Chapter 1
The first chapter of the book “The Accounting Game” by Mullis and Judith provided an overview of the key factors of financial statements, such as cash, original investment, assets, expenses, and balance sheets, etc. It is indicated that debits and credits are equal (Mullis and Judith 17). For instance, one invested $5 in the business and earned $5 in this case cash (debit) and invested capital (credit) will be equal. In addition, if one borrows $ 10 from anyone, it will be cash in hand on one hand, but on the other hand, it will be one’s liability because one owes those $ 10 to someone. That’s why those $ 10 will be on the right hand side (credit) as notes payable. What a person/business has called assets like cash on left side. On the other hand, upper right side is known as liabilities because one is liable to pay back the loan he/she has taken. In addition, lower right side is known as equity/net worth because it is the portion of business one owns. Assets are equal to sum of liabilities and owner’s equity (Mullis and Judith 19).
The chapter identified the items of balance sheet like total purchases (Mullis and Judith 22). For instance, to make lemonade one needs lemons and sugar knowns as supplies. One will take out cash to buy suppliers that needs to be recorded. Hence, those supplies (owner of sugar and lemons) will be recorded as inventory under assets. Inventory includes raw material, goods in process, and finished goods to sell (Mullis and Judith 22). Cost per unit of an item to be sold can be calculated by dividing total cost of production by number of items to be sold. The chapter provided a notion that sales minus cost of goods sold known as gross profit and the steps one take to run the business like advertising and rent are known as expenses. The point to be noted is that the left side will always be equal to right side due to counter effect (Mullis and Judith 27).
Chapter 2
Chapter 2 provided an overview of the key statements and their items like gross profit and net profit. Gross profit is sales minus cost of goods sold, but net profits is different (Mullis and Judith 35). Net profit is the gross profit minus expenses (Mullis and Judith 36). For a business with no tangible product like service business, expenses are classified into cost of goods sold and expenses (non-products costs) categories (Mullis and Judith 35). The aim of the income statement is to keep track of sales minus cost of goods sold that gives gross profit and cost of goods sold minus expenses that gives net profit/net earnings. Income statement can be made for a period of one week, one month, and a quarter of year or for one year, etc. General ledgers (manual/software) are used by the businesses to keep record of everything happens to the business (Mullis and Judith 38).
One of the items of income statement is beginning inventory. If one has any inventory before starting business for next period, it will be the beginning inventory. However, in case of no inventory for next period, beginning inventory will be zero. Beginning inventory plus purchases gives total items to be sold minus items that are not sold gives ending inventory. In this case, cost of goods sold will be beginning inventory plus purchases minus ending inventory. Balance sheet and income statement are interrelated to each other as beginning and ending inventory connects balance sheet to the income statement. One point is that principle of a loan does not go to income statement because one did not earn it. Income statement and balance sheet are not enough to provide complete picture of business. Statement of cash flow is important to consider because cash is key to run business (Mullis and Judith 42).
Chapter 3
Third chapter of the book provided an insight of the retained earnings, loans, credit, account payable and note payable. Retained earnings refer to the earning from past accounting periods. The business can retain earnings or distribute them to shareholders of the company. Distribution of earnings means payment of dividend by the company to shareholders. Bankers give loan to businesses by examining their income statement and balance sheet with extensive profit and assets in hand. For example, $5 original investment and $ 10 profit indicates 200% ROI. The loan of $50 by bank will appear in balance sheet under liabilities as notes payable. If one reduces inventory worth $2, it will appear in balance sheet as cash (Mullis and Judith 49).
In other words, the counter effects or double entry lead to no change in the overall balance sheet. In case, business buy supplies on credit, it will be payable as accounts payable, but on the other side inventory will also be increased by the same amount. In turn, there will be no change in assets and liabilities (assets=liabilities). Accounts payable are the short-term loans, which are due in full within 30 days. On the other hand, notes payable are long-term loans and can be paid by several years. This is why accounts payable is known as current liabilities (Mullis and Judith 55).
Chapter 4
Chapter 4 identified the important factors like paid labor, account receivable, bad debt, interest, prepaid expenses, accrual method, cash method, and creative accounting. There are two types of inventory, such as raw material and finished goods as lemons and sugar are raw materials and lemonade is finished goods. In addition, making of the products is called work-in-process. Under assets inventory is classified into raw material and finished goods. Finished goods are sold in cash and on the credit. The goods that are sold on credit go to asset side as account receivables (Mullis and Judith 58).
In addition, there are some losses in the businesses that cannot be recovered. These types of losses are known as bad debts and to record the bad debts businesses have to reduce account receivables. Moreover, the bad debts on the other side need to be recorded as expense and are subtracted from the earnings. In case of paying back loan to bankers, businesses also have to pay interest that leads to reduction in cash (loan + interest). On the other side, amount of loan paid back is subtracted from notes payable and amount of interest is added as interest expense and reduce earnings (Mullis and Judith 62).
An insurance policy is another type of asset. In turn, cash reduces by the amount spent to buy insurance policy. In addition, the amount paid in advance for insurance policy will be treated as prepaid expense. The first year of insurance will be recorded as current expense and amount will be subtracted from prepaid expenses. The amount of current expenses will be taken out from the earnings because prepaid expense is an asset (Mullis and Judith 66). Accrual accounting method refers to a method in which everything is recorded as it happens (Mullis and Judith 70). On the other hand, in cash method everything is accounted for as events happen in cash (Mullis and Judith 78). For instance, in cash method the total sales will not include account receivables because businesses have not received them. In service companies, both methods can be used that is called creative accounting (Mullis and Judith 82).
Chapter 5
Chapter 5 provided an overview of the understanding of service company’s issues and accounting. For instance, in case of consulting business one sells consulting services at $8/day for three days so the total revenue will be $48. The cost of service will include $12 as one paid $2/day to his/her two consultants for three days, $6 for their travel and $3 worth of product. It means total cost of services will be $21 ((Mullis and Judith 88). Subtraction of cost of services from sales gives gross profit and the expenses include sales commission, advertising, administrative work, and research and development. Subtraction of these types of expenses from gross income gives net income. In addition, other types of expenses in relation to service companies include interest expenses, other expenses and taxes. Other expenses include loss or gain from selling a fixed asset (Mullis and Judith 90).
Chapter 6
Chapter 6 provided a notion about the LIFO and FIFO methods with respect to inventory. Sometime in service companies, businesses have to purchase the raw material on credit. In turn, accounts payable increases. However, there is one issue that service and other companies face regarding inventory. The issue is related to recording of inventory at different costs due to increase in prices of raw materials. To record the inventory with different costs, there are two methods such as FIFO and LIFO. FIFO stands for first in first out that means the raw material that came to inventory at first place will be out first (Mullis and Judith 94).
For example, business purchased lemons (raw material) at two costs (20 cents and 40 cents). To make one batch of lemonade (60 glasses), there is a need of five pounds of sugar and 50 lemons. Now, the cost of production will include ($10) cost of lemons purchased at 20 cents/lemon and five pounds of sugar at 40cents/IB (total $2). It can be seen from the example that the cost of lemons is 20 cents/lemon using FIFO method. The sales of 60 glasses of lemonade, including 50 on cash and 10 on credit will contribute to total sales of $30 (50 cents/glass). Accordingly, $25 will appear under assets as cash and $5.00 as account receivables (Mullis and Judith 96).
LIFO stands for last in first out. The cost of production of lemonade in case of LIFO will be $22. It is due to the fact that in this case lemons with higher cost (lastly purchased) are used and lemons with lower cost will be in the ending inventory (Mullis and Judith 103). LIFO and FIFO both methods have advantages and disadvantages and businesses use these methods, according to their needs. For example, the businesses that use FIFO method their cost of goods sold is lower that leads to high ending inventory and high net profit. On the other hand, the businesses that use LIFO method to record inventory their cost of goods sold is higher that contributes to low ending inventory and low net profit. The businesses make accounting creative by choosing the right inventory recording method. They use FIFO to look better on papers, but it also leads to more taxes due to high level of earnings. In addition, they use LIFO to lower taxes (Mullis and Judith 104).
Mullis and Judith (104) also corroborated that businesses with increasing costs will use LIFO method to pay less taxes. Whereas, in case of decreasing rate in prices the businesses will use FIFO as electronics companies are facing decrease in prices. In turn, they use FIFO method to save taxes. The selection of LIFO or FIFO method by businesses depends on the tax strategy and direction of prices in the industry. In addition, these are the methods of valuing inventory and not the methods of using inventory (Mullis and Judith 108).
Chapter 7
Chapter 7 provided an overview of the cash statements, fixed assets, capitalization, and depreciation. The cash statement only record cash that comes in and the cash that goes out in a specified time period. Cash receivables will be added into cash in hand. In case business expands its operations by buying new stand. The new stand will be the fixed asset like furniture and its addition to the balance sheet is known as capitalization of asset. In cash statement, cash used to purchase a new stand (asset) will be subtracted on fixed asset investment line. Moreover, if an item has 10 years value it will be considered as an asset and business will needs to capitalize it. Nevertheless, if the item is less expensive with less than one year of value it will be considered as an expense. In turn, the earnings will be reduced. The cash statement on weekly basis will include collection, inventory paid, fixed asset investment, and expense paid that will give the amount in terms of changes in cash. The beginning cash will be added in the amount that will ultimately provide ending cash (Mullis and Judith 124).
The assets other than building are depreciated. One of the methods of depreciating the asset is Straight Line Depreciation. Using this depreciation method, businesses subtract equal percentage of amount from asset for a specified time period. Consequently, the value of asset will decrease by that amount each year. In other words, the net book value of asset is purchase price minus depreciation. The depreciation is a non-cash expense that means reduction in the earnings. The benefit of considering depreciation as non-cash expense is that it reduces earnings as well as taxes without decreasing cash (Mullis and Judith 128)
Work Cited
Mullis, Darrell, and Judith Orloff. The Accounting Game: Basic Accounting Fresh from the Lemonade Stand. USA: Sourcebooks, Inc., 2008.
