What is a semimonthly pay schedule?

A semimonthly pay schedule means that employees are paid twice a month, on the 1st and 15th (or the 16th, if the 15th falls on a weekend or holiday). This is the most common pay schedule for salaried employees.

Semimonthly Pay Example

What is a biweekly pay schedule?

A biweekly pay schedule means that employees are paid every other week, for a total of 26 pay periods per year. This is the most common pay schedule for hourly employees.

So, what’s the difference between biweekly and semimonthly payroll? The biggest difference is in the frequency of paychecks. With biweekly payroll, employees receive two paychecks each month, while with semimonthly payroll, they receive one paycheck every two weeks.

Another difference is in the timing of paychecks. With biweekly payroll, employees are typically paid on Fridays, while with semimonthly payroll, they are paid on the 1st and 15th (or 16th) of each month.

2022 Biweekly Pay Schedule

What is the difference between semi-monthly pay and bi-weekly pay?

The main difference between semimonthly pay and biweekly pay is the frequency of paychecks. Semimonthly payroll means that employees are paid twice a month, while biweekly payroll means that employees are paid every other week. Another difference is in the timing of paychecks. With semimonthly payroll, employees are typically paid on the 1st and 15th of each month, while with biweekly payroll, they are paid on Fridays.

So, which is better for your business? That depends on a number of factors, including your business size, type of employees, and your own preferences. If you’re not sure which is best for your business, talk to your accountant or payroll provider. They can help you make the best decision for your company.

Advantages of semimonthly pay

There are a few advantages of semi monthly pay schedule for businesses. First, it can simplify your payroll process and is the most cost-effective since there is a fewer number of paychecks to send out than bi- weekly payroll schedule. If you have employees who are paid hourly, you’ll only have to track their hours and calculate their pay once every two weeks. This can save you time and reduce the risk of mistakes. Also, it is somewhat easier to calculate salaries and wages, since there is less need for month-end adjusting entries.  

Second, semimonthly pay can help you stay compliant with labor laws. If you have employees who work overtime, you’ll need to track their hours and make sure they’re paid the correct overtime rate. With semimonthly pay, you can do this once every two weeks, rather than once a week. This can help you avoid mistakes and potential penalties.

Advantages of biweekly pay

There are also a few advantages of biweekly pay for businesses. First, it can align your employees’ paychecks with their work schedule. If your employees work Monday through Friday, they’ll likely prefer payday to be on Fridays. This way, they’ll have the weekend to spend their hard-earned money.

Second, biweekly pay can help you save on payroll costs. If you have hourly employees, you’ll only have to process their hours and calculate their pay once every two weeks. This can save you time and money on payroll processing fees.

Last, employees are paid more often when they are on a biweekly pay schedule as they will receive two extra paychecks each year when compared to a semi-monthly schedule. Employees also know the specific dates they will be getting paid, so they can plan for their living expenses better. 

Preferred industry pay schedules

Now that you know the difference between biweekly and semimonthly payroll, you may be wondering which is preferred in your industry. Here’s a look at the most common pay schedules by industry:

As you can see, the most common pay schedule varies by industry. In general, biweekly pay is more common for hourly employees, while semimonthly pay is more common for salaried employees.

When it comes to your business, there’s no right or wrong answer when it comes to choosing between biweekly and semimonthly payroll. The best solution is the one that works best for your company and your employees. Talk to your accountant or payroll provider to see which option is best for you.

The best way to understand how a business line of credit works is to think about it as a personal line of credit. A personal line of credit (or credit card) is like having a reserve of cash that you can access whenever you need it. You can borrow up to a certain limit and then pay the money back over time. 

A business line of credit works the same way. You can borrow up to a certain limit and then pay the money back over time. The key difference is that a business line of credit is for businesses only. 

A business line of credit is a great option for borrowers that need access to working capital on a short-term basis. For example, if you need to make a large purchase, buy inventory, or pay for unexpected expenses, but don’t have the cash available, you can borrow money from your business line of credit to make the purchase. Then, you can pay the money back over time by making monthly payments. You only pay interest on the amount of money being used, not the entire amount borrowed. Some lenders will have a monthly maintenance fee or annual fee for keeping the account open. 

Different Types of Lines of Credit

Credit lines typically come in two forms: a secured line of credit and unsecured line of credit. 

Unsecured lines of credit are riskier for the lender, so they come with a higher interest rate because the lender has no security if the loan isn’t repaid.  These unsecured lines of credit constitute the most prevalent type of revolving financing for small businesses.

A secured line of credit, on the other hand, is backed by collateral. This could be a piece of property, such as a house or a car, or it could be a certificate of deposit (CD) or savings account. 

The advantage of a secured line of credit is that the interest rates are usually lower than those for an unsecured line of credit. This is because the lender has more security if the loan isn’t repaid. 

How to Get a Business Line of Credit

The best way to get a business line of credit is to apply through a lending institution. 

When you’re applying for a business line of credit, the bank will want to know how you plan to use the money. They’ll also want to know your credit history and your business’s credit history. 

If you have a good credit history, you’re more likely to be approved for a business line of credit. And if you have a good business credit history and a high personal credit score, you’re more likely to get a lower interest rate. 

It’s important to remember that a business line of credit is not a loan. You don’t need to use it all at once and you don’t need to pay it back all at once. You can borrow as little or as much as you need, and you can pay the money back over time. 

A business line of credit can be a great way to free up cash flow when you need it most.

There are several methods that can be used to calculate depreciation. The most common method is the straight line method, which assigns a fixed value to an asset each year. Other methods include the declining balance method and the sum of the years digits method.

Depreciation is used to account for the loss in value of an asset over time. This helps businesses to accurately reflect their financial position and ensure that they are not overstating the value of their assets.

Depreciation is an important part of financial accounting and should be considered when making investment decisions. It is important to understand how depreciation works and the different methods that can be used to calculate it. By doing so, you can make more informed decisions about your finances and ensure that your assets are properly accounted for.

What assets can be depreciated?

The most common type of asset that can be depreciated is a tangible asset, such as a piece of equipment, machinery, or a vehicle. Intangible assets, such as patents or trademarks, can also be depreciated. However, there are some restrictions on what assets can be depreciated.

For example, land cannot be depreciated, because its value does not decrease over time. In addition, assets that are held for investment purposes, such as stocks or bonds, cannot be depreciated. Finally, assets that are being used in a business can be depreciated, but assets that are being used for personal purposes cannot.

How is Depreciation Calculated?

There are a number of different methods that can be used to calculate depreciation. The most common method is the straight line depreciation method, which assigns a fixed value to an asset each year. The formula for calculating depreciation using the straight-line method, subtract the asset’s salvage value (what you expect it to be worth at the end of the useful life of the asset) from its cost.  

Other methods include the declining balance method, double-declining balance method, and the sum of the years digits method. These methods assign a different value to the asset each year, based on the asset’s useful life.

Another method called the units of production method is calculated based on the usage of an asset, or units of goods produced. Therefore, the amount of depreciation will change depending on the usage of the asset. This method is useful in assets where variation in usage is an important factor, such as trucks based on the number of miles driven.

It is important to note that the depreciation amount will vary depending on the method that is used. businesses should use the method that gives the most accurate portrayal of the asset’s value.

Which method is used largely depends on the asset being depreciated.

The type of asset being depreciated will determine the depreciation method that is used. For example, if a business is depreciating a vehicle, the straight line method would be used. However, if the business was depreciating a piece of equipment, the declining balance method would be more appropriate.

It is important to consult with an accountant to determine which method is the best fit for your specific asset.

What are the benefits of depreciation?

There are a number of benefits to depreciation. The most obvious benefit is that it allows businesses to account for the loss in value of an asset over time. Depreciation expenses help businesses to accurately reflect their financial position and ensure that they are not overstating the value of their assets.

Depreciation is also important for tax purposes. The IRS allows businesses to write off the annual depreciation of certain assets aginst the income of the business. This can help businesses to reduce their taxable income and save money on taxes.

Finally, depreciation can be used to raise capital. When an asset is sold, the proceeds can be reinvested in a new asset. This allows businesses to keep their operations running and continue to grow.

What is an S Corporation?

Let’s start with defining an S Corporation and how it is taxed. An S Corporation, Subchapter S Corporation, or S Corp, is a corporation or Limited Liability Company that elects to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. In order to elect S Corp status, you need to file IRS Form 2553 and qualify by meeting requirements including being a domestic corporation, having 100 or fewer shareholders that are individuals or some types of trusts and estates, have only one class of stock, and not be an ineligible corporation. (1)

The concept of the income or loss passing through means that the owners can share the income/loss of the S Corp in the form of distributions, like how a general partnership would share it among partners. 

Instead of paying taxes on self-employment income, as one would as a sole proprietorship or partnership, the business must withhold FICA taxes and federal income taxes from employee pay and, the business must also pay those FICA taxes along with other employment taxes. 

A major tax benefit of S Corps is that the shareholder-employees do not have to pay self-employment tax (15.3% of earnings) on all of the company’s net profits, which could result in a significant payroll tax savings.  Self-employment taxes consist of 12.4% Social Security tax, plus 2.9% Medicare tax.  Combining those the two tax rates brings you to 15.3%. The net business profits of sole proprietorships and partnerships are subject to self-employment taxes. Electing to be taxed as an s-corp means that any shareholder distributions that aren’t salary are not charged the self-employment tax. Another big tax benefit of electing S Corp status is avoiding double-taxation that corporations face. Double-taxation occurs because the entity pays tax on business income, and the corporation’s shareholders pay tax on their dividends.

While that sounds great and easy to do, the Internal Revenue Service isn’t going to just let you minimize compensation in favor of corporate distributions. The caveat to not paying self-employment tax on the distributions is that if the owners provide any kind of service to the company, they must receive “reasonable compensation” in the form of wages/salaries as an employee. These wages are subject to employment tax, which will be discussed shortly.

Well, you don’t have to pay payroll taxes on distributions from your S corporation. Distributions are the earnings and profits that pass through the corporation to you as an owner (shareholder). Keep in mind that distributions are not your employee wages.

What is a reasonable salary?

According to the IRS the right amount of salary to pay depends on many factors, with the major one being industry standards. The salary must be a reasonable amount of compensation, which is open to interpretation but is often considered the median salary someone would earn doing what you do at your company.

The following factors are a few factors the IRS uses when evaluating reasonable owner income:

• Time and effort devoted to the business
• Prevailing rates comparable businesses pay for similar services
• Professional experience
• Duties and responsibilities
• Gross and net income of the business
• Business dividend history payments
• Dividend and bonus history

S corporations must pay reasonable wages to a shareholder-employee in return for services that the employee provides to the corporation before non-wage distributions may be made to the shareholder-employee. Cash distributions aren’t going to count towards reasonable compensation amounts. 

Also, the total amount of reasonable employee compensation is not just the annual salary paid.  It also includes health insurance premiums and HSA contributions. 

Also see: How to pay yourself as a business owner

Dangers of paying owners low wages

The ideal tax situation is to pay yourself $0 salary and the remaining as a distribution. Paying yourself zero salary and the rest in distributions is the riskiest play. Many businesses get away with this, however, there is a substantial risk of an IRS audit. 

You could pay yourself 100% in salary and no distributions which while is the safest route, your tax bill is going to be higher.  What the right amount is and the risk someone is willing to take is going to vary significantly between each person. Basically, the only tax savings an S Corp provides is the reduction of self-employment taxes, which includes Social Security and Medicare taxes (payroll taxes).  As an example, if you are paid $100,000 in shareholder wages, 7.65% is withheld for the employee’s portion of payroll taxes. This is broken down into 6.2% Social Security and 1.45% Medicare. The business will also pay 7.65% for a combined percentage of 15.3%.  This $100,000 shareholder salary costs you $15,300 in additional taxes. 

Tax advisors and the owners of S corporations are often at odds when setting the shareholder-employee’s compensation. Typically, the shareholder-employee will want to minimize compensation in favor of distributions to reduce payroll taxes. Tax advisers, however, are faced with growing scrutiny from the Internal Revenue Service stating the shareholder-employee cannot avoid payroll taxes by forgoing reasonable compensation. 

Because of the opportunity for substantial employment tax savings, the IRS has challenged attempts by shareholder-employees to minimize compensation in favor of distributions. 

There have been many cases tried in Tax Court for unreasonable shareholder salaries. An example is a 2012 case, David E. Watson, PC vs. U.S. A shareholder of an S Corp, who was a CPA of a tax accounting firm, received employee wages of $24,000 per year and dividend distributions of nearly $200,000 per year in 2002 and 2003. The case went to trial, and the government expert testified that the value of Mr. Watson’s services to the firm was $91,044 per year. The Tax Court concluded that any reasonable person in Watson’s role would be expected to earn far more than he was paying himself and rendered a tax deficiency judgment against the firm, which included unpaid employment taxes, penalties, and interest. 

The basic idea here is that employee salary should never be less than distributions. This ratio obviously doesn’t apply in every situation, but it can be a useful rule of thumb in some cases.

Another court case determined that a shareholder should not be paid a lower salary than other less-experienced employees in the business. There can be exceptions, most notably is when there aren’t sufficient profits or cash to pay the owners an appropriate salary.

In each case, shareholder-employees who provided significant services to their S corporation and withdrew sizeable taxable income from their corporation as distributions, neglecting to take any salary. The Tax Court held that the shareholders were employees and recharacterized the distributions as compensation.

In this case and many others, the IRS used a valuation expert who evaluated financial ratios from the Risk Management Association (RMA), which is a company that catalogs industry ratios.  You can use this information as well to evaluate average shareholder salaries in your industry, which can help from being the target of an IRS audit.

Under Section 3401(c) of the Internal Revenue Code, an employee is typically defined to include any officer of a corporation. Almost all S Corporation owners are, to at least some degree, actively engaged in running their corporation, and very frequently fulfill the role of an officer. In some circumstances, when shareholders who are also officers of a corporation, but only provide minor services to the business are not considered employees of the corporation. The key point to consider is they are not entitled to receive direct or indirect compensation.

How to reporting salaries and distributions on taxes

We now know that the S corporation owners (who provide services to the company) receive both a salary and distributions. The salary is compensation for their work, and the distributions are a share of the company’s profits. How are they reported on taxes?

The S Corp as an entity needs to file a Form 1120S for its annual U.S. Income tax return. Schedule K on Form 1120S shows the taxable income information. Each owner’s “distributive share,” or the distributions of the company’s income, is shown on their Schedule K-1, which is filed with their personal tax return.

Salaries, however, are subject to FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act), which are federal payroll taxes. For FICA, the taxes deducted from each paycheck are 6.2% of gross wages for Social Security tax and 1.45% of gross wages for Medicare tax, and the employer (or the S Corp), is responsible for matching it, for a total of 15.3%. The S Corp’s portion of FICA taxes are reported quarterly using Form 941 – Employer’s Quarterly Federal Tax Return. For FUTA, the S Corp pays 0.6% (if the state is eligible for a credit) of the first $7,000 of wages paid to employees in a calendar year. FUTA is reported annually on Form 940 – Employer’s Annual Federal Unemployment Tax. (4)

Impact from the Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act (TCJA) that began in 2018, further complicates calculating employee wages for S Corps.  While S corporations are still attractive to avoid Social Security and Medicare tax the TCJA instituted a new pass-through tax deduction, allowing S corp owners and other pass-through entities to deduct up to 20% of their net business income from their Federal income taxes.

There are a few limitations, such as total taxable income (which includes all W2 income) so be sure to talk with your tax professional to see if you qualify for the 20% deduction.

Simplifying Recordkeeping with Payroll Services

Keeping up with employment taxes is a job in itself, especially as the number of employees in your company grows. Thankfully, there are payroll services to help streamline the process. A payroll service, such as ADP or PayCom, will use employees’ wages to “calculate gross wages, subtract all pertinent withholdings and deductions, print checks, make direct deposits, and prepare all employment tax filings.” (5)

Conclusion

Small businesses can be incredibly costly for a new business owner. Now that you understand how S Corps are taxed, you can evaluate whether the tax benefits of electing S Corp status could be helpful for you in your small business endeavors.

1. “S Corporations,” IRS, last modified July 31, 2020, https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations.
2. “Wage Compensation for S Corporation Officers,” IRS Fact Sheet filed by the Media Relations Office, FS-2008-25, August 2008, https://www.irs.gov/pub/irs-news/fs-08-25.pdf.
3. David E. Watson vs. U.S., filed by the United States Court of Appeals for the Eighth Circuit, No. 11-1589, filed February 21, 2012, https://ecf.ca8.uscourts.gov/opndir/12/02/111589P.pdf.
4. “What is FICA?” Social Security Administration, Publication No. 05-10297, Match 2017, https://www.ssa.gov/thirdparty/materials/pdfs/educators/What-is-FICA-Infographic-EN-05-10297.pdf

Double taxation is a term that refers to when a company’s income is taxed and then the distributions or dividends that are paid to shareholders are also taxed. The C-corporation is the only business structure that undergoes double taxation.

Since a C-corporation is an entity established separately from its owners and its shareholders, each individual must pay their own income taxes from any money that is distributed to them.

Double Taxation in Action

Since C-corporations are considered separate legal entities for tax purposes, they pay taxes on corporate earnings at the corporate income tax rate. The United States tax code from the Internal Revenue Service places a double-tax on corporate income with one tax at the corporate level through the corporate income tax and a second tax at the individual level through the individual income tax on dividends and capital gains. Individuals pay income taxes on their dividend income when they receive a share of their profits as shareholders, which are previously taxed at the corporate level.

Thus, corporate income has been taxed twice.

Double taxation is almost always disadvantageous, but it might actually be favorable for shareholders in high tax brackets.

How Can Businesses be Taxed?

Many business owners want to avoid double taxation, however in some instances of higher-earning individuals, it may be beneficial.

S-Corporations

The term S-corporation does not refer to a business structure. It’s a tax designation that C-corporations and LLCs can elect. 

S-corporations are pass-through entities, meaning the company doesn’t pay taxes on earnings and the entity level. Instead, income and losses flow to each shareholder’s personal returns. This makes S-corporation status beneficial for smaller corporations who need to retain earnings for reinvestment.

One way to have business profits be taxed once is to organize the business as a flow-through or pass-through entity. When a business is organized as a flow-through entity, profits flow directly to the owner or owners

The IRS recoups some tax revenue another way, though. See, S-corporation shareholders that perform duties within the business become employees for tax purposes. The company must pay each of them a reasonable salary based on IRS guidelines. 

Consequently, the S-corporation and the shareholder-employees both owe a share of FICA taxes on the salaries.

LLCs

An LLC can either be a sole proprietorship or a partnership based on its owner (member) count. C-corporations can change to an LLC, but the process is much more involved than electing S-corporation taxation.

Sole Proprietorships

Single-member LLCs are sole proprietorships. The IRS calls sole proprietorships “disregarded entities”, meaning they aren’t separate from their owners for taxes. The owner pays individual income taxes on their LLC’s earnings.

Business income flows to the owner’s personal tax return. The owner records income and losses on Schedule C, then transfers their net profit to Form 1040.

Sole proprietors also pay a 15.3% self-employment tax — 12.4% for Social Security and 2.9% for Medicare — on their net earnings to cover both portions of FICA.

Partnerships

Partnerships are the default structure for LLCs with multiple members. Like with sole proprietorships, the partnership itself pays no tax. Each member pays personal income tax in proportion to their ownership stake. 

Say you have a three-member LLCs. Member X owns 50%, while members Y and Z each own 25%. Member X pays taxes on 50% of the partnership income, while members Y and Z each pay taxes on 25% of it.

In most cases, each member also pays self-employment taxes on their earnings.

How to Avoid Paying Double Taxation

Maximize Your Retained Earnings

Keeping money in the business — called retained earnings — helps you avoid personal income taxes. Plus, you can reinvest them in the corporation.

But be careful. The IRS can levy an accumulated earnings tax of 20% on any retained earnings they deem to be exceeding a reasonable amount.

IRS Publication 542 sets this limit at $250,000 for most businesses. Many services businesses have a lower limit of $150,000.

Elect S-Corporation Taxation

S-corporation structure lets you dodge taxes at the corporate level. However, you must meet several requirements laid out by the IRS to elect and maintain S-corporation status. Otherwise, the IRS will remove it. 

Pay Salaries to Family

The business can employ family members and pay a salary for working in the business.

Pay Salaries to Shareholders

Pay salaries to shareholders that work for the corporation. Salaries are tax-deductible corporate expenses, saving the corporation money while ensuring shareholders benefit from corporate income.

The expanded accounting equation is a useful tool or terminology because of the additional detail on the owner investments section of the accounting equation. Unlike the basic accounting equation (also known as the balance sheet equation), which only focuses on the balance sheet, it serves as the foundation for double-entry bookkeeping. The expanded equation uses the income statement to provide greater detail of business transactions and operations of the business.

Remember that under double-entry accounting, debits are recorded on the left side and, credits are recorded on the right side of the equation.

Expanded Accounting Equation

The expanded accounting equation builds on the standard accounting equation using double-entry accounting by adding granularity to the owners’ equity portion of the formula. The chart of accounts is a numbering system that lists all of a company’s accounts in the order in which they appear on the financial statements, beginning with the balance sheet accounts and then the income statement accounts. For a sole proprietorship, the accounting equation becomes assets are equal to liabilities, plus the owner’s capital, plus revenues, minus expenses minus owner draws. These components help to illustrate cash flows of the business attributable to normal operations and contributions or the owner’s withdrawals. In other words, we can see how the income and expense accounts flow through the equation and eventually end up being reported at the end of the accounting cycle in the equity account of the balance sheet.

If the business is a type of entity structure such as a corporation or another legal entity with multiple owners, the basic accounting equation becomes total assets are equal to liability total, plus paid-in capital or capital contributions cc, plus revenues, minus expenses, minus dividends minus treasury stock. For corporations, this equation sheds light on important capital structure and common stock data points. Without insight into equity, business owners would be unable to effectively manage the finances of a business.

How Is This Equation Used?

Regardless of the form of business, the expanded accounting equation provides insight into two important aspects of operations – revenue and owner transactions. The formula is useful as it shows the relationship between your income statement and balance sheet. Net revenue or loss can impact owners’ equity, and it’s important to understand what percentage change in equity is attributable to net income and the company’s financial position. If a business has had a bad year or quarter, the expanded accounting equation breaks down the impact of negative performance on equity. Conversely, if retained earnings balance is high, that change is also illustrated.

Owner’s contributions and withdrawals are also important to understand because they impact the cash position of a business, and they help illustrate the capital structure of a business during a set accounting period. For example, if there are significant treasury stock transactions, it can give an indication of what management is trying to accomplish regarding stock price. It also indicates what management’s views about the future are.

Example Of The Formula

In a sole proprietorship, the balance sheet may be simple, but the expanded version of the accounting equation is still relevant. On the asset side of the equation, common examples of assets such as cash, machinery, accounts receivable, and inventory is listed. Obligations would include items such as accounts payable and notes payable. The owner’s capital would include all owner contributions to a business. Revenues would include items such as retail sales and similar gross income line items. Expenses could be items such as the cost of goods sold, administrative expenses, and payroll.

Owner draws could be quarterly distributions that an owner would take from their business. Corporations would be similar except for the stockholder’s equity portion of the equation. For example, treasury stock are shares in a corporation that have been purchased back from investors. Paid in capital is a reflection of the sale of stock to investors in a corporation. All of these transactions directly impact the viability of business over the long term, so the effect of transactions has a direct impact on the business.

Relevance For Accountants

From a practical standpoint, the accounting equation helps accountants produce complete and accurate financial statements because it keeps all accounts in balance. If accountants want to ensure the balance sheet accounts are accurate, they can use the accounting equation and perform a high-level analysis. This is very helpful when preparing financial statements outside of an accounting software system. If financials are being prepared in Excel, mistakes can be made, and the basic accounting equation may become out of balance.

The expanded accounting equation can help accountants perform a more granular check on the accuracy of the financial reports. In situations where owners’ equity transactions are under review, using the expanded equation can help catch errors in financial statements and help add credibility to Excel schedules that illustrate financial activity. Tools such as this equation are essential for internal control and the accuracy of financial reporting.

The expanded accounting equation has the power to provide useful insights into the owners’ equity transactions that a business engages in. This granularity can give business owners and leaders alike an understanding of capital structure for strategic planning. If equity transactions are impactful, then the expanded accounting equation is particularly relevant to analysts.

Accountants use a standardized record keeping system to monitor business transactions and financial data relevant to an organization. The general ledger can be kept in a spreadsheet, but it’s often a part of a financial accounting software package. Below are details and an example of the mechanics of a general ledger and how it fits into the accounting cycle.

What Is the General Ledger?

In accounting, there are permanent accounts and temporary accounts that are used to track financial activity. All the accounts in the chart of accounts are listed in the general ledger. Typical categories in ledger accounts include assets, liabilities, equity, revenues, and expenses. It is the summation of all the debits and credits recorded by accounting clerks, bookkeepers, and accountants. The debits and credits in the ledger accounts should be equal when using double entry bookkeeping.

Related: What is double entry accounting?

In accounting software, the general ledger is a part of a database and uses double entry bookkeeping. When a journal entry is posted to the ledger, the debits and credits can be queried from the database to create financial statements, such as the profit and loss / income statement, cash flow statement, and balance sheet. This is where all the recorded financial activity for a business is stored, and it is among the most important tools accountants have for tracking financial activity and making sure a business is profitable.

Why Is a General Ledger Used?

The general ledger is a mechanism to record relevant transactions and economic events related to a small business. It is a source of data that can be used to form trial balances and ultimately a myriad of important financial reports, such as the cash flow statement. Without the general ledger, another system would be needed to house all the financial transactions that form the basis for financial reports. While the process of maintaining the ledger, posting journal entries and reconciling general ledger accounts may be time-consuming and labor-intensive, the investment of time and labor is well worth it.

Accountants often use the general ledger as a data warehouse to create ad hoc reports. For example, if an analysis and schedule of owner distributions are needed, the ledger can serve as a source of information to complete the analysis. Whether it’s an analysis of accounts receivable, accounts payable, revenue, or expenses, the general ledger is a vital source of information. If accountants couldn’t query the general ledger accounts, it would be difficult to verify the accuracy of financial statement account balances or understand why variances exist over time.

General Ledger Example

All the permanent ledger accounts on the balance sheet and all of the temporary accounts on the income statement are reflected on the general ledger. The account is divided by categories and is listed in the same order as are on the balance sheet and income statement. Assets are the first category on the balance sheet, so assets are the first division for your ledger. Liabilities, owner’s equity, revenue, and expenses are the second through fifth categories of division. For example, activity for asset accounts such as cash, fixed assets, inventory, and accounts receivable are recorded on the ledger. Similarly, activity for liabilities such as accounts payable and notes payable are also listed. All of the debits and credits that will form the financial statements are moved from journals and subsidiary ledgers to the general ledger. The most common journals are the sales journal, purchase journal, cash receipts journal, and cash payment journal. 

There are a variety of accounting systems that contain a general ledger. These systems include QuickBooks, Sage, Oracle, and Peoplesoft among many others. The ledger is in many ways indistinguishable from the other modules and reporting features in the software package. However, it is important to remember that the general ledger still exists and the function it plays in the generation of financial statements.

Posting Entries to the General Ledger

When posting entries to the general ledger accounts, all journal entries must have equal debits and credits. This is an important first step in preparing entries for posting. In traditional accounting systems, journals are created and posted to subsidiary ledgers. The subsidiary ledgers are then posted to a general ledger.

The system takes all journal entries and posts them to the general ledger in a seamless transaction. All entries are posted to the ledger, and the system will typically let users query the system to record transaction activity and analyze results during a specified accounting period. The posting process shouldn’t be done unless journal entries have been reviewed and approved according to a company’s internal control structure. Otherwise, errors and omissions may occur that may ultimately materially misstate the financial statements.

Differences Between the General Journal and the General Ledger

General journal accounts serve as the initial recordation tool for a journal entry. It is a tool used in a traditional accounting system, and it helps bookkeepers remain organized. Journal entries are listed by journal number. While this collection of debits and credits is important, it is less relevant when using accounting software. The software takes the entries and posts them to the ledger in behind-the-scenes actions.

The general ledger is the summation of all journal entries listed by account, while the trial balance only contains the ending balance in each of those accounts. All debits & credits are illustrated for all permanent and temporary ledger accounts. The general journal forms the basis for the general ledger and forms the basis for the financial statements. Given the reality of accounting systems, the ledger is the most relevant tool for tracking accounting transaction information and querying the system, to monitor account activity and generate financial reports.

The general ledger is also one of the most important tools accountants use to track critical ledger accounts, such as the operating cash account or COGS expense accounts. The ledger must be maintained on a regular basis by professionals that understand the accounting cycle and how to post a journal ledger entry. Without the general ledger, it would be extremely difficult to create a trial balance, financial statements, or for shareholders to understand a company’s financial position.

Using this information to maintain the financial health of a business, total debit balances must equal total credit balances.   

Differences between the general ledger and balance sheet

A balance sheet is a snapshot of the financial health of a business at a specific moment in time. The balance sheet reports financial information of a company’s assets, liabilities, and shareholders’ equity at a specific point in time and must balance the accounting equation (Assets = Liabilities + Equity).

Definition Of An Outstanding Check

Although direct deposit, online bill payment, wires and electronic fund transfers are popular payment types, paper checks are still a viable option. When a check is created and disbursed, it becomes outstanding until it is drawn at the bank. When a vendor or employee goes to the bank to cash the check, and it’s cleared the bank, the check will show up on the bank statement. A credit on the statement will show the disbursement, and a copy of the check will likely be listed at the bottom of the account’s statement. There is always or should be a paper trail behind every balanced checkbook.

How To Record An Outstanding Check

Most general ledger systems have an automated recordation process of checks that occurs when paying bills. The accounts payable module allows for bill payment, by selection of a pay bill feature. Selecting a check payment automatically reduces the liability in the general ledger and posts a credit to the cash account. The bank reconciliation module registers an outstanding check that cannot be cleared until the money is drawn from the bank account.

How To Find Outstanding Checks

The outstanding check will become a reconciling item in the bank reconciliation process, outstanding checks should be displayed as a “list” or “timing” item, depending on the reconciliation system used. This simply means that the check has been recorded in the general ledger as a cash disbursement, but the money has not been disbursed from the bank account by the bank statement date. This is when the check has not been cashed or deposited into the payee’s bank. At that point, the payer may need to issue a replacement payment or new check to replace the old check which hopefully will end up in the payee’s account. Finding all outstanding checks should be as simple as reviewing the reconciliation. While preparing the reconciliation, which should be done at the end of the month, a comparison of general ledger details and bank details will reveal outstanding checks and the differences between the ledger balance and bank balance.

Checks are often used to pay for inventory, operational expenses and payroll, but the money isn’t disbursed from the business bank account until the check is drawn. Tracking outstanding checks is important for maintaining working capital for on-going operations. Bank reconciliations are an ideal place to track outstanding checks.

There are several issues that can arise from outstanding checks. When a check is outstanding, the company’s bank account will have an inflated account balance. Outstanding checks can result in bank overdrafts due to insufficient funds, not sufficient funds, or NSF which can result in fees. According to the unclaimed property laws, after a long while, outstanding checks must be remitted to the state as unclaimed property, also known as unclaimed assets. Checks that are outstanding for a long period of time are known as stale checks. Businesses that mishandle these kinds of situations are in violation of the law.

Trade Discount Definition

Sellers in business-to-business transactions will offer discounts to clients based on a variety of factors, such as purchasing volume and repeat business. These types of incentives are referred to as trade discounts, and they play a large role in winning clientele. In most cases, the discount is taken from the gross amount, list prices of products, catalog prices of the goods or retail price of the purchase order. The sales price net of the trade discount is the new gross sales amount and accounts receivable. Trade discounts are typically variable and change with the quantity purchased.

Example Of A Trade Discount

Wholesale purchases from a supplier of goods such as plastics used by manufacturers of industrial sight glasses might offer a discount for the purchase of a quantity of goods such as acrylic rods in a tube, in different bulk quantities. For example, with the purchase of 100 to 200 acrylic tubes, there might be a 25-cent discount per unit. This discount could increase with the purchase of large quantity orders of 200 to 500 units, to 30-cents per unit. Trade discounts permeate throughout different industries and are used when resellers sell products as bulk sales and services in business-to-business transactions to those known as a concerned consumer.

Cash Discount Definition

When sellers or suppliers of goods or services want to speed up cash collections as in recovering cash debts, they offer cash discounts or a deduction at the time of purchase. A cash discount or early payment discount is applied to a receivable when a customer pays within a specified time period or specific period of time. These types of sales discounts are used in business-to-business transactions, when a supplier, vendor, or wholesaler wants to increase cash flow through cash payments. When clients take advantage of these discounts, they reduce their cost of goods sold or expenses and improve their balance sheet, which is beneficial for all stakeholders in the transaction.

Example Of A Cash Discount

A seller of marketing analytics and related information may offer a 2 percent discount if customers make prompt payment and pay their invoice price of the goods or the invoiced price within a stipulated time of the due date such as a quick payment of 10 days of receiving their bill. The percentage purchase discount can vary, but the principle is the same. Cash discounts incentivize customers to pay their liabilities quickly resulting in an early clearance of dues, help the seller collect cash faster, and may even prevent the customers from paying additional fees from using a credit card instead. Such discounts of the billed price of products are commonplace throughout the industry.

Trade and cash discounts each have advantages and major differences and can increase sales and cash flow. Knowing when to use these discounts, or when to take advantage of them, can impact bottom-line profit and compel customers to make purchases that result in additional sales.

Perpetual Inventory System

If a business needs a system that tracks physical inventory counts in real-time, then perpetual inventory systems are the best choice. These systems provide the total cost of inventory, inventory balances, inventory purchases, and the purchases account when decision-makers need the information the most. Perpetual systems typically involve automation when recording costs, however, this is not always the case. Accountants and bookkeepers may be responsible for recording invoices and other important data on a daily basis to meet reporting requirements of small businesses.

Periodic Inventory System

Periodic systems are just the opposite of perpetual systems. Instead of sinking resources into the real-time recording of inventory transactions, data is tracked periodically. Source documents are batched at regular intervals and are entered into the general ledger system. However, these batches are prepared to keep transactions in the right accounting period, especially when using the accrual basis of accounting. Periodic systems may be easier for smaller accounting departments to maintain, especially if there is a lack of resources or automated reporting through inventory software.

Major Differences

The largest difference between the two systems is the timeliness of reporting. Under the perpetual system, users can review cost of goods sold data, which can be found on the income statement, in real-time data. Purchases are recorded immediately, allowing for interim analysis of financial statements and adjustments to inventory accounts, if needed. The periodic system is less timely, but it doesn’t mean that financial records are less accurate when prepared at month-end, year-end, or end of the period. Both systems facilitate a physical count of inventory, but the perpetual system makes it easier to perform during interim periods.

Major Advantages

The resources available to businesses and accounting departments directly impact the use of perpetual or periodic systems. Often, business owners with fewer resources opt for the periodic system, which is a temporary account, because they can allocate work proportionately when scarce resources are best utilized. Car dealerships and art galleries would be two types of businesses that would probably opt for the periodic system due to a typically small sales volume. Below are specific advantages of each inventory system or inventory accounting method.

Perpetual Inventory Method

• Real-time reporting and analytics
• Better managerial oversight and control
• Quick identification of errors and oversights
• Accurate interim financial reports
• Better control over purchasing function

Periodic Inventory Method

• Batch reporting
• Less resources required to maintain system
• Reallocation of resources during interim periods
• Less maintenance of computerized tracking
• Retain the ability to control and track inventory costs.

Recording inventory is a process that impacts financial reporting and operational effectiveness, making it important to understand the nuances of inventory management systems. Both the perpetual and periodic systems have advantages but use different approaches to valuing inventory items and inventory levels. Auditing the cost of goods sold cogs is key for validating both systems. Staff must integrate into their routines for the inventory management system to function as designed and produce an accurate inventory account showing the quantity and cost of inventory. Any discrepancies are usually accounted for during the verification process at the end of the accounting period. Accuracy is essential to all financial aspects of a business.