Accountants or bookkeepers? Help me understand this.

[Bone]

@Mr.Nylock

Under GAAP you would use the cost basis for inventory - inventory would be valued at the price you paid.

For the second part of your question, you add another account, gain on sale, which is an equity account.

Debit cash 1000
Credit Gain on sale 500 and credit inventory 500
There is more that can be said about this; but for simplicity sake this should be sufficient to answer your question.

Gain on sale is not an equity account.

@Little_Nemo

A general accounting question.

Say I own a used car lot. One day I buy a used car for five hundred dollars. My assets have been reduced by five hundred dollars in cash and raised by the value of the car. To balance my books, do I assign a value of five hundred dollars to the car because that’s what I paid for it? And when I’m figuring up the total value of my inventory of cars do I use that value?

Now three months later, I sell that car for a thousand dollars. My assets are now reduced by one car and raised by a thousand dollars. Was the car still worth five hundred dollars when I sold it or did it rise in value to the price it sold for? Was it really worth five hundred dollars when I held it in my inventory or should I have valued it at a thousand dollars?

The answers to these questions could depend in part by the internal accounting policy but speaking generally and with only a single car purchase and sale, then using the cost basis of inventory as defined in ASC 330 you would assign a value of $500 because that is what you paid for it. It is also the value you would use for purposes of valuing inventory. When the car is sold for $1000 the car still had a carrying value of $500 (assuming no other changes) so for book purposes it had a value of $500. The sale transaction would yield net income of $500 all other things being equal.

If the car is impaired in some fashion then the write down should be recognized in the P&L in the period of impairment as an expense and reduction of the value of the asset.

[Mr.Nylock]

@Bone

Gain on sale is not an equity account.

Gain is not an equity account I answered the question wrong - I was trying to simplify things but the result was bad.

I actually answered a question little nemo wasn’t even asking, he was only asking about inventory - I was answering a question about sale of PPE. Ooops:(

[D_Anconia]

@Mr.Nylock

Under GAAP you would use the cost basis for inventory - inventory would be valued at the price you paid.

For the second part of your question, you add another account, gain on sale, which is an equity account.

Debit cash 1000
Credit Gain on sale 500 and credit inventory 500

Wouldn’t the transactions be:

DR Cash 1000
CR Revenue 1000

and

DR COGS 500
CR Inventory 500

Once the closing entries are performed, prior to the preparation of the balance sheet, the Revenue and COGS accounts are closed to Income Summary, and the $500 difference flows to Retained Earnings.

If that is incorrect or incomplete, corrections are welcome.

[gigi]

@Lumpy

So you’re saying you don’t worry about the balance sheet until you’re ready to prepare a balance statement, and then you do update the retained earnings so it balances?

Right – but you can always check during the year that your net P&L matches the net change in balance sheet.

[Mr.Nylock]

@D_Anconia

Wouldn’t the transactions be:

DR Cash 1000
CR Revenue 1000

and

DR COGS 500
CR Inventory 500

Once the closing entries are performed, prior to the preparation of the balance sheet, the Revenue and COGS accounts are closed to Income Summary, and the $500 difference flows to Retained Earnings.

If that is incorrect or incomplete, corrections are welcome.

That looks correct to me.

[Lumpy]

OK, I now get that a balance sheet report will take net profit or loss into consideration. Now I have another question: I was studying how adjusting entries are made, specifically “deferral” adjustments to spread out expenses or unearned revenue. The examples given start typically with something like “Insurance expense is debited and cash is credited”, and then you’re supposed to make an adjusting entry deferring the insurance expense over the relevant time period. What I don’t get is why anyone would have listed the expense up front, instead of just trading one asset for another- debit Prepaid Insurance and credit Cash- and then debit Insurance Expense as you go along. Was that just an example for demonstration purposes, or does the Cash Flow statement demand that any diminution of Cash be considered an expense?

[gigi]

@Lumpy

OK, I now get that a balance sheet report will take net profit or loss into consideration. Now I have another question: I was studying how adjusting entries are made, specifically “deferral” adjustments to spread out expenses or unearned revenue. The examples given start typically with something like “Insurance expense is debited and cash is credited”, and then you’re supposed to make an adjusting entry deferring the insurance expense over the relevant time period. What I don’t get is why anyone would have listed the expense up front, instead of just trading one asset for another- debit Prepaid Insurance and credit Cash- and then debit Insurance Expense as you go along. Was that just an example for demonstration purposes, or does the Cash Flow statement demand that any diminution of Cash be considered an expense?

Sometimes practically speaking, Purchase orders are routinely written as expenses, so that the preparers doesn’t have to take into consideration the term of the services being purchased. At year end, these can then be reviewed and depending on materiality, the choice is made to defer them. You’re correct that the PO could have been made out to the Prepaid asset from the beginning, but functionally this doesn’t always happen.

[What_the]

@Lumpy

Ok, the basic accounting equation Assets = Liabilities + Equity. Got it. For every debit there will always be a credit and vice-versa. Got it. But there’s something I’m not understanding:

There are the Balance Sheet accounts that fall under the three main categories of Asset, Liability and Equity. There are also Income Statement accounts documenting Revenue and Expenses. Now to take a trivially simple transaction as an example, the company sells something and so Cash (an asset) is debited and the corresponding Revenue account is credited. Got that.

But here’s what I don’t get: Cash (an asset account) has changed in value, it’s bigger than before. So why isn’t the balance sheet now out of balance? An asset has increased but there has been no corresponding increase in either liability or equity. Sure eventually at the end of the fiscal year the Revenue (technically, the Earnings) account will be closed out to the appropriate equity account. And if you count ALL debits and credits, balance sheet and income statement accounts together, they’ll balance. But just the balance sheet by itself would seem to be out of balance. What am I misunderstanding?

Some of us real accountants are a little busy right now so I don’t have time to read all the words above but…

Your basic error in logic is thinking that the P&L accounts don’t get closed out to equity until the end of the year. They affect equity with every P&L transaction.

[gigi]

We fake accountants figured that out upthread.

[What_the]

@gigi

We fake accountants figured that out upthread.

Well done…too bad all of those other words got in the way of a nice concise answer that would live on to fight ignorance