Understanding Basic Accounting

• Posted on Apr 8, 2019

Understanding Basic Accounting

This is different from Income statement which is prepared for a period of time (for example Income Statement for the month of December). However, if a balance sheet is dated December 31, the amounts shown on the https://www.bookstime.com/ balance sheet are the balances in the accounts after all transactions pertaining to December 31 have been recorded. Now that we have covered the Revenue or Sales, let us look at the Income Statement expenses.

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Accounting Period – The span of time covered by the financial statements is the accounting period. It defines the time frame of transactions included in financial statements.

Introduction to Accounting

First, you buy a product or service in a specific month which is then expensed in this month (income statement). Lastly, your customer pays which means your trade receivable (asset) will Balancing off Accounts be non existent, because you received cash from the customer (cash flow statement). Then, your customer owes you the money and you show that on the balance sheet as a trade receivable.

Retained earnings is a line within the equity section of the balance sheet that shows your company’s cumulative profits over time. If last month’s income statement showed a net income of $50,000, you would close that accounting period by moving that amount to your retained earnings account. You might then dip into this account later to finance a big purchase or pay investors. Reading and understanding your financial statements is one of the most useful weapons in a business owner’s arsenal.

Cash Basis Accounting – A method where income and expenses are recorded only with the payment of cash to the business or from the business. Though not the best method for accurate records, it’s a simple practice suitable for small businesses with mainly cash transactions.

Equity represents your current financial interest in your business and is derived by subtracting your total liabilities total from your total assets. If you have employees or you sell products, you should be using the accrual accounting method. This method records all revenue/income and expenses as they occur, not when your customer pays or you write a check for a bill. After setting up your chart of accounts, you will need to decide what type of accounting method you will use.

A company will usually issue financial statements on a quarterly basis. The main components of the financial statements are the income statement, balance sheet, cash flow statement and the notes to the financial statements. The income statement shows the revenues and expenses the company experienced for the period.

7. Equity (E)

With this let us prepare the Income Statement for the four case studies above. In the case of revenue, we saw the accrual concept of accounting (revenue is recognized when it is earned). Likewise, for expenses, the actual date of payment doesn’t matter; It https://www.bookstime.com/articles/balancing-off-accounts is important to note when the work was done. In this case study, the parcels were delivered (work completed) in the month of December . Money was not received in the month of December, “receivables will be recorded” as assets for the month of December.

• (If the company is a sole proprietorship, it is referred to as Owner’s Equity.) The amount of Shareholder Equity is exactly the difference between the asset amounts and the liability amounts.
• Revenue earned is shown at the top of the report and various costs (expenses) are subtracted from it until all costs are accounted for; the result being Net Income.
• As a result, all accounting designations are the culmination of years of study and rigorous examinations combined with a minimum number of years of practical accounting experience.
• Accounting used to be done by hand in physical ledgers, or books.
• The period of time that the statement covers is chosen by the company.
• Depreciation appears on the Income Statement as an expense and is often categorized as a “Non-Cash Expense” since it doesn’t have a direct impact on a company’s cash position.

If you’re a new business owner, you won’t have beginning balances, but those transitioning from spreadsheet software or another accounting application will need to enter their beginning balances into the appropriate general ledger accounts. Prior to entering transactions, you will need to determine if you want to use the simplified cash accounting method or the more comprehensive accrual method. Remember, if you have employees or manage a lot of inventory, accrual should be your preferred method. Again, using accounting software, this process is usually automated and quite painless, with most small business owners able to use the default chart of accounts provided in the software.

Also known as the profit and loss statement. Closing Entry – A journal entry made at the end of an accounting period to zero out temporary accounts and shift their balances to permanent accounts. These temporary accounts can be revenue, expenses and dividends, all of which can be closed out at the end of the fiscal year. Cash Flow Statement – A summary of the entity’s cash flow over a specific accounting period.

I designed this basic accounting course to give you an understanding of the basic accounting principles, transactions, and operations. Each section has many examples of real business transactions and even sample ledgers and financial statements to help you understand the concepts. This means that all the assets owned by a company have been financed from loans from creditors and from equity from investors. “Assets” here stands for cash, account receivables, inventory, etc., that a company possesses. These entries show that your cash (a balance sheet account) has increased by $1,500, and your accounts receivable have decreased by $1,500.

Using generally accepted accounting principles, accountants record and report financial data in similar ways for all firms. They report their findings in financial statements that summarize a company’s business transactions over a specified time period. As mentioned earlier, the three major financial statements are the balance sheet, income statement, and statement of cash flows.

Fixed assets (non-current) may provide benefits to a company for more than one year—for example, land and machinery. These principles, which serve as the rules for accounting for financial transactions and preparing financial statements, are known as the “Generally Accepted Accounting Principles,” or GAAP.

This allows the accountant to have a visual representation of the account. T accounts are so named because they are shaped like a T. The accountant will put the account name on the top of the T account. The left side of the T account will be any debits made to the account in the general ledger while the right side will be any credits made. Gross Profit indicates the profitability of a company in dollars, without taking overhead expenses into account.

Computerized and online accounting programs now do many different things to make business operations and financial reporting more efficient. For example, most accounting packages offer basic modules that handle general ledger, sales order, accounts receivable, purchase order, accounts payable, and inventory control functions. Tax programs use accounting data to prepare tax returns and tax plans. Point-of-sale terminals used by many retail firms automatically record sales and do some of the bookkeeping.

Monetary Unit Principle – Business transactions that are recognized as monetary currency are only recorded in a business’s accounting records. Cost Principle – A business should record its fixed short and long-term assets at original cost and not fair value at the time of acquisition minus accumulated depreciation. Accounting Period Principle – A business should report the results of its operations over a standard period of time, typically monthly, quarterly or annually in order to make useful comparisons. We also increased our Sales Revenue, but since it is an income account we would need to record it on the Credit side (right side). Accounting is setting up a system of recording and summarizing financial transactions in such a way that they can later be analyzed or used to communicate with others.

It’s time to roll up those sleeves and build your accounting vocabulary. To help with this, we’ve compiled an assortment of basic financial terms and acronyms and created a simple accounting glossary for beginners. Data analytics can be defined as the process of examining numerous data sets (sometimes called big data) to draw conclusions about the information they contain, with the assistance of specialized systems and software. Using data analytics effectively can help businesses increase revenue, expand operations, maximize customer service, and more.