The Balanced Scorecard

The Balanced Scorecard
Traditional financial reporting systems provide an indication of how a firm has performed in the past, but offer little information about how it might perform in the future. For example, a firm might reduce its level of customer service in order to boost current earnings, but then future earnings might be negatively impacted due to reduced customer satisfaction.
To deal with this problem, Robert Kaplan and David Norton developed the Balanced Scorecard, a performance measurement system that considers not only financial measures, but also customer, business process, and learning measures. The Balanced Scorecard framework is depicted in the following diagram:

Diagram of the Balanced Scorecard

		Financial
Customer		Strategy		Business    Processes
		Learning    & Growth

The balanced scorecard translates the organization's strategy into four perspectives, with a balance between the following:

• between internal and external measures
• between objective measures and subjective measures
• between performance results and the drivers of future results

Beyond the Financial Perspective

In the industrial age, most of the assets of a firm were in property, plant, and equipment, and the financial accounting system performed an adequate job of valuing those assets. In the information age, much of the value of the firm is embedded in innovative processes, customer relationships, and human resources. The financial accounting system is not so good at valuing such assets.
The Balanced Scorecard goes beyond standard financial measures to include the following additional perspectives: the customer perspective, the internal process perspective, and the learning and growth perspective.

• Financial perspective - includes measures such as operating income, return on capital employed, and economic value added.
• Customer perspective - includes measures such as customer satisfaction, customer retention, and market share in target segments.
• Business process perspective - includes measures such as cost, throughput, and quality. These are for business processes such as procurement, production, and order fulfillment.
• Learning & growth perspective - includes measures such as employee satisfaction, employee retention, skill sets, etc.

These four realms are not simply a collection of independent perspectives. Rather, there is a logical connection between them - learning and growth lead to better business processes, which in turn lead to increased value to the customer, which finally leads to improved financial performance.

Objectives, Measures, Targets, and Initiatives

Each perspective of the Balanced Scorecard includes objectives, measures of those objectives, target values of those measures, and initiatives, defined as follows:

• Objectives - major objectives to be achieved, for example, profitable growth.
• Measures - the observable parameters that will be used to measure progress toward reaching the objective. For example, the objective of profitable growth might be measured by growth in net margin.
• Targets - the specific target values for the measures, for example, +2% growth in net margin.
• Initiatives - action programs to be initiated in order to meet the objective.

These can be organized for each perspective in a table as shown below.

	Objectives	Measures	Targets	Initiatives
Financial
Customer
Process
Learning

Balanced Scorecard as a Strategic Management System

The Balanced Scorecard originally was conceived as an improved performance measurement system. However, it soon became evident that it could be used as a management system to implement strategy at all levels of the organization by facilitating the following functions:

1. Clarifying strategy - the translation of strategic objectives into quantifiable measures clarifies the management team's understanding of the strategy and helps to develop a coherent consensus.
2. Communicating strategic objectives - the Balanced Scorecard can serve to translate high level objectives into operational objectives and communicate the strategy effectively throughout the organization.
3. Planning, setting targets, and aligning strategic initiatives - ambitious but achievable targets are set for each perspective and initiatives are developed to align efforts to reach the targets.
4. Strategic feedback and learning - executives receive feedback on whether the strategy implementation is proceeding according to plan and on whether the strategy itself is successful ("double-loop learning").

These functions have made the Balanced Scorecard an effective management system for the implementation of strategy. The Balanced Scorecard has been applied successfully to private sector companies, non-profit organizations, and government agencies.

Recommended Reading
Robert S. Kaplan and David P. Norton,  The Balanced Scorecard : Translating Strategy into Action

Read more »

Financial Accounting Standards

Financial Accounting Standards

Accounting standards are needed so that financial statements will fairly and consistently describe financial performance. Without standards, users of financial statements would need to learn the accounting rules of each company, and comparisons between companies would be difficult.
Accounting standards used today are referred to as Generally Accepted Accounting Principles (GAAP). These principles are "generally accepted" because an authoritative body has set them or the accounting profession widely accepts them as appropriate.

Securities and Exchange Commission (SEC) The Securities and Exchange Commission is a U.S. regulatory agency that has the authority to establish accounting standards for publicly traded companies. The Securities Act of 1933 and the Securities Exchange Act of 1934 require certain reports to be filed with the SEC. For example, Forms 10-Q and 10-K must be filed quarterly and annually, respectively. The head of the SEC is appointed by the President of the United States.
When the SEC was formed there was no standards-issuing body. However, rather than set standards, the SEC encouraged the private sector to set them. The SEC has stated that FASB standards are considered to have authoritative support.


Committee on Accounting Procedure (CAP)
In 1939, encouraged by the SEC, the American Institute of Certified Public Accountants (AICPA) formed the Committee on Accounting Procedure (CAP). From 1939 to 1959, CAP issued 51 Accounting Research Bulletins that dealt with issues as they arose. CAP had only limited success because it did not develop an overall accounting framework, but rather, acted upon specific problems as they arose.



Accounting Principles Board (APB)
In 1959, the AICPA replaced CAP with the Accounting Principles Board (APB), which issued 31 opinions and 4 statements until it was dissolved in 1973. GAAP essentially arose from the opinions of the APB.
The APB was criticized for its structure and for several of its positions on controversial topics. In 1971 the Wheat Committee (chaired by Francis Wheat) was formed to evaluate the APB and propose changes.

Financial Accounting Standards Board (FASB)
The Wheat Committee recommended the replacement of the Accounting Principles Board with a new standards-setting structure. This new structure was implemented in 1973 and was made up of three organizations:

• Financial Accounting Foundation (FAF)
• Financial Accounting Standards Board (FASB)
• Financial Accounting Standards Advisory Council (FASAC).

Of these organizations, FASB (pronounced "FAS-B") is the primary operating organization.
Unlike the APB, FASB was designed to be an independent board comprised of members who have severed their ties with their employers and private firms. FASB issues statements of financial accounting standards, which define GAAP. The AICPA issues audit guides. When a conflict occurs, FASB rules.



International Accounting Standards Committee (IASC)
The International Accounting Standards Committee (IASC) was formed in 1973 to encourage international cooperation in developing consistent worldwide accounting principles. In 2001, the IASC was succeeded by the International Accounting Standards Board (IASB), an independent private sector body that is structured similar to FASB.

Governmental Accounting Standards Board (GASB)
The financial reports of state and local goverment entities are not directly comparable to those of businesses. In 1984, the Governmental Accounting Standards Board (GASB) was formed to set standards for the financial reports of state and local government. GASB was modeled after FASB.

Recommended Reading
Tracy, John A., How to Read a Financial Report: Wringing Vital Signs Out of the Numbers

Read more »

Closing Entries

Closing Entries

Revenue, expense, and capital withdrawal (dividend) accounts are temporary accounts that are reset at the end of the accounting period so that they will have zero balances at the start of the next period. Closing entries are the journal entries used to transfer the balances of these temporary accounts to permanent accounts.
After the closing entries have been made, the temporary account balances will be reflected in the Retained Earnings (a capital account). However, an intermediate account called Income Summary usually is created. Revenues and expenses are transferred to the Income Summary account, the balance of which clearly shows the firm's income for the period. Then, Income Summary is closed to Retained Earnings.
The sequence of the closing process is as follows:

1. Close the revenue accounts to Income Summary.
2. Close the expense accounts to Income Summary.
3. Close Income Summary to Retained Earnings.
4. Close Dividends to Retained Earnings.

The closing journal entries associated with these steps are demonstrated below. The closing entries may be in the form of a compound journal entry if there are several accounts to close. For example, there may be dozens or more of expense accounts to close to Income Summary.

1.  Close Revenue to Income Summary

The balance of the revenue account is the total revenue for the accounting period. Since revenue is one of the components of the income calculation (the other component being expenses), in the last day of the accounting period it is closed to the Income Summary account as follows:

Closing Entry :  Revenue to Income Summary

Date	Accounts	Debit	Credit
mm/dd	Revenue	xxxx.xx
	Income Summary		xxxx.xx

Once this closing entry is made, the revenue account balance will be zero and the account will be ready to accumulate revenue at the beginning of the next accounting period.

2.  Close Expenses to Income Summary

Expenses are the other component of the income calculation and like revenue, are closed to the Income Summary account:

Closing Entry :  Expenses to Income Summary

Date	Accounts	Debit	Credit
mm/dd	Income Summary	xxxx.xx
	Expenses		xxxx.xx

After closing, the balance of Expenses will be zero and the account will be ready for the expenses of the next accounting period. At this point, the credit column of the Income Summary represents the firm's revenue, the debit column represents the expenses, and balance represents the firm's income for the period.

3.  Close Income Summary to Retained Earnings

The income or loss for the period ultimately adds to or subtracts from the firm's capital. The Retained Earnings account is a capital account that accumulates the income from each accounting period. The Income Summary account is closed to Retained Earnings as follows:

Closing Entry :  Income Summary to Retained Earnings

Date	Accounts	Debit	Credit
mm/dd	Income Summary	xxxx.xx
	Retained Earnings		xxxx.xx

4.  Close Dividends to Retained Earnings

Any capital withdrawals (e.g. dividends paid) during the period will reduce the capital account balance, so the withdrawal is closed to Retained Earnings:

Closing Entry :  Dividends to Retained Earnings

Date	Accounts	Debit	Credit
mm/dd	Retained Earnings	xxxx.xx
	Dividends		xxxx.xx

After closing, the dividend account will have a zero balance and be ready for the next period's dividend payments.

Posting of the Closing Entries

As with other journal entries, the closing entries are posted to the appropriate general ledger accounts. After the closing entries have been posted, only the permanent accounts in the ledger will have non-zero balances.

Post-Closing Trial Balance

Once the closing entries have been posted, the trial balance calculation is performed to help detect any errors that may have occurred in the closing process.

Recommended Reading
Schaum's Outline of Bookkeeping and Accounting

Read more »

Trial Balance

Trial Balance

A basic rule of double-entry accounting is that for every credit there must be an equal debit amount. From this concept, one can say that the sum of all debits must equal the sum of all credits in the accounting system. If debits do not equal credits, then an error has been made. The trial balance is a tool for detecting such errors.
The trial balance is calculated by summing the balances of all the ledger accounts. The account balances are used because the balance summarizes the net effect of all of the debits and credits in an account. To calculate the trial balance, construct a table in the following format:

Trial Balance Calculation

Account         Debits         Credits     Account 1 xxxx.xx Account 2 xxxx.xx Account 3 xxxx.xx . . . Account 4 xxxx.xx Account 5 xxxx.xx Account 6 xxxx.xx . . . ________ ________ Totals:  xxxx.xx  xxxx.xx

In the above trial balance, the balances of Accounts 1, 2, and 3 are net debits, and the balances of Accounts 4, 5, and 6 are net credits. The totals of the debits and credits should be equal; if they are not, then an error was made somewhere in the accounting process. Some common errors include the following:

1. Error in totaling the columns - make sure that the trial balance columns were summed properly.
2. Error in transferring account balances to proper trial balance columns - make sure that debit and credit account balances are in the appropriate debit and credit columns of the trial balance calculation. Check for reversed digits and misplaced decimal points.
3. Omission of an account - an account may be missing in the trial balance calculation.
4. Error in account balance - an error may have been made in the calculation of a ledger account balance.
5. Error in posting a journal entry - a journal entry may not have been posted properly to the general ledger.
6. Error in recording a transaction in the journal - for example, making an error in a debit or credit, or failing to enter a debit or credit.

In general, the most effective way to isolate an error is to work backward from the trial balance itself to the initial journal entry, as outlined in the above list.
Note that a balanced trial balance does not guarantee that there are no errors. An error of omission could have been made in which a transaction was not recorded, a journal entry could have been posted to the wrong ledger account, or a debit and credit could have been transposed. Such errors are not caught by the trial balance.

Recommended Reading
Schaum's Outline of Bookkeeping and Accounting

Read more »

Adjusting Entries

Adjusting Entries

In the accounting process, there may be economic events that do not immediately trigger the recording of the transaction. These are addressed via adjusting entries, which serve to match expenses to revenues in the accounting period in which they occur. There are two general classes of adjustments:

• Accruals - revenues or expenses that have accrued but have not yet been recorded. An example of an accrual is interest revenue that has been earned in one period even though the actual cash payment will not be received until early in the next period. An adjusting entry is made to recognize the revenue in the period in which it was earned.
• Deferrals - revenues or expenses that have been recorded but need to be deferred to a later date. An example of a deferral is an insurance premium that was paid at the end of one accounting period for insurance coverage in the next period. A deferred entry is made to show the insurance expense in the period in which the insurance coverage is in effect.

How to Make Adjusting Entries

Like regular transactions, adjusting entries are recorded as journal entries. The following illustrates adjustments for accrued and deferred items.

Accrued Items
As an example of an accrued item, consider the accrual of interest revenue. The journal entry would be similar to the following:

Adjusting Entry for Interest Accrual

Date	Accounts	Debit	Credit
mm/dd	Interest Receivable	xxxx.xx
	Interest Revenue		xxxx.xx

The date of the above entry would be at the end of the period in which the interest was earned. The adjusting entry is needed because the interest was accrued during that period but is not payable until sometime in the next period. The adjusting entry is posted to the general ledger in the same manner as other journal entries.
In the next period when the cash is actually received, one makes the following journal entry:

Journal Entry for Interest Received

Date	Accounts	Debit	Credit
mm/dd	Cash	xxxx.xx
	Interest Receivable		xxxx.xx

Deferred Items
For deferrals, a journal entry already has been made in asset or liability accounts and an adjusting entry is needed to move the balances to expense or revenue accounts in the next accounting period. Consider the case in which the firm prepays insurance premiums in one period for insurance coverage in the next period. The journal entry made at the time of payment would be similar to the following:

Journal Entry for Prepaid Insurance

Date	Accounts	Debit	Credit
mm/dd	Prepaid Insurance	xxxx.xx
	Cash		xxxx.xx

In the next period when the insurance coverage is in effect, one makes the following adjusting entry:

Adjusting Entry for Prepaid Insurance

Date	Accounts	Debit	Credit
mm/dd	Insurance Expense	xxxx.xx
	Prepaid Insurance		xxxx.xx

For a single deferred item, there may be several adjusting entries over subsequent accounting periods as the expense or revenue for the item is recognized over time.

Recommended Reading
Schaum's Outline of Bookkeeping and Accounting

Read more »

Debits and Credits

Debits and Credits

In double entry accounting, rather than using a single column for each account and entering some numbers as positive and others as negative, we use two columns for each account and enter only positive numbers. Whether the entry increases or decreases the account is determined by choice of the column in which it is entered. Entries in the left column are referred to as debits, and entries in the right column are referred to as credits.
Two accounts always are affected by each transaction, and one of those entries must be a debit and the other must be a credit of equal amount. Actually, more than two accounts can be used if the transaction is spread among them, just as long as the sum of debits for the transaction equals the sum of credits for it.
The double entry accounting system provides a system of checks and balances. By summing up all of the debits and summing up all of the credits and comparing the two totals, one can detect and have the opportunity to correct many common types of bookkeeping errors.
To avoid confusion over debits and credits, avoid thinking of them in the way that they are used in everyday language, which often refers to a credit as increasing an account and a debit as decreasing an account. For example, if our bank credits our checking account, money is added to it and the balance increases. In accounting terms, however, if a transaction causes a company's checking account to be credited, its balance decreases. Moreover, crediting another company account such as accounts payable will increase its balance. Without further explanation, it is no wonder that there often is confusion between debits and credits.
The confusion can be eliminated by remembering one thing. In accounting, the verbs "debit" and "credit" have the following meanings:

Debit "Enter in the left column of"

Credit "Enter in the right column of"

Thats all. Debit refers to the left column; credit refers to the right column. To debit the cash account simply means to enter the value in the left column of the cash account. There are no deeper meanings with which to be concerned.
The reason for the apparent inconsistency when comparing everyday language to accounting language is that from the bank customer's perspective, a checking account is an asset account. From the bank's perspective, the customer's account appears on the balance sheet as a liability account, and a liability account's balance is increased by crediting it. In common use, we use the terminology from the perspective of the bank's books, hence the apparent inconsistency.
Whether a debit or a credit increases or decreases an account balance depends on the type of account. Asset and expense accounts are increased on the debit side, and liability, equity, and revenue accounts are increased on the credit side. The following chart serves as a graphical reference for increasing and decreasing account balances:

Assets	=	Liabilities	+	Owner's Equity
Cash Debit + Credit -		A/P Debit - Credit +		Retained Earnings Debit - Credit + Expense Debit + Credit - Revenue Debit - Credit +

Recommended Reading
Bookkeeping the Easy Way - From The Easy Way Series.

Read more »

The General Ledger

The General Ledger

While the journal lists transactions in chronological order, its format does not faciliate the tracking of individual account balances. The general ledger is used for this purpose.
The general ledger is a collection of T-accounts to which debits and credits are transferred. The action of recording a debit or credit in the general ledger is referred to as posting. The posting of a journal entry to the general ledger accounts is a purely mechanical process using information already in the journal entry and requiring no additional analysis.
To understand the posting process, consider a journal entry in the following format:

General Journal Entry

Date	Accounts	Debit	Credit
mm/dd	Account 1	xxxx.xx
	Account 2		xxxx.xx

There are two ledger accounts affected by the above journal entry (Account 1 and Account 2). Each of these accounts is represented by a T-account in the general ledger. To post the entry to the ledger, simply transfer the information to the T-accounts:

Ledger Accounts

Account 1 mm/dd xxxx.xx                                                           Bal. xxxx.xx

Account 2                            mm/dd xxxx.xx                                          Bal. xxxx.xx

Note that the debit portion of the journal entry is posted to the left side of its associated T-account, and the credit portion is posted to the right side of its T-account. The date helps to identify the transactions with the journal entries. Additionally, a reference number may be added to further facilitate cross-referencing.
Because the general ledger is organized by account, it allows one to view the activity and balance of any account at a glance.

Recommended Reading
Schaum's Outline of Bookkeeping and Accounting

Read more »