What is Accounting – A Basic Overview

Definition of Accounting

Accounting is the art of analyzing, recording, summarizing, reporting, reviewing, and interpreting financial information.

In simple words, Accounting includes three basic activities, identify, record, and communicate the economic events of a firm/company.

 

The Basic Accounting Equation

 

ASSET = LIABILITIES + OWNER’S EQUITY

Whereas,

 

Asset

Assets are resources owned by businesses. The item that has some value. Land or property have the value, machinery, the equipment has a value or any other thing which help in carrying out business activities are called an asset.

Liabilities

Liabilities are claims against an asset. It is an existing debt and obligation. Examples of liabilities are loans, mortgages, unpaid bills, etc.

Owner’s Equity

It is equal to total assets minus total liabilities. The owner’s Equity shows the ownership claim against the total assets.  The owner’s equity is further subdivided into the following categories.

• Capital
• Drawing
• Revenue
• Expenses

 

Understanding Accounting with Explanation

Accounting plays a significant role in almost all types of business. It is performed by an accountant in the case of large companies and by a bookkeeper in small companies.

It is accounting, that tells you that your business is making a profit or not. What is the current asset and liabilities, your company is holding, and what is making money for your company?

It would be most difficult to determine which products or decisions were successful and effective, It would also be impossible to determine how much taxes to pay, whether to purchase or lease a land/ property or whether to merge with another firm without accounting.

Actually, if you look at the definition of Accounting, it clearly defines that it is an art of analyzing, means analyzing the records such as financial transactions which you maintain in the ledger register, and then summarize the financial data of specific accounting period such as a month, quarter or year and make a report on it. In the last, you just interpret the final information based on the report, such as statements issued by accounting bodies.

 

Record-keeping in Accounting

Before starting a business every firm must have to set up accounts in which to store information at the beginning of the business day. Accounts are classified as follow:

Assets

These refer to resources that the company owns. Assets have future economic value that can be measured and can be expressed in financial terms. Such as firm’s assets include investments, accounts receivable, cash, land, supplies, inventory, vehicles, equipment, and buildings.

Liabilities

These denote the legal financial obligations that firms incur during business operations. Liabilities could be limited or unlimited. Such as loans, accounts payable, mortgages, accrued expenses, and deferred revenues.

Equity

Equity denotes the amount of money that a company must return to its shareholders after all of its assets are liquidated and all of its debt is paid off.

Expenses

Expenses refer to the costs of operations that businesses incur to generate revenue. Such as payments to suppliers, employee wages, equipment depreciation, etc.

Revenue

Revenue denotes the income that a firm makes from its normal business operations. Revenue is the gross income figure from which costs are subtracted to determine net income.

 

Transactions in Accounting

A transaction is an event generated while business activity, whereas, other departments of a company also forward business transactions to the accountant of that company, and all transactions are recorded as an entry within the accounts mentioned below. There are four types of business transactions, listed below:

• Sales
• Purchases
• Receipts
• Employee’s compensation

 

Sales in Accounting

Sale is the transaction in which the seller sells his products or service to the buyer on cash or on credit. It is recorded on the accounting general of the seller. Sales involve the creation of an invoice to be sent to the customers.

Purchases

The transactions that firms/businesses need in order to get products or services required to achieve their goals. Purchases can be made in cash or on credit. Cash purchases are recorded as a debit to the inventory account and a credit to cash. If the purchase is made with a credit account, the entry will be recorded in the accounts payable account and the debit entry will be recorded in the inventory account.

Receipts

These transactions denote firms paid for providing goods and services to customers. The receipt transaction is recorded in the journal for the seller as a credit to accounts receivable and a debit to cash.

Employee’s compensation

This needs information regarding the number of hours that employees consumed at paid labor, then it is used to generate gross wage information, tax deductions, which results in net pay to employees.

 

What is Reporting in Accounting

When all the firm’s transactions associated with an accounting period have been completed, then the accountant consolidates all the information saved in the accounts and arrange those records into three documents that are jointly called financial statements, given below:

Income statement

It measures the capability of a company to increase its customer base and function in an efficient manner. It is actually the document that contains data of the company’s revenue and deducts all expenses incurred to determine the net profit or loss for the reporting period.

Balance sheet in Accounting

It displays the financial position of the business and determines an organization’s ability to pay its bills. This document contains data about a company’s assets, liabilities, and equity as of the end of the reporting period.

Statement of cash flows

it is when the amount of net income shows on the income statement is different from the net change in cash during the reporting period. This document show information about the uses and sources of cash during the reporting period.

 

What is Accounting Period

Businesses need to select an annual tax year. Your two core choices are a fiscal tax year and a calendar tax year.

A calendar tax year is twelve consecutive months starting from January 1 and finish on December 31. A Fiscal tax year is 12 months consecutive starting from any month and finish on the last day of any month except December 31. Mostly used accounting period is the calendar tax year.

When business activity is low, then you may choose fiscal tax year, this makes the process of what is called closing the books a little easier.

 

Type of Business Activity

Our system is made of different kinds of businesses.

Retailer

Some sell products to the consumer directly and are called retailers.

Wholesaler

Sell large quantities of product to the retailer who in turn sell it to us (consumer) are called as wholesalers.

Manufacturer

Some business has the task of producing the products are called as a manufacturer.

 

Forms of Business Ownership

One of the first decisions that people need to make is how the firm should be structured. So, those structured can be one of follow and each one has its own pros and cons. There are four legal forms of ownership for business, listed below:

1. Sole Proprietorship
2. Partnership
3. Corporation
4. Limited Liability Company (LLC)

For full details of types of business ownership Click Here