Chapter 4: Reconciliation and financial statements

on the book side adjust for:

collections by the bank, bank service charges or fees, NSF checks, errors in the companys ledger

source documents

the original records that prove a specific transaction took place

what accounts should be reconciled?

accounts found in the balance sheet, bank, and credit card accounts

the reconciliation process generally involves:

• gather source documents

• compare accounts and/or transactions

• make any adjustments necessary and complete reconciliation

• close the accounting period

bank reconciliation

compare the books to the statement issued by the bank

what are typical source documents for a bank reconciliation

bank statements & deposit receipts

what should you do if a deposit is still in transit?

nothing. wait for them to show up in the next reconciliation

what should you do if you have an NSFcheck?

debit accounts receivable and credit the bank account

error of omission

a bookkeepping entry (transaction) is missing

data entry error

the amount was written incorrectly or under the incorrect account

error of principle in accounting

a type of data entry error where the bookkeeping entry is made to the wrong type of account

error of commission

the bookkeeping error was made to the correct type of account but the wrong customer or item

error of original entry

a type of data entry error where the numbers were flip-flopped

complete reversal of entries

the correct amount is posted to the correct accounts but the debits and credits are reversed

compensating error

two or more errors cancel each other out

liquidity

the ability to pay down current liabilities expressed as a ratio or percentage

effieciency

how effectively a business is doing something over a g

solvency

a business’s ability to pay a long-term debt

current ratio

• formula: current asstes / current liabilities

• does a business have enough current assets to cover its immediate debts

cash ratio

• formula: liquid assets / current liabilities

• how well a business can meet immediate demands from its most liquid assets

A/P turnover ratio

• formula: net credit purchases / average A/P

• represents how many times a business pays off its accounts payable during a period

A/R receivable turnover ratio

• formula: net credit sales / average A/R

• tells us how quickly a business collects payments from its customers or clients for goods or services provided on credit

debt to equity ratio

• formula: total liabilities (debt) / total equity

debt to asset ratio

• formula: total liabilities / total asset

horizontal analysis

comparing financial data of a business over multiple periods

vertical analysis

analyzing a financial statement at a specific point in time

gross profit margin

• sales revenue - COGS / sales revenue

operating profit margin

• operating expenses / sales revenue

net profit margin

• net profit / sales revenue

cash flow coverage

cash flow operations / total debt

current liability coverage ratio

• net cash operations / average current liabilities

cash flow margin

operating activity cash flow / net sales