What to Look for When You Analyze Account Balances
As an auditor you have to analyze your client’s account balances. Management assertions address the correctness of balance sheet account balances at year-end. These account balances include the company’s assets, liabilities, and equity. Here’s a refresher on the balance sheet accounts:
Assets are resources the company owns. Examples of assets are cash, accounts receivable, and property, plant, and equipment.
Liabilities are claims against the company by other businesses. Examples of liabilities are accounts payable, unearned revenues (which occur when a client pays the business for goods or services it hasn’t yet received — like a deposit), and salaries payable (wages the company owes to employees).
Equity represents the difference between assets and liabilities. It’s also known as net assets or net worth. Examples of equity are retained earnings (the total of all company earnings from day one to the date of the balance sheet after deducting dividends) and common stock.
Four types of management assertions directly influence account balances:
Existence: This means that any asset, liability, or equity account and dollar balance on the financial statements actually exists as of the balance sheet date. For example, assuming a December 31 year-end date, if the company purchases a delivery truck in October, the asset account has to reflect the cost of that truck plus any other trucks it owns.
Rights and obligations: The balances reflect assets the company owns or obligations the company owes. A car that the business’s president personally owns isn’t shown on the balance sheet in the vehicle asset account. It doesn’t make any difference if the president drives the car only for company business; he holds legal title to the car — not the company.
Completeness: All balances as of the balance sheet date are complete and include all transactions that occurred during the year. For example, if the company sells a delivery truck, the truck and all related depreciation are removed from the balance sheet, and the gain or loss on the sale is recorded in equity. Depreciation is the way the cost of using assets is moved from the balance sheet to the income statement.
Valuation and allocation: Valuation means that a business records all account balances in the right amounts, and allocation means that the company records the amounts in the appropriate accounting period. For example, a company takes a physical count of its inventory, which totals $500,000. The inventory asset account on the balance sheet shows $510,000. The difference between the two ($10,000) needs to be allocated from inventory to the current year expense cost of goods sold
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
