The Essence of Accounting W. Terry Dancer, PH. D. Associate Professor of Accounting Department of Accounting and Law College of Business Arkansas State University Box 550 State University, Arkansas, 72467 Home: 870-935-1579 Work: 870-972-3038 Fax: 870-932-1459 dancer@astate.edu December 2006
I started teaching accounting almost 30 years ago. When I started teaching, computers were the size of classrooms, hand held calculators cost hundreds of dollars, and a personal trainer was someone who helped you get your shape in shape. Things have certainly changed over 30 years. Computers are now small enough to hold in your hand, calculators can be purchased for under $5, and a personal trainer might be something to help you learn accounting. While some things are going through significant change, some things in accounting remain the same today as they were 30 or even 500 years ago. Assets still equal liabilities plus owner s equity; net income still equals revenues-expenses; and what you own still equals what you started with plus what you added less what you took out. The balance sheet, income statement, and statement of owner s capital have changed very little thru the years. The addition of a fourth financial statement, the statement of cash flow, was not without problems. We went from the statement of where got, where gone to the present day statement of cash flow, but not without quite a bit of debate and change. I thought trying to add a new statement to compliment statements 500 years old was a monumental task, and it proved to be. This educational note is about the essence of accounting. When you begin to explore the essence of anything, you must take an item and break it down into the most fundamental elements possible. I ask my students about the essence of life. After much discussion we usually settle on four elements: Eat right, get lots of exercise, get plenty of rest, and don t smoke. Clearly, there is far more to life then these four elements, but consider what our life would be like if we exercised, ate right, rested properly, and didn t smoke. I am up to three out of four and will work hard to get to four out of four. Then I ask my students about the essence of accounting. If you break down accounting to the most fundamental elements what do you have? After much discussion, we settle on two elements. Accounting is accounts and amounts. Clearly there is much more to accounting than just accounts and amounts, but if students attempting to learn accounting understood accounts and amounts, then perhaps the learning would begin to flow like dominos. Once you break something into its most fundamental elements, then you begin to add to the elements. For example, on the account side, there are two parts. You have classification and presentation. Students quickly learn that this is really the same side of a single coin. Once a student learns cash is an asset, they realize presentation is on the balance sheet. Once they learn unearned revenue is a liability, they realize presentation is on the balance sheet. So on the account side, emphasis is on how the account is classified and where the account is presented in the financial statements. On the amount side, you must deal with methods and calculations. At times a transaction will require no calculations. A payment for rent of $500 goes on the books at the price paid without the necessity to perform any calculations or consider any alternate methods to make calculations. Then consider depreciation expense. Students must consider the various methods available, select an appropriate method, and make calculations based on the method selected.
Every chapter of every accounting test ever written lends itself to a fundamental study of accounts and amounts. If students understand the nature of accounts and amounts and how they are used as the building blocks to prepare the financial statements they may be able to more easily grasp the overall nature of accounting and the articulation existing among all the statements. I have prepared accounts and amounts for all chapters. One assignment for each chapter is for the students to make a list of all the accounts presented in the chapter and identify the proper classification and presentation for each account. Then the students are required to consider the amounts for each account and identify the various methods used to determine an appropriate amount and the manner in which calculations are made. The balance of this article deals with accounts and amounts related to current liabilities. I realize accounts may vary from book to book, but I believe the ones listed are representative of many intermediate accounting texts when dealing with current liabilities. At the end you will read some additional notes about the topic. I suppose this is the teacher coming out in me. In this section I attempt to include items of importance not covered in the discussion of accounts and amounts. ACCOUNTING FOR CURRENT LIABILITIES : An obligation whose liquidation will require use of existing current assets or create another current liability. THE ACCOUNTS AND AMOUNTS FOR CURRENT LIABILITIES CLASSIFICATION and PRESENTATION METHODS and CALCULATION NOTES PAYABLE NOTES PAYABLE=FACE AMOUNT OF THE NOTE DISCOUNT ON NOTES PAYABLE (ZERO INTEREST NOTE) CONTRA ACCOUNT TO NOTES PAYABLE : DEDUCTED FROM NOTES PAYABLE DISCOUNT=FACE-PRESENT VALUE OF NOTE CASH DIVIDENDS PAYABLE / DIVIDENDS PAYABLE= (SHARES OUTSTANDING) (DIVIDEND PER SHARE)
RETURNABLE CASH DEPOSITS RETURNABLE CASH DEPOSITS=AMOUNTS RECEIVED FROM CUSTOMERS UNEARNED REVENUE UNEARNED REVENUE=AMOUNT OF CASH RECEIVED IN ADVANCE SALES TAX PAYABLE SALES TAX PAYABLE= (SALES) (SALES TAX RATE) NOTE: IF THE TAX IS INCLUDED IN SALES BEFORE CALCULATION SALES TAX PAYABLE= (SALES/1+TAX RATE) (TAX RATE) PROPERTY TAXES PAYABLE PROPERTY TAXES PAYABLE=AMOUNT OF TAX ASSESSMENT INCOME TAXES PAYABLE INCOME TAXES PAYABLE= (TAXABLE INCOME) (TAX RATE) FICA TAXES PAYABLE FICA TAXES PAYABLE= {(RATE) (TAXABLE EARNINGS)} (2) WITHHOLDINGS TAXES PAYABLE WITHHOLDINGS TAXES PAYABLE=AMOUNT HELD FROM EMPLOYEES FEDERAL UNEMPLOYMENT TAXES PAYABLE FEDERAL UNEMPLOYMENT TAXES PAYABLE= (RATE) (TAXABLE EARNINGS)
STATE UNEMPLOYMENT TAXES PAYABLE STATE UNEMPLOYMENT TAXES PAYABLE= (RATE) (TAXABLE EARNINGS) VACATION WAGES PAYABLE VACATION WAGES PAYABLE= (WEEKLY VACATION EARNINGS) (WEEKS) PROFIT-SHARING BONUS PAYABLE PROFIT-SHARING BONUS PAYABLE= (COMPANY PROFIT) (SPECIFIED RATE) ESTIMATED LIABILITY UNDER WARRANTY METHODS: EXPENSE WARRANTY APPROACH SALES WARRANTY APPROACH ESTIMATED LIABILITY UNDER WARRANTY (EXPENSE WARRANTY APPROACH) = (UNITS SOLD) (AVERAGE WARRANTY COST PER UNIT. UNEARNED WARRANTY REVENUE (SALES WARRANTY APPROACH) =THE COST OF THE WARRANTY TO THE CUSTOMER. ESTIMATED LIABILITIES FOR PREMIUMS ESTIMATED LIABILITY UNDER PREMIUMS= (ESTIMATED PREMIUMS) (COST) ADDITIONAL ITEMS OF NOTE CURRENT PORTION OF ANY LONG TERM DEBT: CLASSIFIED AS A CURRENT LIABILITY SHORT TERM OBLIGATIONS EXPECTED TO BE REFINANCED: MAY BE EXCLUDED FROM CURRENT LIABILITIES DEPENDING ON INTENT AND ABILITY PREFERRED DIVIDENDS IN ARREARS ARE NOT A Liability CONTINGENCES: GAIN CONTINGENCIES ARE NEVER RECORDED, LOSS CONTINGENCIES ARE RECORDED ONLY IF THEY ARE PROBABLE
SUMMARY Students will never learn all they need to know about accounting by just learning accounts and amounts. However, my experience using this teaching method proved a very effective way to get students headed in the right direction. Teaching pension accounting is still quite a challenge, but I truly believe students better understand accounting for pensions using the account and amount method of teaching accounting.