That is a common question comes from those starts to learn accounting for the first time. Here are some pointers:
First, Accounting Is a Tool (not a law)
Accounting is a tool that helps users to understand financial position of organization (for profit or not for profit). Not a law. You are small business owner runs a solo business, as an example. It is okay if you record a cash receipt and cash spent in the same column although the accounting equation says that you should record them in different side, as long as you are able to differentiate which are cash receipt and which are cash spent. You’re not going to go any jails just because of you don’t follow the equation.
Also, there is no exact ‘wrong and correct’ term in the accounting. Let’s say a company files a Profit and Loss (P & L) Statement and it shows a $1000 bottom line. Is the bottom line correct or incorrect? So you dig every single number to get the answer and catch the inventory usage is $20 higher than ‘it should be’. The question is, what costing system do you use to count? So you said ‘FIFO’ for example. What if the bookkeeper uses a physical count?
Well, we, in the accounting have numerous standards to use, and everyone (organization) may chose any of them as along as it is consistently applied. So the point IS NOT ‘wrong-or-correct‘, but ‘appropriate-or-inappropriate‘. That is why accountants release opinions (NOT judgment.)
Here is a more comprehensive explanation about assumptions, principles and constraints used in the accounting:
Back to recording cash receipt and spent. So you record everything in the same column. That is fine. In the end of the month, you want to know if your business made profit or not. How if you have a thousand transaction in a month? How if you have 10K transaction? You definitely need a tool to help you to organize your financial record. There the accounting comes in.
Second, Understand The Nature of Accounting
An understanding of the principles of bookkeeping and accounting is essential for anyone who is interested in a successful career in business. The purpose of bookkeeping and accounting is to provide information concerning the financial affairs of a business. This information is needed by owners, managers, creditors, and governmental agencies.
Here some good pointers to start with:
- Accounting: The Language of Business, Investing, Finance, and Taxes – Here you can observe and sense whether or not accounting is the right stuff for you.
- Range Of Accounting: What Accounting Department Mainly Responsible For? – Through this post, you can learn what accounting mainly responsible for and get the sense of where accounting likely involves in most of your life, as an accountant, business owner and individual.
- Why businesses need proper bookkeeping – Focusing on a business owner’s perspective, why they need bookkeeping (and accounting in a broader scope).
An individual who earns a living by recording the financial activities of a business is known as a bookkeeper, while the process of classifying and summarizing business transactions and interpreting their effects is accomplished by the accountant. The bookkeeper is concerned with techniques involving the recording transactions, and the accountant’s objective is the use of data for interpretation.
Third, Understand The Accounting Equation
The financial condition or position of a business enterprise is represented by the relationship of assets to liabilities and capital.
- Assets – Properties that are owned and have money value—for instance, cash, inventory, buildings, equipment.
- Liabilities – Amounts owed to outsiders, such as notes payable, accounts payable, bonds payable.
- Capital – The interest of the owners in an enterprise; also known as owners’ equity.
These three basic elements are connected by a fundamental relationship called the accounting equation. This equation expresses the equality of the assets on one side with the claims of the creditors and owners on the other side:
Assets = Liabilities + Capital (Owner’s Equity)
Preparing a new equation ‘A = L + C’ after each transaction would be cumbersome and costly, especially when there are a great many transactions in an accounting period. Also, information for a specific item such as cash would be lost as successive transactions were recorded. This information could be obtained by going back and summarizing the transactions, but that would be very time-consuming.
Forth, Understand The Account
An account may be defined as a record of the increases, decreases, and balances in an individual item of asset, liability, capital, income (revenue), or expense.
The simplest form of the account is known as the “T” account because it resembles the letter “T.” The account has three parts:
- the name of the account and the account number;
- the debit side (left side); and
- the credit side (right side).
The increases are entered on one side, the decreases on the other. The balance (the excess of the total of one side over the total of the other) is inserted near the last figure on the side with the larger amount.
Fifth, Understand The Debits and Credits
When an amount is entered on the left side of an account, it is a debit, and the account is said to be debited. When an amount is entered on the right side, it is a credit, and the account is said to be credited. The abbreviations for debit and credit are Dr. and Cr., respectively.
Whether an increase in a given item is credited or debited depends on the category of the item. By convention, asset and expense increases are recorded as debits, whereas liability, capital, and income increases are recorded as credits. Asset and expenses decreases are recorded as credits, whereas liability, capital, and income decreases are recorded as debits.
An account has a debit balance when the sum of its debits exceeds the sum of its credits; it has a credit balance when the sum of the credits is the greater. In double-entry accounting, which is in almost universal use, there are equal debit and credit entries for every transaction. Where only two accounts are affected, the debit and credit amounts are equal. If more than two accounts are affected, the total of the debit entries must equal the total of the credit entries.
Here is a ‘debit-credit’ technique in more details:
- Basic Accounting: Debit and Credit – Double Entry System – This post provides you with basic ‘debit-and-credit’ concept famously known as “double entry accounting system” (a.k.a the modern accounting).
Sixth, Understand The Chart of Accounts
It is desirable to establish a systematic method of identifying and locating each account in the ledger. The chart of accounts, sometimes called the code of accounts, is a listing of the accounts by title and numerical description. In some companies, the chart of accounts may run to hundreds of items.
In designing a numbering structure for the accounts, it is important to provide adequate flexibility to permit expansion without having to revise the basic system. Generally, blocks of numbers are assigned to various groups of accounts, such as assets, liabilities, and so on. There are various systems of coding, depending on the needs and desires of the company.
Here are in more details:
- Chart Of Accounts – This post covers the types of account numbering formats that can be used to construct a chart of accounts, and eventually lists sample charts of accounts that use each of the formats for both balance sheets and income statements.
- Accounting Term And Definitions For Chart Of Accounts – This post describes terms and definitions used on the chart of accounts, thus (hopefully) helps you understand the chart even better. Not only for starters, may even seniors (management-level) find it useful, particularly when setting up chart of accounts and its procedure for the first time.
- Understanding the Real and Nominal Accounts
Seventh, Understand The Ledger
The complete set of accounts for a business entry is called a ledger. It is the “reference book” of the accounting system and is used to classify and summarize transactions and to prepare data for financial statements. It is also a valuable source of information for managerial purposes, giving, for example, the amount of sales for the period or the cash balance at the end of the period.
Here are good pointers to start with:
- Bookkeeping Fundamentals – This is an extremely long post. It explains the first three elements of the bookkeeping fundamental: debit-and-credit (again), chart of accounts, and initial entries to the books.
- How to Set-up General Ledger [GL] and Opening Entries (learn how to make opening entries)
- Accounting Records And Its Flow Process [Basic] – This post helps you understand the role and function of accounting record as source documents (such as: bills, invoices) and introduces the books of prime entry and the ledgers. You then are able to look at the link between source documents and books of prime entry and the accounting ledgers.
Last (For a start), Understand The Trial Balance
As every transaction results in an equal amount of debits and credits in the ledger, the total of all debit entries in the ledger should equal the total of all credit entries. At the end of the accounting period, we check this equality by preparing a two-column schedule called a trial balance, which compares the total of all debit balances with the total of all credit balances. The procedure is as follows:
- List account titles in numerical order.
- Record balances of each account, entering debit balances in the left column and credit balances in the right column.
- Add the columns and record the totals.
- Compare the totals. They must be the same.
If the totals agree, the trial balance is in balance, indicating that debits and credits are equal for the hundreds or thousands of transactions entered in the ledger. While the trial balance provides arithmetic proof of the accuracy of the records, it does not provide theoretical proof.
For example, if the purchase of equipment was incorrectly charged to Expense, the trial balance columns may agree, but theoretically the accounts would be wrong, as Expense would be overstated and Equipment understated. In addition to providing proof of arithmetic accuracy in accounts, the trial balance facilitates the preparation of the periodic financial statements.
Generally, the trial balance comprises the first two columns of a worksheet, from which financial statements are prepared.
Those all are about nature of business transactions and the manner in which they are analyzed and classified. The primary emphasis was the “WHY” rather than the “HOW” of accounting operations; it is aimed at an understanding of the reason for making the entry in a particular way.
The missing information is furnished by the use of an accounting form known as the journal. The journal or “day book”, is the book of original entry for accounting data. Afterward, the data is transferred or posted to the ledger, the book of subsequent or secondary entry. The various transactions are evidenced by bills, receiving slips, check stubs, payment slips, wire transfer slips, and so on. On the basis of this evidence, the transactions are entered in chronological order in the journal. The process is called “JOURNALIZING“.
Once you really, I meant really understand all those basics, you can continue to learn all the HO-TO’s, the accounting standard, auditing, taxation, and so forth. For those purposes, I provide a lot of technical information about how to’s accounting in this site. You can browse it through the website’s main navigation menu OR visit the “Beginner’s Guide” section.
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