Introduction to QuickBooks Online Edition Course Manual

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1 Introduction to QuickBooks Online Edition Course Manual Module 2 Setting Up the Chart of Accounts Copyright Notice. Each module of the Introduction To QuickBooks Course Manual may be viewed online, saved to disk, or printed (each is composed of 10 to 15 printed pages of text) by students enrolled in the author s accounting course for use in that course. Otherwise, no part of the Course Manual or its modules may be reproduced or copied in any form or by any means graphic, electronic, or mechanical, including photocopying, taping, or information storage and retrieval systems without the written permission of the author. Requests for permission to use or reproduce these materials should be mailed to the author About Accounting QuickBooks and other accounting software programs often downplay the need for understanding accounting, but a sound grasp of accounting fundamentals is necessary when working with any accounting system, whether automated or not. All accounting systems are designed to record information about the company s assets, liabilities and owner s equity. Assets Assets are resources that the business owns that have not expired or were not used up in the current period. Examples include cash balances in checking accounts and savings accounts, supplies, equipment, vehicles, buildings, and inventory. Assets also include amounts that customers owe to the business (these amounts are called Accounts Receivable, or receivables for short). Liabilities Liabilities are the amounts that the company owes to its creditors. Examples would include amounts owed to suppliers, the utility company, employees, and state and local governments. The account used for short-term amounts owed to Craig Pence, All Rights Reserved.

2 Introduction to QuickBooks, Module 2 2 suppliers is called Accounts Payable, or payables for short. Other liability accounts include Wages Payable, Notes Payable, and Taxes Payable, among others. Owner s Equity Owner's Equity is the ownership interest of the owner in the business' assets. It is equal to the difference between what is owned by the business (the business assets) and what is owed (its liabilities). This is a residual concept, and it can be expressed in an equation: Equity = Assets Liabilities. For example, if the business failed and it was then liquidated, its assets would be sold and the creditors would be paid from the proceeds. Whatever is left over, the "residue," would go to the owner. Therefore, the owner's equity in the business assets is equal to the value of the assets minus the amounts owed to creditors (the liabilities). The greater the owner's equity in the business, the more creditworthy the business will be. This is because a large amount of owner's equity means that the liabilities are small, making it more likely that the liabilities can be paid. If a business is unable to pay its liabilities when they come due, and cannot raise the money to pay them, the business is said to be insolvent. Unless additional financing can be found, the business will probably be unable to pay its creditors and it will go bankrupt. Owner s equity comes from two sources: Asset investments in the company by the owner Business profits retained in the business and not withdrawn by the owner. These reinvested profits are called Retained earnings, and they increase owner's equity. Withdrawals are referred to as owner draws, and draws reduce owner s equity. The Accounting Equation In the section above, we noted that the Owner s Equity = Assets Liabilities. Turning this around, we have: Assets = Liabilities + Owner s Equity This equation is called the accounting equation, and it is the basis for a double-entry accounting system. Since the assets in the business are owned either by creditors or by

3 Introduction to QuickBooks, Module 2 3 the owner, then the sum of the assets must equal the sum of the ownership claims of creditors against the business assets (the liabilities) plus the ownership interest of the owner (the owner s equity). If you would like to view a short video presentation that explains the accounting equation and introduces basic accounting principles, just click here: Cash-Basis Versus Accrual-Basis Accounting. When we were setting up our business preferences in Module 1, we selected accrual basis as our accounting method. We were also given the option to use the cash basis method, but we did not select it. Accounting systems utilize either cash basis or accrual basis accounting. The method chosen determines when and how revenues and expenses will be recorded. Cash basis Many small businesses record income when money is received and expenses when the bills are paid. This cash in cash out method is known as cash basis accounting. If the bookkeeper has been recording deposits of the customers payments but hasn t been including the money customers owe the business as part of income, cash basis is being used. Similarly, if the bookkeeper has been recording expenses at the time they are paid, rather than at the time the bills are first received, cash-basis has been used. Accrual basis Under accrual-basis accounting, income is recorded when it has been earned, whether or not payment has been received. Likewise, expenses are recorded when the they have been incurred, whether or not they have been paid. The accrual method provides a more accurate picture of business profitability because it matches up all the expenses that were incurred during the period with all the revenue that was earned during that period. Creditors often require that the reports that accompany loan applications be prepared using the accrual basis. Furthermore, a CPA cannot express an audit opinion on financial statements that are not prepared on the accrual basis. For these reasons, larger sized businesses usually use the accrual basis method, and small businesses may decide to follow suit.

4 Introduction to QuickBooks, Module 2 4 Here's an Example! Suppose Gordon's Gardening Service has collected $100 from customers this week for work done during the week, and has done $900 of work for other customers on account. The $900 will be collected next week. Suppose further that $200 of expenses have been paid this week, but another $100 of expenses were incurred on account and must be paid next week. How profitable has the business been? Under cash basis accounting, the amount of revenue recorded for the week is equal to only the $100 collected from the customers. The amount of the expenses for the week is equal to the $200 that was paid. This results in a net loss of $100 for the week. However, we know that $1,000 of revenue was actually earned, and $300 of expenses were incurred. These are the amounts that would be reported under accrual basis accounting, and they result in a $700 profit for the week. This $700 accrual-basis profit is obviously a much more accurate reflection of reality than the $100 loss produced by the cash basis method. Conclusion: Cash basis accounting is easier to use than accrual basis, but it is likely to produce distortions when reporting on profits and losses for a period of time. Therefore, the accrual basis accounting method is usually preferred over the cash basis accounting method. IRS Requirements In general, large businesses must use accrual basis accounting for tax purposes. However, the IRS does allow small businesses to use the cash basis. What is a small business? Any business that averages less than $1 million in gross receipts for the prior three years may use the cash basis. For example, at the beginning of 2012, a business that wishes to use the cash basis will need to compute its average gross receipts from 2009, 2010 and If the average is less than $1 million, it will be allowed to use the cash basis. If the business has been in existence for less than 3 years, the receipts from the years that it has been in operation are averaged. Depending on the type of business, preparing tax returns on a cash basis can be more advantageous than preparing them on the accrual basis. For one thing, cash basis is easier to use and it can reduce accounting fees. Also, under the cash basis, the business is only

5 Introduction to QuickBooks, Module 2 5 taxed on what it collects from customers. Under the accrual method, taxes are based on what it has billed its customers. If the business has many credit customers and carries a large amount of receivables, less revenue may be reported on the tax return under the cash basis method and the tax bill may be reduced. However, for businesses with few or no receivables, such as retail stores and restaurants, the accrual basis may be more beneficial. If the cash basis method is used, only cash expenses can be deducted. Under the accrual basis method, the business can deduct expenses when they have been incurred, not just when they have been paid. This can reduce the tax bill. The choice between the cash-basis and accrual-basis methods is an important one, and the business owner should consult with his or her accountant before making the selection. Once a method is chosen, the business cannot arbitrarily switch back and forth between the two methods for tax purposes. The accounting method is selected on the business initial tax return and any change from that accounting method requires IRS approval. Does the Choice of Accounting Method Affect QuickBooks Transactions? The choice we make regarding the cash or accrual method has no effect on the way transactions are recorded in QuickBooks. Regardless of the method used, customer invoices are recorded when it is time to bill the customer and the invoice is entered into QuickBooks. Bills are recorded when they are received and recorded in QuickBooks for later payment. When it is time to prepare reports, the system, by default, automatically utilizes the accrual basis method. That is, income is reported for customer invoices as soon as they are recorded, even if payment has not been received. Expenses appear in the reports as soon as bills are recorded, even if they re unpaid. However, when reports are created in QuickBooks, we can easily switch between the cash-basis and accrual-basis methods by simply clicking a button. This is illustrated in a later module. Measuring Business Profitability and Credit-Worthiness Two of the most important reports for measuring the profitability and the creditworthiness of the business are the profit and loss statement (also called an income statement) and the balance sheet. These are the reports most often requested by CPAs and financial officers. (For example, banks request both documents when the business applies for a loan.) Our business is setting up its accounts in QuickBooks on October 31. The profit and loss statement for our business will tell us how much profit has been earned in the first 10 months of the year, and the balance sheet will show us what we have in assets, liabilities and owner s equity at the present time.

6 Introduction to QuickBooks, Module 2 6 The profit and loss statement A profit and loss statement (or income statement) reports the revenues that were earned, the expenses that were incurred, and net profit or loss (equal to revenues minus expenses) that resulted from operating the business over a period of time. The QuickBooks income statement summarizes the revenue and expenses of the business by category (first income, then expenses). The income statement below was prepared for your business, and it reports your earnings for 2011 from the beginning of the year until the present time, October 31, 2011: <Your Name> Service Company Profit and Loss Statement January 1 through October 31, 2011 Revenues: Service Revenues $ 70,000 Expenses: Operating Expenses $ 10,000 Rent Expense 20,000 Supplies Expense 15,000 Total Expenses $ - 45,000 Net Income $ 25,000 The Balance Sheet A balance sheet is a financial snapshot of your company on one date. It shows: What you have (assets) What people owe you (accounts receivable) What your business owes to other people (liabilities and accounts payable) The net worth of your business (equity) <Your Name> Service Company Balance Sheet The <Your Name> Service Company that you set up in QuickBooks in Module 1 is an existing business, and it is converting from a manual pen-and-ink accounting system to QuickBooks Online Edition on October 31, It has an existing set of accounts, and has balances in them. The balance sheet for the company, as of October 31, 2011 is as follows:

7 Introduction to QuickBooks, Module 2 7 ASSETS Current Assets: Cash $ 5,000 Accounts Receivable 5,000 Prepaid Rent 0 Prepaid Insurance 1,200 Supplies 600 Total Current Assets $ 11,800 Fixed Assets: Automobile $ 20,000 Depreciation (3,000) $ 17,000 Office Equipment 6,000 Depreciation (1,000) 5,000 Total Fixed Assets 22,000 TOTAL ASSETS 33,800 LIABILITIES AND EQUITY Liabilities: Current Liabilities: Accounts Payable $ 3,000 MasterCard Payable 1,523 Total Current Liabilities $ 4,523 Long Term Liabilities: Loan Payable 3,000 Total Liabilities 7,523 Ow ner's Equity: <Your Name> Service Company Balance Sheet October 31, 2011 <Your Name>, Capital 26,277 TOTAL LIABILITIES AND EQUITY 33,800 The Chart of Accounts When we keep books for a company, we want to keep track of the business assets and liabilities, and the owner s equity in the business. We also want to know how much income we earned, where the income came from, what the expenses were, and what caused them to be incurred. This information is recorded in the set of accounts that have been established for the business. This set of accounts is called the chart of accounts. In general, there are two types of accounts: The balance sheet accounts (also called permanent accounts) are the asset, liability and owner s equity accounts. The income statement accounts (also called temporary accounts) are the income and expense accounts.

8 Introduction to QuickBooks, Module 2 8 Displaying the Chart of Accounts Login to QuickBooks Online Edition by going to and entering your username and password. When your Home Page appears, click the Company tab. QuickBooks displays the chart of accounts that was automatically established for our company through the setup process: Scroll through the accounts that are listed here. Note that the balance sheet accounts are displayed first (the assets, liabilities and owner s equity), followed by income statement (revenue and expense) accounts. Also note that we are given a very broad set of accounts

9 Introduction to QuickBooks, Module 2 9 to begin with and that they do not match the accounts that are actually used by our company and reported on the current <Your Name> Service Company balance sheet (see page 7 above). Fortunately, QuickBooks makes it easy to add, delete, or edit the accounts, so we will be able to modify the chart of accounts that QuickBooks has given us and bring it into line with the accounts the business actually uses. Account Terminology You are probably thinking that several of the accounts that appear in our chart of accounts are different. They don t look like the ones that you may have seen in introductory accounting textbooks. Retained Earnings? Billable Expense Income? Undeposited Funds? For now we should simply accept that fact that in the business world the accounts utilized by actual companies are not standardized. In general, assets are still assets, liabilities are liabilities, and owner's equity is owner s equity; but the way this information is reported differs from company to company and their terminology is not likely to conform with the terms that were presented in your accounting textbook. The "Standard" Chart of Accounts When we set up our business in Module 1, we accepted the standard chart of accounts for a service business as provided by QuickBooks. Alternatively, we could have chosen to create an empty chart of accounts by clicking Create an empty chart of accounts (see below). Caution - do not attempt to change your setup selection; we are only discussing the possibility of creating an empty chart of accounts. If we choose to create an empty chart of accounts, we will have to enter the accounts into QuickBooks individually. This is a time-consuming process, and it is usually easier to accept the standard accounts and then modify them to suit the needs of the business. QuickBooks and Account Types In QuickBooks, the chart of accounts is divided into 15 different account types. When an account is created, the account type selected determines where the account will be listed on financial statements and other reports. There are 10 balance sheet account types and 5 income statement account types in QuickBooks. The table below lists and describes them.

10 Introduction to QuickBooks, Module 2 10 Understanding QuickBooks Account Types Bank Accounts Receivable Other Current Asset Fixed Asset Other Asset Account Payable Credit Card Other Current Liability Long-Term Liability Equity Income Cost of Goods Sold Expense Other Income Other Expense Balance Sheet Account Types Use these accounts for checking, savings and money market accounts. Add one bank type account for every account maintained at banks or other institutions. This account type can also be used for Petty Cash. Use these accounts for transactions related to customers who own the company money. Includes accounts used to record invoices, customer deposits, refunds, credit memos, and other items appearing on customer statements. If it has not been set up, QuickBooks automatically creates an Accounts Receivable account the first time an invoice is created. Additional receivable type accounts may be created if needed. These accounts are used for assets that will be converted to cash or used up within one year from the present date. This account type is used for depreciable assets that are not likely to be converted into cash or used up within one year from the present date. This account type is used for assets that are not current assets or fixed assets, such as long-term notes receivable. Used to record transactions related to money the company owes, including vendors bills and any credits the company has with vendors. If one has not been set up, QuickBooks automatically creates an accounts payable account the first time a bill is entered. Used to track credit card purchases. This account type is used for liabilities due within one year, such as sales tax, payroll taxes, accrued expenses, and short-term loans. QuickBooks automatically creates accounts for sales tax payable and payroll liabilities. Used for liabilities due more than one year from the present, such as loans and mortgages. This account type is used to track owner s equity, including investments, drawings, and retained earnings. QuickBooks creates an Opening Balance Equity and a Retained Earnings account automatically. Income Statement Account Types Income account types track revenues from the sale of the products and services that are the main source of income for the business. This account type is used for the costs of services and materials directly related to income production, including goods and materials held in inventory. Expense account types are used to record the expenses incurred by the business for services provided to it or assets consumed by business operations. Other income account types track income earned from other than normal business operations, such as interest income or income from other peripheral activities. This account type is used to record expenses arising from other than normal business operations, such as income tax or interest expense.

11 Introduction to QuickBooks, Module 2 11 More about Accounts and Account Types in QuickBooks The following rules apply to the accounts and account types used in QuickBooks Online Edition: The 15 account types are the only ones that are allowed in QuickBooks. Users cannot add account types to the list or alter the 15 account types provided. Users cannot change the names of the account types, though the account titles can be edited and changed in any way the user wants. Within each account type, the accounts themselves are, by default, listed alphanumerically. Users can only change the order of the accounts in the Online Edition by making accounts sub-accounts of other accounts or by assigning account numbers to the accounts in the order the user wants them to be displayed. These topics are discussed below. Adding Accounts and Entering Opening Balances QuickBooks will allow us to create accounts directly and establish opening balances in them. QuickBooks also provides us with the option to use mini-interviews to set up many standard accounts. It is often wise to use the mini-interview when it is available, since this ensures that the account is set up correctly within QuickBooks. Setting Up a Bank Account Let s begin by establishing a QuickBooks account for our bank checking account (i.e., a Cash account). If this account is set up correctly, it will be listed as the first of the asset accounts on our company's balance sheet, since that is the proper place for cash balances to appear. It will also be the account that is reduced when we write checks and increased when we record bank deposits. Since QuickBooks uses a forms-based approach to data entry, we will not always see the account that is being affected when we complete a bill payment form, write a check, or record a deposit, so we want to make sure that the account is set up correctly. Using the mini-interview process will ensure that the First Bank account is set up properly in QuickBooks, so that is the approach we will take. Click the New button the bottom of the Chart of Accounts page:

12 Introduction to QuickBooks, Module 2 12 A mini-interview box appears (see opposite), the first of 5 that we will complete in setting up this new account. Since we want to set up a bank checking account, click the Bank Account button, and then click Next. Another mini interview box appears, asking us to select the type of bank account we want to establish (see below). Note that we can set up many different types of bank accounts here in addition to checking. Select Checking as the bank account type, and then click Next. A final mini-interview box appears that asks us to enter the details about the account, including its opening balance (see below). Enter First Bank Checking as the name of the account. Leave the other fields blank. Click on the No button below Download transactions from my bank? and a Balance field and date field appear. Enter $5,000 as the balance, and November 1, 2011 as the date. Click Finish after filling in the information and you will be returned to the Chart of Accounts page. You should see the screen below:

13 Introduction to QuickBooks, Module 2 13 Note that First Bank Checking is now listed among the assets, and a new account, Opening Balance Equity appears with Retained Earnings as a new equity account. This opening balance account is equivalent to the Capital account that is presented in introductory accounting textbooks. Both accounts have a balance of $5,000. This is appropriate since the business received a contribution of assets from the owner. Assets must be equal to Liabilities and Owner s Equity, so the investment of assets into the business by the owner increases both the assets and the owner s equity in the business. Setting Up a Credit Card Account To set up a credit card account, let s again click the New button at the bottom of the chart of accounts screen: The mini-interview box again appears (see opposite). Since we want to set up a credit card account this time, click the Credit card button, and then click Next. Another mini interview box appears that asks us for details about the account (see the illustration on the following page). Enter MasterCard as the name of the account. Leave the "Number" and "Description" fields blank. Click on the No button below Download transactions from my bank? and a Balance field and date field appear. Enter $1,523 as the balance, and November 1, 2011 as the date.

14 Introduction to QuickBooks, Module 2 14 Click Finish after filling in the information and you will be returned to the Chart of Accounts page. You should now see a new account, MasterCard, with a balance of $1,523: Note that the Opening Balance Equity account balance has been reduced. This is appropriate because Assets must equal Liabilities and Owner s Equity. Since the credit card balance is a liability, the owner s equity fell when the liability was contributed to the business by the owner. Adding Other Non-Standard Accounts The QuickBooks chart of accounts is extremely flexible, and accounts can be added, edited and deleted as circumstances dictate. If it is known that a particular account will be needed later during the period, it can be added prior to recording the period s transactions. Accounts can also be added on the fly, as a transaction is recorded. This will be illustrated in a later module. In all these cases, QuickBooks makes the addition of new accounts an easy process, but we need to be aware that QuickBooks classifies new accounts according to its default settings. When we set up the checking account earlier and clicked "bank account" on the new account page, QuickBooks automatically classified the account as a cash-equivalent current asset. The account classification determines how the account will be displayed on the company's financial statements. What if our account should actually be classified as some other kind of asset? Adding Interest Expense Let's illustrate this problem regarding account types with an example concerning interest expense. Suppose we realize that we will need to record interest expense on a business loan that is currently outstanding. Since there is no Interest Expense account in our chart of accounts, let s add one. Once again, click on the New button at the bottom of the Chart of Accounts screen:

15 Introduction to QuickBooks, Module 2 15 The mini-interview box again appears (see opposite). Expense is shown on the list of account types, but selecting it means that we will allow QuickBooks to determine the account's classification and the way it will be displaying on the financial statements. This was acceptable to us when we set up the bank and credit card accounts, but suppose we want to make sure that the new Interest Expense account is classified according to our preferences. We are able to do this by selecting Choose from all account types. Click the button beside Choose from all account types, and then click Next at the bottom of the screen. The screen shown opposite appears, and we see that there are two expense types that we can choose between, "Expense" and "Other Expense." Select the Other expense option, then click Next. We see the screen below. Amortization and depreciation are expenses associated with wear and tear from the use of equipment or the expiration over time of patents and other legal protections. Interest is a different type of expense, so select Other miscellaneous expense and click Next. The screen illustrated on the following page now appears.

16 Introduction to QuickBooks, Module 2 16 Type Interest Expense as the name of the account, and click on Finish. After clicking Finish, you will be returned to the chart of accounts screen, and you should see the new account listed in the Chart of Accounts (see below). Note that the "Interest Expense" account is classified as "Other Expense." Had we not clicked "choose from all account types" and then miscellaneous other expense when we set up the account, QuickBooks would have assigned it the account classification of "Expenses" instead of "Other Expense." Non-operating kinds of expenses, like interest, should be classified and reported on the income statement as something other than a regular operating expense. Operating expenses are incurred directly in the operation of the business, while interest represents the cost of financing the business. Examples of operating expenses include heating and lighting, salaries, advertising, and so on. Just remember that "Other Expense" is the expense category used for a non-operating kind of expense, and Expense is used for the operating expenses. Adding an Equipment Account "Fixed Assets" are long-term assets such as machinery, vehicles or equipment. Adding a fixed asset account to QuickBooks is a little more complicated process than what we have experienced so far, since fixed assets depreciate as they are used and an Accumulated Depreciation account must be maintained along with the fixed asset account.

17 Introduction to QuickBooks, Module 2 17 "Accumulated Deprecation" is a contra-asset account, which means its balance is subtracted from the fixed asset account balance when financial statements are prepared. The resulting dollar amount is referred to as the book value of the fixed asset. This is because it represents the net amount (original cost minus accumulated depreciation) at which the asset is carried in the company s books. To add an Equipment account, once again click on the New button at the bottom of the chart of accounts screen. There is no "Equipment" button to click on the account type screen, so select Choose from all account types again, just as you did above, then click Next (see opposite). The mini-interview screen for account types appears. Select Fixed assets (see opposite). Click Next, and you will see the screen on the following page.

18 Introduction to QuickBooks, Module 2 18 There are many different types of assets, and it is important that we categorize the assets correctly. The category we place them in determines how they will be reported on the balance sheet. Since we are setting up an equipment account, select Machinery and Equipment as the asset type (see opposite). Click Next. When the final mini-interview screen appears, type Office Equipment as the name of the account and make sure the Yes button is selected for the answer to the question, Do you want to track depreciation of this asset? Click Next, and you will see the screen below. Since this equipment was acquired on January 1, 2008, enter this as the date on the Original cost line. Enter the original cost of the equipment, $6,000, as the amount. This asset has been used in the business since 2008, and it was depreciated during 2008, 2009, 2010 and part of Enter the amount of the accumulated depreciation, $1,000, on the second line, and enter a date of November 1, Now click Finish. When you do, a popup box appears (see below).

19 Introduction to QuickBooks, Module 2 19 This is the warning we receive when we attempt to record a transaction, or to make a change in a previously recorded transaction, that is dated prior to the date the accounts were last closed (that is, prior to January 1, 2011). Click Yes and you will be returned to the Chart of Accounts page. The Equipment account and its Accumulated Depreciation account now appear in the chart of accounts. Note that the owner s equity has also increased by $5,000. This is appropriate since the owner has contributed an asset that is worth $5,000 to the business. Note that Depreciation and Original Cost appear below the Office Equipment account, and that they are indented. This means that they are sub-accounts of the parent account above them (Office Equipment). These sub-accounts were automatically created by QuickBooks when we completed the mini-interview and indicated that we wanted to track depreciation on the equipment. We can also create sub-accounts, and they can be very useful to us in the accounting and reporting process. Sub-accounts A sub-account is merely a piece of the parent account, and QuickBooks makes it easy to divide accounts up this way. You may have noticed that when we added the Office Equipment account, we were given the opportunity to make the new account a subaccount (see opposite). Had we checked the Is sub-account box, we would have been asked to specify the parent account.

20 Introduction to QuickBooks, Module 2 20 Why Use Sub-accounts? It can sometimes be helpful to break an account up into pieces by adding sub-accounts to it. For example, if there are two of us writing checks against the checking account, we might want to add two sub-accounts to the First Bank Checking account, one for you and one for me. That way the total balance could be divided into two pieces, and you would make deposits into your piece and write checks against it. I would do the same with my piece. If one of us overwrites the portion of the account that belongs to us, we will see a negative amount as the balance in that sub-account. In the case of equipment and other depreciable assets, QuickBooks records the original cost of the equipment in one sub-account, Original Cost, and the accumulated depreciation that has been recorded for the asset in another sub-account, Depreciation. Since depreciation reduces the equipment account, it appears as a negative amount. The parent account, Office Equipment, has a balance that is equal to the sum of the two subaccounts ($6,000 - $1,000 = $5,000). This amount is the book value of the asset. Adding an Automobile Account Let s now set up a new account for an automobile that the owner contributed to the business in Once again, from the Chart of Accounts window click on New at the bottom of the screen. When the screen shown opposite appears, select the Car option and then click Next. Note that you could also click Choose from all account types and go through the same steps that we did with the equipment. Selecting Car, though, saves you some time and takes you immediately to the What do you want to call this account? screen (see opposite).

21 Introduction to QuickBooks, Module 2 21 When the next screen appears, allow the account name to remain Vehicles. Click Yes in answer to the question regarding depreciation, then click Next. The next screen asks for cost and depreciation information. Our car was acquired on January 1, 2008 at a cost of $15,000, and it had been depreciated by $3,000 by November 1, Enter these amounts and dates for original cost and depreciation, as shown in the illustration opposite. Click Finish and you will again see the warning message about entering an opening balance that is dated prior to the closing date. Answer Yes, and you will be returned to the Chart of Accounts page. Your chart of accounts should match the illustration below: Note that Vehicles now appears on the chart of accounts, along with its sub-accounts. Note also that the owner s equity in the business has increased by the $12,000 book value of the automobile that the owner contributed to the business.

22 Introduction to QuickBooks, Module 2 22 Compare your chart of accounts with the illustration above. If yours does not match, you will need to edit your accounts and make corrections. Don t try to do this now, but instead complete the remainder of the module. In it, we explain how the accounts can be edited and illustrate the way that errors can be corrected. Correcting Errors in the Chart of Accounts It is very easy to make mistakes when setting up accounts or recording transactions, but it is also usually easy to correct them in QuickBooks. Mistakes are a fact of life, and are inevitable. In fact, we just made one! The cost of the automobile we just entered should have been $20,000 instead of $15,000. To correct the amount, first open the account register for the Vehicles account by double-clicking Vehicles on the Chart of Accounts screen (the highlighted account in the illustration above): This register is simply the general ledger Vehicles account, where all the entries that have been made to the account have been recorded. When we open the account register, we can see all the account entries and, if necessary, edit them and make changes. By looking inside the account, we can see that an increase, dated January 1, 2008, was recorded for the incorrect amount of $15,000. A $3,000 decrease was also recorded on

23 Introduction to QuickBooks, Module 2 23 November 1, As we know, these two amounts were actually recorded in the subaccounts Opening Balance and Depreciation, but since the sub-accounts are just pieces of the parent account, both are shown here in the Vehicles parent account. To make the correction, click once on the $15,000 amount. The $15,000 amount now darkens and becomes active for editing: Since the $15,000 amount is now active, we could simply type in $20,000 to change the amount and then click "Save." (Don t do this). However, there are usually many ways to do a task in QuickBooks, and we ll use this opportunity to explore one of them. Instead of changing the amount directly, click Edit (see above) and you will be able to take a detailed look at the entry that was made. The following screen appears: We now see the Journal Entry screen. Transactions can always be recorded in QuickBooks by entering traditional journal entries (entries composed of debits and credits) into this screen. (Remember that you do not need to know how do make traditional debit-and-credit entries in order to complete this class!)

24 Introduction to QuickBooks, Module 2 24 Data is usually entered into QuickBooks by completing a form or by answering questions in a mini-interview. Behind the scenes, though, the data is actually being recorded as debit and credit entries to the accounts. Click the $15,000 amounts and change them to $20,000 (see above). Then click the Save button at the bottom of the screen. We again see the warning about modifying a transaction from a prior period. Answer Yes and continue. Another warning box appears, telling us that this change might cause errors the next time we reconcile our accounts (more on reconciliation later). Answer Yes to this question as well. We are now returned to the Account Register page, and we can see that the new amount, $20,000, has replaced the $15,000 amount: Verify that the correction has been made in your account register, then go to Chart of Accounts under the Company tab. You will see that $20,000 is now the balance in the Original Cost account instead of $15,000. Also, the Opening Balance Equity account has increased by another $5,000. Your chart of accounts should appear as follows:

25 Introduction to QuickBooks, Module 2 25 Editing Accounts In addition to correcting account balances, we may also make changes to the account titles, their types, and even make them sub-accounts to other accounts. Let s illustrate this. Highlight Vehicles in the chart of accounts by single-clicking the account, and then click on the Edit button at the bottom of the screen (see below). The following screen appears: Click on the Name field and replace the Vehicles account name with Automobile. Click on Save. The chart of accounts now appears, and it displays the new account name, Automobile (see below). Note that the position of the account has also changed. QuickBooks lists the accounts by type, and lists the accounts alphabetically within each type.

26 Introduction to QuickBooks, Module 2 26 Deleting Accounts It is also easy to delete accounts in QuickBooks. Since our business will not make credit card sales, let s remove the Credit Card Receivables account. From the chart of accounts screen, click on Credit Card Receivables to highlight the account, and then click the Delete button at the bottom of the screen: A warning appears (see opposite). Click the Yes button, and the box disappears. When the chart of accounts reappears on the screen, the Credit Card Receivables account is gone. If you find that you do need an account that was previously deleted, it is a simple matter to click on the New button and add the account back to the chart of accounts. Use the "Delete" button with caution. If an account that contains transactions (ours had none) is deleted, QuickBooks will make automatic entries to other accounts in order to offset the erasure of these transactions. The consequences can be very unpleasant! This brings us to our first cardinal rule regarding QuickBooks: QB Cardinal Rule 1: Never delete an account that has entries in it! Creating Sub-accounts Directly One of the accounts on our list is Prepaid Expenses. These items are assets, but it is not obvious why they are assets and students are often confused by them. Prepaid expense assets are recorded when things are purchased that will be used up or will expire in the near future, but that have not done so yet. Examples would be payments for rent, supplies, and insurance. In these cases, the accountant would record increases in the Prepaid Rent, Supplies, or Prepaid Insurance asset accounts, along with a decrease in the Cash asset account.

27 Introduction to QuickBooks, Module 2 27 It is easy to understand why Cash is an asset, since it can be used to purchase other assets or to pay the business bills. Supplies, insurance policies, or rent payments are also assets because they can, if they have not been used or expired, be sold for cash or canceled for a refund of cash. However, when cash is used to pay for something that is not another asset (an employee s wages or a utility bill, for example) the cash asset is lost and an expense is incurred. Similarly, when the supplies are used up, or when the rent or insurance expires, the prepaid expense asset s value is lost. It can no longer be exchanged for cash, and its loss of value is recorded as a business expense. In accounting for any of these transactions, the accountant must record a decrease in the appropriate asset s account balance when the asset is paid out, expires, or is used up; along with an increase in an expense account. Our business does prepay its rent and insurance, and it does have supplies. We might choose to record all three assets in this single Prepaid Expenses account, or we could decide to do away with this single account and create a separate asset account for each one (Supplies, Prepaid Rent, and Prepaid Insurance). Then we could account for them separately. Another way to account for them would be to leave Prepaid Expenses in the chart of accounts, and create separate sub-accounts for each of the individual items. Let's do this. From the Chart of Accounts, click on the New button at the bottom of the screen. Select Choose from all account types in the mini-interview box (see opposite), and then click Next.

28 Introduction to QuickBooks, Module 2 28 On the following screen, highlight Other current assets and click Next (see opposite). Now select Prepaid Expenses and click Next. On the screen that follows, type the Supplies in the Name field, and then check the box beside Is a sub-account (see opposite). When you do, a new entry box opens up, asking you to select the parent account. Use the drop-down list and select Prepaid Expenses. Enter $600 as the opening balance, and make the date November 1, Now click Finish and the chart of accounts

29 Introduction to QuickBooks, Module 2 29 refreshes. The new Supplies sub-account is displayed (see below). The "Supplies" account is indented and placed beneath the "Prepaid Expenses" account. This indicates that Supplies is a sub-account, and that Prepaid Expenses is the parent account. Note that Prepaid Expenses has a balance of $600. The parent account will have a balance that is equal to the sum of the balances in all of its sub-accounts. Apply What you Have Learned Repeat these steps, adding new Prepaid Insurance and Prepaid Rent subaccounts. The parent account is again Prepaid Expenses. Make the balance in Prepaid Insurance $1,200, and make the balance in Prepaid Rent zero (no balance). Enter a date of November 1, 2011 for both accounts. When you are finished, your chart of accounts should look like the one below. If it does not, edit the accounts and correct them. More About Sub-Accounts As we saw above, sub-accounts are used to provide more detail about the parent account, but they can also be used to group accounts and to create subtotals on the financial statements. For example, we have just set up a parent account called Prepaid Expenses. The subaccounts that belonged to this parent account were Prepaid Insurance, Prepaid Rent, and Supplies. The relationship between the parent account and the sub-accounts can be illustrated in diagram form as follows:

30 Introduction to QuickBooks, Module 2 30 Prepaid Expenses (Parent) Prepaid Insurance Prepaid Rent Supplies When the balance sheet report is run, the sub-accounts are displayed as sub-divisions of the parent account, providing detail about the parent account: Prepaid Expenses Prepaid Insurance 1, Prepaid Rent 0 Supplies Total Prepaid Expenses 1, Note that the sub-accounts are automatically listed in alphabetical order beneath the parent account. This groups the accounts on the balance sheet, and reports them as a single, combined asset type. Had we not used sub-accounts, the three accounts would simply be listed haphazardly among all the other current assets on the balance sheet. A balance sheet user would not be able to easily determine how much the company has in total prepaid expenses. When using sub-accounts, we must remember to record transactions in the appropriate sub-account and to not record them in the parent account. After all, the reason for using sub-accounts is to provide detail about the parent account, while still reporting an overall balance for the parent account. For example, had $700 of the insurance payment been recorded in the Prepaid Expenses parent account instead of the Prepaid Insurance sub-account, the balance sheet would appear as follows, and we would not be able to tell what the $700 prepaid expense asset is: Prepaid Expenses Prepaid Insurance Prepaid Rent 0 Supplies Total Prepaid Expenses 1, What is this $700 asset? We have no way to tell!

31 Introduction to QuickBooks, Module 2 31 Nested Sub-Accounts QuickBooks even allows us to set up sub-accounts of sub-accounts. In fact, we may nest sub-accounts as many as 5 layers deep in QuickBooks! Here is an example of a series of sub-accounts that are 2 layers deep. (Caution. The illustration below is presented only as an example -- do not change your chart of accounts). The Prepaid Expenses parent account has three sub-accounts, Prepaid Insurance, Prepaid Rent, and Supplies. However, Supplies has two sub-accounts, General Office Supplies and Printer/Copies Supplies. General Office Supplies is the parent account for the Client Work Supplies and Postage Supplies sub-accounts. In diagram form, this would appear as follows: Prepaid Expenses (Parent) Prepaid Insurance Prepaid Rent Supplies (Parent) General Office Supplies (Parent) Printer/Copier Supplies Client Work Supplies Postage Supplies Using this many sub-accounts has the advantage of providing a lot of detail, but too much detail is often confusing and may not really benefit to the user of the accounting

32 Introduction to QuickBooks, Module 2 32 information. Also, it is difficult to avoid the error of making entries directly into the parent accounts when there are so many of them. In higher versions of QuickBooks, it is possible to set a preference to Show lowest subaccount only. When this preference is turned on, QuickBooks displays the sub-account name in the transaction column, and the name of the parent account is not visible. Unfortunately, this preference is not available in QuickBooks Online Edition. What we might do, though, in order to prevent accidental entries to parent accounts, is to provide a visual cue by adding a text warning to the parent account's name something like Parent or some other text label that will help the user understand that the account is off limits. A Word About Account Numbering In order to use account numbers in QuickBooks, we must turn on the Account numbers preference (which we did in Module 1) and then assign account numbers to the accounts (which we have not done). Once account numbers have been assigned, we may turn the number display on or off by clicking the Show Account Numbers box in the Chart of Accounts window (see below). When the account numbering is turned on, QuickBooks displays the number before the account name in the Chart of Accounts list. The number also displays in the Account fields on transaction forms such as checks, bills and journal entries, and they are shown in the reports where accounts are listed. When account numbering is turned off, the numbers are not visible at all. We see here that the accounts have been numbered in the 100 s, with decimal values used to further sub-divide the account types. The parent account, Prepaid Expenses, has been numbered with a text value, Parent1, to identify it as a parent and to set it apart from the sub-accounts. Remember, since we have not entered account numbers, you will not see any in your display if you click the Show Account Numbers box.

33 Introduction to QuickBooks, Module 2 33 Why Number the Accounts? Account numbers can be used to formally organize the accounts according to their types, and to re-arrange the order in which the accounts are listed in the chart of accounts and on the financial statements. Without account numbers, the default order in which the accounts are listed is alphabetic, by type. The Bank type accounts are listed first, and if there is more than one of them they will be shown in alphabetic order. Current Assets comes next, and so on. Sub-accounts are treated as separate category, and they are listed beneath the parent account in alphabetic order. Instructor s Note: Note that in the illustration above, the Supplies subaccount is listed first under the Parent1 Prepaid Expenses account. This is because its account number comes before the account numbers for Prepaid Rent and Prepaid Insurance. Without account numbers, these sub-accounts would be listed, alphabetically, in the reverse order (Prepaid Insurance first, then Prepaid Rent and, last, Supplies). This numeric order will be maintained in the chart of accounts whether the numbers are turned on or off. However, in order to display the accounts in account number order on the balance sheet or income statement, the numbers must be turned on. When they are, the account numbers will be visible on the statements. Adding the Loan Payable Account You are probably now feeling rather comfortable with the process of adding, deleting and editing accounts. Let s add one more account, the Loan Payable account. Select New from the Chart of Accounts screen: Since the option Loan is available (see opposite), select it. When we click Next and continue on, we see the screen below.

34 Introduction to QuickBooks, Module 2 34 Name the account Loan Payable, and enter a balance of $3,000 as of November 1, Note, though, that QuickBooks has already set Other Current Liabilities as the Type of account. This is a default in QuickBooks, but our loan is not a current liability. Instead, it is a longterm liability. Go ahead and click Finish at the bottom of the screen anyway, and accept the "Other Current Liabilities" default. You are returned to the chart of accounts screen: The chart of accounts now lists the Loan Payable account, but it shows the Type as Other Current Liabilities. In order to fix this, click on the account to highlight it, and then click Edit at the bottom of the screen. After clicking on the Edit button, we see the screen opposite. Click on the Change Type button.

35 Introduction to QuickBooks, Module 2 35 After clicking Change Type, we are given another warning message. Click the Yes button and you will be returned to the same screen we began with earlier when we first established the new Loan Payable account (see below). Since we now know that selecting the Loan option gives us the wrong type for the account, let s select Choose from all account types instead (see opposite). Click Next and we see the screen below. Select Long term liability and click Next. The screen opposite now appears. Select Notes Payable and then click Finish.

36 Introduction to QuickBooks, Module 2 36 The Account Information screen appears again, and we can confirm that the account type is shown as Long Term Liabilities (see opposite). Click Save to record the change. When the chart of accounts refreshes, we will see again that the Loan Payable account is now a long-term liability instead of a current liability. What have you learned in this lesson? The set of accounts the business uses to record information is referred to as the Chart of Accounts. The major account types are asset, liability, owner equity, revenue and expense, but these classifications can be subdivided into several other account types (current assets, fixed assets, current liabilities, long-term liabilities, owner s equity, revenues and expenses). QuickBooks makes it easy to add, edit, and delete accounts, but care must be taken in the mini-interviews since the program s defaults may result in the selection of inappropriate account types or (as we will see in the next module) entries to inappropriate accounts.

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