This chapter presents many additional accounting treatments for frequently encountered business and less-frequently found personal activities that need recording in accounting books. The explanations below cover both the description and purpose of the activity, and they include also the usual accounting treatments (bookings or recordings) for these transactions.
These concepts have evolved over centuries of experience by those keeping accounting records and will help you maximize your record keeping’s utility and meaningfulness.
This section introduces categorization of assets in the balance sheet based on time or the asset’s useful life (current and long-term). Sometimes assets are also considered from the standpoint of their liquidity, which is regarded as how close or distant the asset is from being turned into cash. Near-cash assets are relatively quickly converted to cash (e.g., accounts receivable), while assets requiring rather a long time to convert to cash are considered to be relatively fixed in their non-cash state (e.g., heavy equipment, buildings, land). (Fixed does not mean they were repaired!)
You should find that current assets parallel those with more liquidity, while long-term and fixed assets are those with much less liquidity. Finally, below you will find a few assets that could be either current or long-term based on the nature of the facts constituting them.
Other Assets Described
Current Assets are those activities whose normal expected life would be one year or less. Such activities could be tracking reimbursable expenses, travel advances, short-term loans to a friend or family member, prepaid expenses, annual insurance premium amortization, and so on. The individual entity could have many other kinds of short term activities that reflect what it is doing. (These asset types are explained individually below.)
Long-term (Fixed) Assets
Long-term (Fixed) Assets are those activities whose normal expected life exceeds one or more years. This grouping covers both tangible and intangible assets. Examples of tangible assets are land, buildings, and vehicles (cars, trucks, construction equipment, factory presses, etc.) Intangible assets include such things as patents, copy rights, goodwill, etc. Because the lives of some of these assets show wear and tear and deterioration in value over time, businesses and individuals can allow for that diminution in value by calculating depreciation on such assets. For example, land normally does not depreciate, but buildings do, as do equipment and vehicles. (These asset types are explained individually below.)
This section explains short-term receivables, reimbursable expenses, travel advances, prepaid premiums, prepaid rent, suspense or wash accounts.
This kind of account is useful to reflect an agreement made with someone you trust. Suppose you lent someone $500 and he agreed to repay you $50 a month. If he paid on time, the loan you made would be paid off within a year, which is why it is classified as a short-term receivable. So you could record that loan initially in this account tree: OtherAssets:Current Assets:LoanToJoe. At the time you give him the money: your entry is debit (increase) LoanToJoe $500 and credit (decrease) Bank $500. Each time you receive Joe’s payment you record $50 debit (increase) to Bank and credit (decrease) LoanToJoe.
Don’t become confused by the use of the word "Loan". "Loan-To" is the tipoff that you really have a receivable, that is, you will receive from Joe, the money you previously loaned. Until he actually pays the money owed you, you reflect his debt in your books by an account describing your expectation–you will receive the money owed you, hence the word "receivable".
This kind of activity is one in which you spend your own money on behalf of someone else (your employer, perhaps) and later you receive repayment of what you spent. The case might be a business trip. The employer has a policy of covering (paying for) all authorized expenses. After the trip is over, the employee submits a report listing dates and amounts spent with receipts for all the expenditures. The employer reviews the report and pays for all items that it considers as having a valid business reason. (Normally, employees know in advance what the employer will reimburse, so only those items are recorded as a reimbursable expense on the employee’s books.)
Because a business trip can involve different kinds of expenditures (air travel, lodging, transportation at the destination, etc.), different kinds of expenditures would be recorded in the one account as long as the expenditures all related to the same trip. In other words, if a second trip is made before the first is fully settled, a second account for a different event could be set up. It would make sense to do this, if it would help to keep separate all the details of one trip from those of another. It is up to the person making the trip to decide how much trouble it would be to put separate trips in separate accounts or to put them all in the same account. The trip taker should remember that the account must be reconciled in order to know with certainty that all expenses have been reimbursed.
Recording the expenditures on the trip would be much the same. That is, if you paid trip expenses by cash you would debit (increase) the reimburseable expense account for the money paid in cash, because it is a receivable to you until it has been reimbursed to you. The credit offsetting your expenditure would decrease the account that shows the cash in your pocket or the account from which you drew the cash for the payment made. If you paid by credit card, the debit side would be the same as just described, but the credit would be an increase to the credit card company account on your books.
When you received your reimbursement, then the journal entry (or transaction) to record receipt of the funds from the employer would be: debit (increase) Bank for the check amount and credit (decrease) the reimbursable expense account for the check amount.
If it turns out that the reimbursable expense account is not zero balance after processing the employer’s payment, then it means that there is a difference between you and the employer in handling the expense, which needs to be investigated. If the balance is a debit (a positive balance), your account has some money that was not reimbursed. If the balance is a credit (a negative balance), you were paid for more than what you recorded as due you. In both of those situations you should reconcile the difference between what you recorded and what was paid. That effort should disclose exactly what is causing the discrepancy. You will need to contact the employer’s bookkeeper to know what was paid, if the reimbursement check was not accompanied by a detailed list of the items being paid you.
In the event the employer refused to reimburse you for an expenditure, that effectively makes it your expense. In that case, you would make this entry: debit (increase) your own Expense (appropriately named) and credit (decrease) the Reimbursable Expense account. That entry should result in a zero balance in the Reimbursable Expense account. If not, reconcile until you identify the difference.
Sometimes there are small differences that don’t match an individual entry. In those cases divide the amount by 2 or by 9. If the unresolved amount is divisible by two, it suggests that both you and the employer entered the item in the same manner: both as debits or both as credits. If it is divisible by 9, then likely one of you transposed adjoining numbers; e.g., one entered 69 and the other entered 96. If the difference is divisible neither by 2 or by 9, then it could be that more than one error is present.
These are very similar to Reimbursable Expenses. The difference is that someone gives you money first; you spend it, and then you give a report accounting for what you spent it on. The report is supported by invoices establishing who, what, where, when, and how much for each expenditure. In the Reimbursable Expense case, you spent your money first and later recovered it.
In the Travel Advance case when you receive the advance, you record on your books this entry: debit (increase) Bank for the travel advance amount received (say, $500); credit (increase) the short-term liability Travel Advance ($500). This is a liability, because you are not gifted with the money, but only loaned it for the purpose of having funds to spend when doing the employer’s business.
Frequently, the way these monetary arrangements work is that at the beginning of for example a salesperson’s employment, he or she receives the advance and monthly (or more frequently) turns in a report about who, what, where, when, and how much he spent. The money in the report is reimbursed if approved.
During the period after receiving the advance and before filing a request for reimbursement report, the salesperson can record his or her expenditures into the advance liability account. In that case, the balance in the account will show how much of the advance has not yet been spent (assuming the Travel Advance balance is a credit). If no mistakes have been made and all expenses are approved, then the sum of the unspent account balance and the reimbursing check amount will equal the original travel advance amount.
It makes sense for the salesperson to record the travel expenses to this advance account (and not to his or her own expense accounts), because the money is being spent on behalf of the employer, for the employer’s authorized expenses. It is not the employee’s own money, and therefore not his or her own expense.
When the salesperson receives the report reimbursement (say, $350), he or she debits (increases) Bank, and credits (increases) again the Travel Advance liability account, assuming that previously he or she had been recording expenditures to the travel advance account. Tracking activity in this manner causes the account to always show the amount that is owed the employer.
See Reimbursable Expenses above for what to do if the employer does not accept an item the employee put on the travel advance reimbursement request report. The difference resolution effort is essentially the same for both types of accounts.
Prepaid Premiums or Prepaid Rent
Some types of expenses are usually billed as semi-annual or annual amounts. For example, the insurance industry will bill home insurance annually, while car insurance premiums can be annual or semi-annual. For those that pay an amount that covers several months or a full year, the proper accounting treatment is to reflect in each accounting period the amount that expresses the benefit applying to that period.
In the case of someone who pays a full-year’s insurance premium at the beginning of the insurance period, the entry to record this is debit (increase) Prepaid Insurance Premium for say, $1,200, and credit (decrease) Bank for $1,200.
Then a monthly recurring journal entry (scheduled transaction) is created that debits (increases) Insurance Expense $100 and credits (decreases) Prepaid Insurance Premium $100. This technique spreads the cost over the periods that receive the insurance coverage benefit. Businesses following generally accepted accounting practices would normally use this technique, especially if they had to present financial statements to banks or other lenders. Whether individuals do depends on the person and how concerned they are to match cost with benefit across time periods. Another factor influencing use of this technique would be the number of such situations the person encounters. It is relatively easy to remember one or two, but more difficult if having to manage 10 to 20. You would set up as many or as few as proved useful and important to you.
Suspense or Wash Accounts
The purpose of these accounts is to provide a device to track "change of mind" situations. The objective of these accounts is to provide a temporary location to record charges and credits that are not to be included permanently in your books of record. When the transactions reflected in these accounts have been fully completed, Wash/Suspense accounts will normally carry a zero balance.
For example, say in the grocery store you see canned vegetables on sale, so you buy 6 cans at $1 per can. Say that the total purchases were $50. When you come home and are putting things in the cupboard you discover you already had 12 cans. You decide to return the 6 you just bought. Some persons in this situation would charge (increase) the whole bill to Grocery Expense; and when they returned the cans, they would credit (decrease) Grocery Expense. That is one way of handling that. The effect of this method is to leave recorded on your books the cost of items that you really did not purchase from a permanent standpoint. It is only when the items have actually been returned and the vendor’s return receipt has also been recorded that the distortion this method generates will then be removed.
Actually, there are several treatments, depending on when and how the original transaction was booked/recorded and when you decided to return the items purchased. Basically, did you change your mind before you recorded the transaction or after doing so?
If you decided to return the items after recording the purchase transaction, you may originally have charged Grocery Expense for the full amount ($50) of all items. In that scenario, what you kept and the amount of the items to be returned were grouped into one account. You could edit the original transaction and restate the amount charged to the Grocery Expense account to be the difference ($44) between the total paid ($50) for groceries and the value of the items to be returned. That leaves the returned-item value as the amount ($6) you should record to the Suspense account.
Obviously, if you decided to return items before you recorded your purchase, then you would book the original entry as a charge to Grocery Expense for the amount kept ($44) and as a charge to Suspense for the amount returned ($6). The off-setting credit ($50) to cash or credit card is not affected by these treatments.
When there are several persons shopping and at different vendors, there can be a case where there are several returns happening at once and in overlapping time frames. In that case the Wash Account is charged (increased) at time of changing the mind, and either Bank or Credit Card is credited. When the return occurs, the reverse happens: Bank or Credit Card is debited for the cash value of the returned items and the Wash/Suspense Account is credited in the same amount.
If the wash account has a non-zero balance, scanning the debit and credit entries in the account will show the non-matched items. That is, debits not matched by offsetting credits indicate items intended to be returned but not actually returned yet. The reverse (credits not matched by offsetting debits) indicates that returns were made but the original charge was not recorded in the Wash Account.
These differences can be cleared up by returning unreturned items or recording charges (debits) for items already returned. The mechanics of doing that likely will be finding the original expense account the item was charged to and making an entry like: debit Wash Account, credit original expense. It also could be as described above where the original recording is adjusted by adding a charge to Wash/Suspense account and decreasing the amount charged to the original account.
Short or Long-term Assets
This section explains why some types of assets may be short or long-term and presents an example.
An example is deposits (e.g., utility, rental, security). If the deposit agreement contains a provision to recover the deposit at the end of a year, the treatment could be that of a short-term asset. However, when the agreement is that the deposit holder returns the funds only upon successful inspection at the end of the relationship, then at the start of the relationship or agreement, the person paying the deposit has to decide whether to write it off as a current expense or to track it for eventual recovery at the end of the agreement (not infrequently, moving to a new location).
Whichever decision is made, the accounting treatment is to debit (increase) expense (assuming the write-off decision) or debit (increase) Deposits Receivable (assuming the intent is to recover the deposit in the future) and credit (decrease) Bank for the amount of the deposit (if paid by cash) or credit (increase) credit card if paid using that payment method.
Long-term (Fixed) Assets
This section illustrates long-term assets (those whose useful lives exceed a year) and discusses these types: land, buildings, leasehold improvements, intangibles, vehicles and other equipment.
Land is not a wasting asset. That is, it does not get used up over time and rarely suffers damage such that it loses value. For that reason, it usually is recorded at cost at the time of purchase. Appreciation in its value over decades is not recorded and is not recognized in any way on the books of the owner. It is only after land has been sold that sale price and purchase cost are compared to calculate gain or loss on sale.
Land is frequently sold/purchased in combination with structures upon it. That means that the cost has to become separated from the cost of structures on it. Land valuation is usually part of the transfer of ownership process and its value is shown on the purchase documents separately from that of any structures it supports.
Land values shown on purchase documents frequently arise from the process of value determination managed by assessors whose job it is to assign values to land for tax purposes. Local and regional areas of a state or province use the values determined by assessors in their tax formulas, which provide revenues for local and regional governing authorities to finance their required community services.
Should land be acquired in a situation not subject to a history of land valuation by a formal valuation system, then the purchaser can appeal to real estate agents and an examination of recent sale transactions for information that would allow calculating a reasonable amount to express the value of the land.
Buildings are the man-made "caves" in which much of life’s human interaction occurs. These structures are wasting assets, because in their use they or their components gradually wear. Over time they begin to lose some of their function and they can suffer damage due to planetary elements or human action.
Accepted accounting practice is to record the cost of the building determined at time of ownership transfer (purchase) or at conclusion of all costs of construction. Because buildings are frequently used for decades, and due to the need to be able to calculate gain or loss on sale, accounting practice preserves the original cost by not recording declines in value in the account containing the original purchase or construction cost.
Instead, the depreciation technique is used to show (in the balance sheet) the structure’s net book value (original cost reduced by accumulated depreciation). Depreciation is a separate topic treated elsewhere in this Guide.
When a business does not own the building where it operates, and instead has a long-term lease, it is not uncommon for the business tenant to make improvements to the premises so that the structure obtains both function and appearance that enhances conducting its business activities.
In these cases, the expenditures that the business incurs are recorded in a Leasehold Improvements account: increase (debit) Leasehold Improvements, decrease (credit) Bank or increase (credit) a suitable liability account (which could be a liability to a contractor or a bank or a credit card, etc.).
Vehicles or Equipment
Vehicles or Equipment of all kinds usually last for several years, but their useful lives are much shorter than that of assets that have little movement in their functioning. Because they do wear out over time, common accounting practice in business is to record depreciation using life spans and depreciation methods appropriate to the nature and use of the asset. Frequently, the life and depreciation methods chosen are influenced by what is permitted per national tax regulations for the kind of asset being depreciated.
Usually, businesses depreciate their assets. Individuals can do so as well to the degree that taxing authorities permit. Very wealthy persons employ accountants and attorneys to track and manage their investments and assets holdings to take advantage of all tax benefits permitted by law.
The mechanics of accounting (debiting and crediting appropriate accounts) for these assets are relatively simple, much the same as for any of the above assets. Where the difficulty lies is in their valuation, which is an advanced topic and not something that individual persons and small businesses would likely encounter. For that reason further discussion of items such as patents, copyrights, goodwill, etc. are left out of this Guide.