these errors, the correction of the error will be either an increase or a decrease to the balance in the Cash account on the company's books.

Step 3. Comparing the Adjusted Balances

After adjusting the balance per bank (Step 1) and after adjusting the balance per books (Step 2), the two adjusted amounts should be equal. If they are not equal, you must repeat the process until the balances are identical. The balances should be the true, correct amount of cash as of the date of the bank reconciliation.

Step 4. Preparing Journal Entries

Journal entries must be prepared for the adjustments to the balance per books (Step 2). Adjustments to increase the cash balance will require a journal entry that debits Cash and credits another account. Adjustments to decrease the cash balance will require a credit to Cash and a debit to another account.

Bank Reconciliation

Bank Reconciliation

Introduction to Bank Reconciliation

A company's general ledger account Cash contains a record of the transactions (checks written, receipts from customers, etc.) that involve its checking account. The bank also creates a record of the company's checking account when it processes the company's checks, deposits, service charges, and other items. Soon after each month ends the bank usually mails a bank statement to the company. The bank statement lists the activity in the bank account during the recent month as well as the balance in the bank account.

When the company receives its bank statement, the company should verify that the amounts on the bank statement are consistent or compatible with the amounts in the company's Cash account in its general ledger and vice versa. This process of confirming the amounts is referred to as reconciling the bank statement, bank statement reconciliation, bank reconciliation, or doing a "bank rec." The benefit of reconciling the bank statement is knowing that the amount of Cash reported by the company (company's books) is consistent with the amount of cash shown in the bank's records.

Because most companies write hundreds of checks each month and make many deposits, reconciling the amounts on the company's books with the amounts on the bank statement can be time consuming. The process is complicated because some items appear in the company's Cash account in one month, but appear on the bank statement in a different month. For example, checks written near the end of August are deducted immediately on the company's books, but those checks will likely clear the bank account in early September. Sometimes the bank decreases the company's bank account without informing the company of the amount. For example, a bank service charge might be deducted on the bank statement on August 31, but the company will not learn of the amount until the company receives the bank statement in early September. From these two examples, you can understand why there will likely be a difference in the balance on the bank statement vs. the balance in the Cash account on the company's books. It is also possible (perhaps likely) that neither balance is the true balance. Both balances may need adjustment in order to report the true amount of cash.

After you adjust the balance per bank to be the true balance and after you adjust the balance per books to also be the same true balance, you have reconciled the bank statement. Most accountants would simply say that you have done the bank reconciliation or the bank rec.

In addition to the following explanation of the bank reconciliation, we have developed a visual tutorial, business forms, and exam questions to help you reinforce your understanding. They are part of

Bank Reconciliation Process

Step 1. Adjusting the Balance per Bank

We will demonstrate the bank reconciliation process in several steps. The first step is to adjust the balance on the bank statement to the true, adjusted, or corrected balance. The items necessary for this step are listed in the following schedule:

13X-table-01

Deposits in transit are amounts already received and recorded by the company, but are not yet recorded by the bank. For example, a retail store deposits its cash receipts of August 31 into the bank's night depository at 10:00 p.m. on August 31. The bank will process this deposit on the morning of September 1. As of August 31 (the bank statement date) this is a deposit in transit.

Because deposits in transit are already included in the company's Cash account, there is no need to adjust the company's records. However, deposits in transit are not yet on the bank statement. Therefore, they need to be listed on the bank reconciliation as an increase to the balance per bank in order to report the true amount of cash.

A helpful rule of thumb is "put it where it isn't." A deposit in transit is on the company's books, but it isn't on the bank statement. Put it where it isn't: as an adjustment to the balance on the bank statement.

Outstanding checks are checks that have been written and recorded in the company's Cash account, but have not yet cleared the bank account. Checks written during the last few days of the month plus a few older checks are likely to be among the outstanding checks.

Because all checks that have been written are immediately recorded in the company's Cash account, there is no need to adjust the company's records for the outstanding checks. However, the outstanding checks have not yet reached the bank and the bank statement. Therefore, outstanding checks are listed on the bank reconciliation as a decrease in the balance per bank.

Recall the helpful tip "put it where it isn't." An outstanding check is on the company's books, but it isn't on the bank statement. Put it where it isn't: as an adjustment to the balance on the bank statement.

Bank errors are mistakes made by the bank. Bank errors could include the bank recording an incorrect amount, entering an amount that does not belong on a company's bank statement, or omitting an amount from a company's bank statement. The company should notify the bank of its errors. Depending on the error, the correction could increase or decrease the balance shown on the bank statement. (Since the company did not make the error, the company's records are not changed.)

Step 2. Adjusting the Balance per Books

The second step of the bank reconciliation is to adjust the balance in the company's Cash account so that it is the true, adjusted, or corrected balance. Examples of the items involved are shown in the following schedule:

13X-table-02

Bank service charges are fees deducted from the bank statement for the bank's processing of the checking account activity (accepting deposits, posting checks, mailing the bank statement, etc.) Other types of bank service charges include the fee charged when a company overdraws its checking account and the bank fee for processing a stop payment order on a company's check. The bank might deduct these charges or fees on the bank statement without notifying the company. When that occurs the company usually learns of the amounts only after receiving its bank statement.

Because the bank service charges have already been deducted on the bank statement, there is no adjustment to the balance per bank. However, the service charges will have to be entered as an adjustment to the company's books. The company's Cash account will need to be decreased by the amount of the service charges.

Recall the helpful tip "put it where it isn't." A bank service charge is already listed on the bank statement, but it isn't on the company's books. Put it where it isn't: as an adjustment to the Cash account on the company's books.

An NSF check is a check that was not honored by the bank of the person or company writing the check because that account did not have a sufficient balance. As a result, the check is returned without being honored or paid. (NSF is the acronym for not sufficient funds. Often the bank describes the returned check as a return item. Others refer to the NSF check as a "rubber check" because the check "bounced" back from the bank on which it was written.) When the NSF check comes back to the bank in which it was deposited, the bank will decrease the checking account of the company that had deposited the check. The amount charged will be the amount of the check plus a bank fee.

Because the NSF check and the related bank fee have already been deducted on the bank statement, there is no need to adjust the balance per the bank. However, if the company has not yet decreased its Cash account balance for the returned check and the bank fee, the company must decrease the balance per books in order to reconcile.

Check printing charges occur when a company arranges for its bank to handle the reordering of its checks. The cost of the printed checks will automatically be deducted from the company's checking account.

Because the check printing charges have already been deducted on the bank statement, there is no adjustment to the balance per bank. However, the check printing charges need to be an adjustment on the company's books. They will be a deduction to the company's Cash account.

Recall the general rule, "put it where it isn't." A check printing charge is on the bank statement, but it isn't on the company's books. Put it where it isn't: as an adjustment to the Cash account on the company's books.

Interest earned will appear on the bank statement when a bank gives a company interest on its account balances. The amount is added to the checking account balance and is automatically on the bank statement. Hence there is no need to adjust the balance per the bank statement. However, the amount of interest earned will increase the balance in the company's Cash account on its books.

Recall "put it where it isn't." Interest received from the bank is on the bank statement, but it isn't on the company's books. Put it where it isn't: as an adjustment to the Cash account on the company's books.

Notes Receivable are assets of a company. When notes come due, the company might ask its bank to collect the notes receivable. For this service the bank will charge a fee. The bank will increase the company's checking account for the amount it collected (principal and interest) and will decrease the account by the collection fee it charges.Since these amounts are already on the bank statement, the company must be certain that the amounts appear on the company's books in its Cash account.

Recall the tip "put it where it isn't." The amounts collected by the bank and the bank's fees are on the bank statement, but they are not on the company's books. Put them where they aren't: as adjustments to the Cash account on the company's books.

Errors in the company's Cash account result from the company entering an incorrect amount, entering a transaction that does not belong in the account, or omitting a transaction that should be in the account. Since the company made these errors, the correction of the error will be either an increase or a decrease to the balance in the Cash account on the company's books.

Step 3. Comparing the Adjusted Balances

After adjusting the balance per bank (Step 1) and after adjusting the balance per books (Step 2), the two adjusted amounts should be equal. If they are not equal, you must repeat the process until the balances are identical. The balances should be the true, correct amount of cash as of the date of the bank reconciliation.

Step 4. Preparing Journal Entries

Journal entries must be prepared for the adjustments to the balance per books (Step 2). Adjustments to increase the cash balance will require a journal entry that debits Cash and credits another account. Adjustments to decrease the cash balance will require a credit to Cash and a debit to another account.

Business Plans

Business Plans

Business Plans

 A Step-by-Step Guide

A business plan is a written description of your business's future, a document that tells what you plan to do and how you plan to do it. If you jot down a paragraph on the back of an envelope describing your business strategy, you've written a plan, or at least the germ of a plan.

Business plans are inherently strategic. You start here, today, with certain resources and abilities. You want to get to a there, a point in the future (usually three to five years out) at which time your business will have a different set of resources and abilities as well as greater profitability and increased assets. Your plan shows how you will get from here to there.

Plan Your Business Plan

You've decided to write a business plan, and you're ready to get started. Congratulations. You've just greatly increased the chances that your business venture will succeed. But before you start drafting your plan, you need to--you guessed it--plan your draft.

One of the most important reasons to plan your plan is that you may be held accountable for the projections and proposals it contains. That's especially true if you use your plan to raise money to finance your company. Let's say you forecast opening four new locations in the second year of your retail operation. An investor may have a beef if, due to circumstances you could have foreseen, you only open two. A business plan can take on a life of its own, so thinking a little about what you want to include in your plan is no more than common prudence.

Second, as you'll soon learn if you haven't already, business plans can be complicated documents. As you draft your plan, you'll be making lots of decisions on serious matters, such as what strategy you'll pursue, as well as less important ones, like what color paper to print it on. Thinking about these decisions in advance is an important way to minimize the time you spend planning your business and maximize the time you spend generating income.

To sum up, planning your plan will help control your degree of accountability and reduce time-wasting indecision. To plan your plan, you'll first need to decide what your goals and objectives in business are. As part of that, you'll assess the business you've chosen to start, or are already running, to see what the chances are that it will actually achieve those ends. Finally, you'll take a look at common elements of most plans to get an idea of which ones you want to include and how each will be treated.

Determine Your Objectives

Close your eyes. Imagine that the date is five years from now. Where do you want to be? Will you be running a business that hasn't increased significantly in size? Will you command a rapidly growing empire? Will you have already cashed out and be relaxing on a beach somewhere, enjoying your hard-won gains?

Answering these questions is an important part of building a successful business plan. In fact, without knowing where you're going, it's not really possible to plan at all.

Now is a good time to free-associate a little bit--to let your mind roam, exploring every avenue that you'd like your business to go down. Try writing a personal essay on your business goals. It could take the form of a letter to yourself, written from five years in the future, describing all you have accomplished and how it came about.

As you read such a document, you may make a surprising discovery, such as that you don't really want to own a large, fast-growing enterprise but would be content with a stable small business. Even if you don't learn anything new, though, getting a firm handle on your goals and objectives is a big help in deciding how you'll plan your business.

Goals and Objectives Checklist

If you're having trouble deciding what your goals and objectives are, here are some questions to ask yourself:

How determined am I to see this succeed?

Am I willing to invest my own money and work long hours for no pay, sacrificing personal time and lifestyle, maybe for years?

What's going to happen to me if this venture doesn't work out?

If it does succeed, how many employees will this company eventually have?

What will be its annual revenues in a year? Five years?

What will be its market share in that time frame?

Will it be a niche marketer, or will it sell a broad spectrum of good and services?

What are my plans for geographic expansion? Local? National? Global?

Am I going to be a hands-on manager, or will I delegate a large proportion of tasks to others?

If I delegate, what sorts of tasks will I share? Sales? Technical? Others?

How comfortable am I taking direction from others? Could I work with partners or investors who demand input into the company's management?

Is it going to remain independent and privately owned, or will it eventually be acquired or go public?

Your Financing Goals

It doesn't necessarily take a lot of money to make a lot of money, but it does take some. That's especially true if, as part of examining your goals and objectives, you envision very rapid growth.

Energetic, optimistic entrepreneurs often tend to believe that sales growth will take care of everything, that they'll be able to fund their own growth by generating profits. However, this is rarely the case, for one simple reason: You usually have to pay your own suppliers before your customers pay you. This cash flow conundrum is the reason so many fast-growing companies have to seek bank financing or equity sales to finance their growth. They are literally growing faster than they can afford.

Start by asking yourself what kinds of financing you're likely to need--and what you'd be willing to accept. It's easy when you're short of cash, or expect to be short of cash, to take the attitude that almost any source of funding is just fine. But each kind of financing has different characteristics that you should take into consideration when planning your plan. These characteristics take three primary forms:

First, there's the amount of control you'll have to surrender. An equal partner may, quite naturally, demand approximately equal control. Venture capitalists often demand significant input into management decisions by, for instance, placing one or more people on your board of directors. Angel investors may be very involved or not involved at all, depending on their personal style. Bankers, at the other end of the scale, are likely to offer no advice whatsoever as long as you make payments of principal and interest on time and are not in violation of any other terms of your loan.

You should also consider the amount of money you're likely to need. Any amount less than several million dollars is too small to be considered for a standard initial public offering of stock, for example. Venture capital investors are most likely to invest amounts of $250,000 to $3 million. On the other hand, only the richest angel investor will be able to provide more than a few hundred thousand dollars, if that.

Almost any source of funds, from a bank to a factor, has some guidelines about the size of financing it prefers. Anticipating the size of your needs now will guide you in preparing your plan.

The third consideration is cost. This can be measured in terms of interest rates and shares of ownership as well as in time, paperwork and plain old hassle.

How Will You Use Your Plan

Believe it or not, part of planning your plan is planning what you'll do with it. No, we haven't gone crazy--at least not yet. A business plan can be used for several things, from monitoring your company's progress toward goals to enticing key employees to join your firm. Deciding how you intend to use yours is an important part of preparing to write it.

Do you intend to use your plan to help you raise money? In that case, you'll have to focus very carefully on the executive summary, the management, and marketing and financial aspects. You'll need to have a clearly focused vision of how your company is going to make money. If you're looking for a bank loan, you'll need to stress your ability to generate sufficient cash flow to service loans. Equity investors, especially venture capitalists, must be shown how they can cash out of your company and generate a rate of return they'll find acceptable.

Do you intend to use your plan to attract talented employees? Then you'll want to emphasize such things as stock options and other aspects of compensation as well as location, work environment, corporate culture and opportunities for growth and advancement.

Do you anticipate showing your plan to suppliers to demonstrate that you're a worthy customer? A solid business plan may convince a supplier of some precious commodity to favor you over your rivals. It may also help you arrange supplier credit. You may want to stress your blue-ribbon customer list and spotless record of repaying trade debts in this plan.

Assessing Your Company's Potential

For most of us, unfortunately, our desires about where we would like to go aren't as important as our businesses' ability to take us there. Put another way, if you choose the wrong business, you're going nowhere.

Luckily, one of the most valuable uses of a business plan is to help you decide whether the venture you have your heart set on is really likely to fulfill your dreams. Many, many business ideas never make it past the planning stage because their would-be founders, as part of a logical and coherent planning process, test their assumptions and find them wanting.

Test your idea against at least two variables. First, financial, to make sure this business makes economic sense. Second, lifestyle, because who wants a successful business that they hate?

Answer the following questions to help you outline your company's potential. There are no wrong answers. The objective is simply to help you decide how well your proposed venture is likely to match up with your goals and objectives.

Financial:

What initial investment will the business require?

How much control are you willing to relinquish to investors?

When will the business turn a profit?

When can investors, including you, expect a return on their money?

What are the projected profits of the business over time?

Will you be able to devote yourself full time to the business, financially?

What kind of salary or profit distribution can you expect to take home?

What are the chances the business will fail?

What will happen if it does?

Lifestyle:

Where are you going to live?

What kind of work are you going to be doing?

How many hours will you be working?

Will you be able to take vacations?

What happens if you get sick?

Will you earn enough to maintain your lifestyle?

Does your family understand and agree with the sacrifices you envision?

Sources: The Small Business Encyclopedia, Business Plans Made Easy, Start Your Own Business and Entrepreneur magazine.

Continue on to the next section of our Business Plan How-To >> Elements of a Business Plan

business Objectives

business Objectives

business Objectives

You've decided to write a business plan, and you're ready to get started. Congratulations. You've just greatly increased the chances that your business venture will succeed. But before you start drafting your plan, you need to--you guessed it--plan your draft.

One of the most important reasons to plan your plan is that you may be held accountable for the projections and proposals it contains. That's especially true if you use your plan to raise money to finance your company. Let's say you forecast opening four new locations in the second year of your retail operation. An investor may have a beef if, due to circumstances you could have foreseen, you only open two. A business plan can take on a life of its own, so thinking a little about what you want to include in your plan is no more than common prudence.

Second, as you'll soon learn if you haven't already, business plans can be complicated documents. As you draft your plan, you'll be making lots of decisions on serious matters, such as what strategy you'll pursue, as well as less important ones, like what color paper to print it on. Thinking about these decisions in advance is an important way to minimize the time you spend planning your business and maximize the time you spend generating income.

To sum up, planning your plan will help control your degree of accountability and reduce time-wasting indecision. To plan your plan, you'll first need to decide what your goals and objectives in business are. As part of that, you'll assess the business you've chosen to start, or are already running, to see what the chances are that it will actually achieve those ends. Finally, you'll take a look at common elements of most plans to get an idea of which ones you want to include and how each will be treated.

Determine Your Objectives

Close your eyes. Imagine that the date is five years from now. Where do you want to be? Will you be running a business that hasn't increased significantly in size? Will you command a rapidly growing empire? Will you have already cashed out and be relaxing on a beach somewhere, enjoying your hard-won gains?

Answering these questions is an important part of building a successful business plan. In fact, without knowing where you're going, it's not really possible to plan at all.

Now is a good time to free-associate a little bit--to let your mind roam, exploring every avenue that you'd like your business to go down. Try writing a personal essay on your business goals. It could take the form of a letter to yourself, written from five years in the future, describing all you have accomplished and how it came about.

As you read such a document, you may make a surprising discovery, such as that you don't really want to own a large, fast-growing enterprise but would be content with a stable small business. Even if you don't learn anything new, though, getting a firm handle on your goals and objectives is a big help in deciding how you'll plan your business.

Goals and Objectives Checklist

If you're having trouble deciding what your goals and objectives are, here are some questions to ask yourself:

How determined am I to see this succeed?

Am I willing to invest my own money and work long hours for no pay, sacrificing personal time and lifestyle, maybe for years?

What's going to happen to me if this venture doesn't work out?

If it does succeed, how many employees will this company eventually have?

What will be its annual revenues in a year? Five years?

What will be its market share in that time frame?

Will it be a niche marketer, or will it sell a broad spectrum of good and services?

What are my plans for geographic expansion? Local? National? Global?

Am I going to be a hands-on manager, or will I delegate a large proportion of tasks to others?

If I delegate, what sorts of tasks will I share? Sales? Technical? Others?

How comfortable am I taking direction from others? Could I work with partners or investors who demand input into the company's management?

Is it going to remain independent and privately owned, or will it eventually be acquired or go public?

Your Financing Goals

It doesn't necessarily take a lot of money to make a lot of money, but it does take some. That's especially true if, as part of examining your goals and objectives, you envision very rapid growth.

Energetic, optimistic entrepreneurs often tend to believe that sales growth will take care of everything, that they'll be able to fund their own growth by generating profits. However, this is rarely the case, for one simple reason: You usually have to pay your own suppliers before your customers pay you. This cash flow conundrum is the reason so many fast-growing companies have to seek bank financing or equity sales to finance their growth. They are literally growing faster than they can afford.

Start by asking yourself what kinds of financing you're likely to need--and what you'd be willing to accept. It's easy when you're short of cash, or expect to be short of cash, to take the attitude that almost any source of funding is just fine. But each kind of financing has different characteristics that you should take into consideration when planning your plan. These characteristics take three primary forms:

First, there's the amount of control you'll have to surrender. An equal partner may, quite naturally, demand approximately equal control. Venture capitalists often demand significant input into management decisions by, for instance, placing one or more people on your board of directors. Angel investors may be very involved or not involved at all, depending on their personal style. Bankers, at the other end of the scale, are likely to offer no advice whatsoever as long as you make payments of principal and interest on time and are not in violation of any other terms of your loan.

You should also consider the amount of money you're likely to need. Any amount less than several million dollars is too small to be considered for a standard initial public offering of stock, for example. Venture capital investors are most likely to invest amounts of $250,000 to $3 million. On the other hand, only the richest angel investor will be able to provide more than a few hundred thousand dollars, if that.

Almost any source of funds, from a bank to a factor, has some guidelines about the size of financing it prefers. Anticipating the size of your needs now will guide you in preparing your plan.

The third consideration is cost. This can be measured in terms of interest rates and shares of ownership as well as in time, paperwork and plain old hassle.

How Will You Use Your Plan

Believe it or not, part of planning your plan is planning what you'll do with it. No, we haven't gone crazy--at least not yet. A business plan can be used for several things, from monitoring your company's progress toward goals to enticing key employees to join your firm. Deciding how you intend to use yours is an important part of preparing to write it.

Do you intend to use your plan to help you raise money? In that case, you'll have to focus very carefully on the executive summary, the management, and marketing and financial aspects. You'll need to have a clearly focused vision of how your company is going to make money. If you're looking for a bank loan, you'll need to stress your ability to generate sufficient cash flow to service loans. Equity investors, especially venture capitalists, must be shown how they can cash out of your company and generate a rate of return they'll find acceptable.

Do you intend to use your plan to attract talented employees? Then you'll want to emphasize such things as stock options and other aspects of compensation as well as location, work environment, corporate culture and opportunities for growth and advancement.

Do you anticipate showing your plan to suppliers to demonstrate that you're a worthy customer? A solid business plan may convince a supplier of some precious commodity to favor you over your rivals. It may also help you arrange supplier credit. You may want to stress your blue-ribbon customer list and spotless record of repaying trade debts in this plan.

Assessing Your Company's Potential

For most of us, unfortunately, our desires about where we would like to go aren't as important as our businesses' ability to take us there. Put another way, if you choose the wrong business, you're going nowhere.

Luckily, one of the most valuable uses of a business plan is to help you decide whether the venture you have your heart set on is really likely to fulfill your dreams. Many, many business ideas never make it past the planning stage because their would-be founders, as part of a logical and coherent planning process, test their assumptions and find them wanting.

Test your idea against at least two variables. First, financial, to make sure this business makes economic sense. Second, lifestyle, because who wants a successful business that they hate?

Answer the following questions to help you outline your company's potential. There are no wrong answers. The objective is simply to help you decide how well your proposed venture is likely to match up with your goals and objectives.

Financial:

What initial investment will the business require?

How much control are you willing to relinquish to investors?

When will the business turn a profit?

When can investors, including you, expect a return on their money?

What are the projected profits of the business over time?

Will you be able to devote yourself full time to the business, financially?

What kind of salary or profit distribution can you expect to take home?

What are the chances the business will fail?

What will happen if it does?

Lifestyle:

Where are you going to live?

What kind of work are you going to be doing?

How many hours will you be working?

Will you be able to take vacations?

What happens if you get sick?

Will you earn enough to maintain your lifestyle?

Does your family understand and agree with the sacrifices you