An Introduction to Accounting Basics

Accounting Basics

Accounting is an organized process of identifying, recording, measuring, classifying, verifying, summarizing, interpreting, and communicating financial information.

According to The American Accounting Association, it is “the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.

The Purpose of Accounting

Business organizations heavily depend on financial information to develop core business strategies. Each and every transaction that is carried out by business organizations is recorded so, at some defined period, businesses will have a fair idea of their financial position.

Generally, the financial information will be accumulated in accounting records; it will encompass details on the performance, financial position, and the cash flow. The report prepared will be then compiled into financial statements, and it includes,

  1. Balance Sheet
    • A Balance sheet helps investors and creditors to understand how working capital is being utilized in one day at the certain point of time. The sheet includes assets, liabilities, and owner’s equity as of the report date.
  1. Income Statement
    • Also referred as profit and loss statement/statement of revenue and expense, an income statement reports a company’s financial performance over a specific period.
  1. Statement of Cash Flows
    • Also known as cash flow statement, this financial statement records the amount of cash and cash equivalents entering and leaving the company. The information is then used for budgeting and business planning.
  1. Statement of Owner’s Equity
    • The statement reports events that increased or decreased stockholder’s equity over the course of the accounting period. The statement will be usually presented in a simple equation style format,
    • Beginning Equity Balance
    • PLUS
      • Net Income
      • Owner’s Contribution
    • LESS
      • Net Loss
      • Owner’s Withdrawals
    • Ending Equity Balance

    Related: A Detailed Guide to Accounting Services

    Related: Accrual vs. Cash Methods: Which is the best option for Small Business Accounting?

Elements of Accounting

Terms that we commonly come across an accounting process is explained below.

  1. Assets
    • Assets are resources or things of some value owned by a company to increase its value or income. Assets are classified as current and non-current.
    • Current assets include cash and cash equivalents, prepaid expenses, marketable securities, inventory, and accounts receivable.
    • Non-current/long-term assets are further classified as tangible fixed-assets, non-tangible fixed assets, and Goodwill. Physical properties such as vehicles, machinery, and buildings are all are tangible assets. Trademark, software, and patented technology are intangible assets.
    • Goodwill is also an intangible asset, it cannot be generated internally, and is acquired only in the form of an acquisition.
  1. Liabilities
    • Liability is the financial amount or obligations owed by a company, which are expected to be paid off within a year.
    • Current Liabilities (short-term) are the company’s debts or obligations that are due within a year.
    • Non-Current Liabilities (long-term) are the long-term debts or obligations that are not due within the present accounting year.
  1. Capital
    • It is the funds gathered to run a business; hence, capital refers to stock or ownership of a company. It also represents the accumulated wealth of a business that is assets less liabilities.

Accounting Principles & Guidelines

Accounting principles differ for each country and for companies working in the U.S soil should follow GAAP, while preparing financial statements.

The definition of accounting principles is as follows, ’they are the basic rules and definitions that must be followed when reporting financial data’.

Generally accepted accounting principles abbreviated as GAAP was developed to keep financial reporting transparent and consistent across the organizations. GAAP consists of three important set of rules: the basic accounting principles and guidelines, the rules and standards issued by FASB and APB, and finally, the generally accepted industry practices.

Important Accounting Concepts  

The entire financial accounting principles are based on accounting concepts and conventions, following is a list of important accounting concepts explained.

  • (Separate) Business Entity Concept
    • As far as the financial transactions are concerned, the affairs of business should be considered as a separate entity from the personal affairs of the proprietor.
  • Money Measurement Concept
    • Also referred as measurability concept, it deals with any transaction related to business that can be recorded in monetary terms in the financial statements.
  • Dual Aspect Concept
    • The concept is the underlying basis of double entry accounting system; it involves recordation of a business transaction in two different accounts. The aspects of transactions are classified into two main types, debit and credit.
  • Going Concern Concept
    • One of the fundamental principles of accounting, under this concept, there will be an assumption that company will complete its current plans through existing assets and will continue to meet its financial obligations.
  • Cost Concept
    • According to this concept, the value of fixed assets is recorded as per the original purchase price; the market value is not taken into consideration.
  • Accounting Year Concept
    • The period taken to complete the cycle of the accounting process is different based on how each business chose the time period. It can be monthly, quarterly, or annual basis- as per fiscal or calendar year.
  • Matching Concept
    • Firms recognize revenues and other related expenses under the same accounting period. The main purpose of carrying out this process is to avoid misstating earning of a period.
  • Realization Concept
    • It implies that revenue is realized when the goods are delivered or services are rendered. Under this concept, a profit is recognized only when it is earned.

The Bottom Line

Understanding the basics of accounting essentially helps every businessman to make smart finance decisions. Even if you hire a bookkeeper or an accountant to do the job, learning the fundamentals of accounting will help you assess the qualities of your resource and as a business owner you should not overlook such aspects.

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