What is Accounting?
Accounting is the process of recording all financial transactions that a business undertakes. Accountants are responsible for recording, classifying, and organizing every financial transaction that occurs through business operations. Accounting differs from bookkeeping. The accounting process uses the books maintained by the accountant to prepare financial statements and accounts at the end of the year.
What is Accounting?
Accounting is the process of tracking every financial transaction made by a company from its inception until closure. Depending on the type of accounting system the company uses, each financial transaction is recorded based on supporting documents. Accounting transactions can be recorded manually in a ledger or using spreadsheet software like Microsoft Excel. Most companies now use specialized accounting software to record financial transactions. Accountants can use either a single-entry or double-entry accounting system to document financial transactions. Accountants must understand the company’s chart of accounts and how to use debits and credits to balance the books.
How does Accounting Differ from Bookkeeping?
Accounting in a business is an important function but is considered a preliminary function to actual bookkeeping. The accountant gathers documentation for each financial transaction, records the transactions in the accounting ledger, classifies each transaction as one or more debits and one or more credits, and organizes the transactions according to the company’s chart of accounts.
All financial transactions are recorded, but they must be summarized at the end of specific time periods. Some companies require quarterly reports. Smaller companies may only need reports at year-end in preparation for tax filing.
At the end of the appropriate time period, the accountant takes over and analyzes, reviews, interprets, and presents financial information to the business. The accountant also prepares the year-end financial statements and the appropriate accounts for the company. Reports prepared by the accountant must comply with the standards set by the Financial Accounting Standards Board (FASB). These rules are known as Generally Accepted Accounting Principles (GAAP).
What Do You Need to Set Up Accounting for Your Business?
One of the first decisions to make when setting up your accounting system is whether to use a cash basis accounting system or an accrual basis accounting system. If you are running a small business that consists of just one person from home or even a larger consulting practice with just one person, you may wish to continue using cash accounting.
With cash accounting, you record the transaction when cash changes hands. Using accrual accounting, you record purchases or sales immediately, even if cash does not change hands until later, and some businesses start with cash accounting and switch to accrual accounting as they grow.
If you will be extending credit to your customers or if you will be requesting credit from your suppliers, you should use an accrual basis accounting system.
As a new business owner, you also need to decide whether to use single-entry bookkeeping or double-entry bookkeeping. Single-entry bookkeeping is very similar to keeping your check register. You record transactions as you pay bills and deposit funds into the company account. It only works if your business is relatively small with a low volume of transactions.
If your business is larger and more complex, you need to set up a double-entry bookkeeping system. At least two entries are made for each transaction. A credit and a debit entry are made to at least one other account. This is key to double-entry accounting.
Companies should also establish their computerized accounting systems when setting up accounting for their businesses. Most companies use computer software to track their accounting records with accounting entries. Very small businesses may use a basic spreadsheet like Microsoft Excel. Larger companies rely on more complex programs to track accounting records.
Finally,
The company must prepare its chart of accounts. The chart of accounts may change over time as the company grows and evolves.
Understanding Assets, Liabilities, and Equity when Balancing the Books
Effective accounting requires an understanding of the company’s core accounts. These accounts and their sub-accounts make up the company’s chart of accounts. Assets, liabilities, and equity comprise the accounts that make up the company’s balance sheet.
Assets are what the company owns, such as inventory and accounts receivable. Assets also include fixed assets, which are generally buildings, machinery, and land. If you look at the balance sheet format, you will see asset accounts listed in order of liquidity. Asset accounts start with the cash account because cash is completely liquid. After the cash account, there are inventory accounts, accounts receivable, and fixed asset accounts. Those are tangible assets. Companies can also own intangible assets such as goodwill from customers, which may be listed on the balance sheet.
Liabilities are what the company owes, such as what it owes to its suppliers, bank loans, commercial loans, mortgages, and any other debts on the books. Liability accounts on the balance sheet include current liabilities and long-term liabilities. Current liabilities usually consist of accounts payable and accruals. Accounts payable are usually what the company owes to its suppliers and credit cards, bank loans. Accruals consist of taxes owed including sales tax owed, federal and state taxes, social security tax, and health insurance for employees that are typically paid quarterly. Long-term liabilities have maturities greater than one year and include items like mortgage loans.
Equity is the investment held by the owner and any other investors in the company. Equity accounts include all claims that the owners have against the company. The owner has an investment, which may be the only investment in the company. If the company has accepted other investors, this will be reflected here.
In accounting, you must balance your books at the end of the year. The accountant must carefully track these items and make sure to record transactions involving assets, liabilities, and equity properly and in the right places. There is a key formula you can use to ensure that your books are always balanced. This formula is called the accounting equation:
Assets = Liabilities + Equity
Income Statement and Accounting: Revenue, Expenses, and Costs
The income statement is developed using revenue from sales and other sources, along with expenses and costs. In accounting, you must record every financial transaction in the accounting record that falls into one of these three categories.
Revenue is all income that the business receives from selling its products or services. Costs, also known as the cost of goods sold, are all the money that the business spends to buy or manufacture the goods or services that it sells to its customers. The purchases account in the chart of accounts tracks the goods purchased.
Expenses are all the money spent to operate the business that is not specifically linked to a product or service sold. An example of an expense account is employee salaries and wages or selling and administrative expenses.
The accountant is responsible for determining which accounts to record transactions in. For example, if the company makes a cash sale to a customer and your company is using double-entry accounting, the cash received should be recorded in the asset account named “Cash” and the sale will be recorded in the revenue account named “Sales.”
Key Takeaways
– Accounting is the process of tracking every financial transaction that a company makes from the time the company opens until it closes.
– Accounting analyzes, reviews, interprets, and provides financial information for the business. The accountant also prepares year-end financial statements and the appropriate accounts for the company.
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In cash accounting, a transaction is recorded when cash changes hands. Using accrual accounting, purchases or sales are recorded immediately, even if cash does not change hands until later.
– Effective accounting requires an understanding of the company’s basic accounts. These accounts and their sub-accounts form the company’s chart of accounts.
– The company’s accounts include assets, liabilities, equity, revenues, expenses, and costs.
Source: https://www.thebalancemoney.com/bookkeeping-101-a-beginning-tutorial-392961
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