Accounting is the process of identifying, collecting, recording, summarizing and communicating the financial information of an entity
Bookkeeping is the process of identifying and recording the financial information of an entity which is the basic phase of accounting
Bookkeeping is concerned with the recording of financial information which is the basic phase of accounting. In contrary to this, accounting is related to identifying, collecting, recording, summarizing and communicating the financial information.
There was times when goods and services were bartered or exchanged among between people to fulfill their needs for goods and services. However, with passage of time people realized that money is good to do financial transactions and this was the time when people started recording transaction in books since transactions got complicated with emergence of money concept
Accounts are good way to record, summarize and communicate financial information and track of money by presenting where did money come from and how had we spent it.
By definition business is a legal commercial entity which exists to make profit
The major types of business entity are:
- Sole proprietorship
- Joint stock companies
Any party that has interest in your business for instance government agencies, employees, customers, tax authorities etc.
Accounting is done for the various reasons for example:
- To maintain the records of financial information
- To protect the business from fraud and misappropriations by setting rules and procedures
- Legal requirements of a country for various reasons for example it serves as a base for income tax calculation
- Accounting helps in communicating the financial results of your entity to stakeholders or people that are interested in your business
There are two major categories of financial statements’ users internal users and external users
Internal users are those stakeholders that have a direct relationship with the organization
Board of directors
To formulate corporate level strategies, BOD needs financial information
Management of the business
Management needs financial information for decision making
Owner of the business
Owner wishes to know the profitably and financial position of his/her business
External users have an indirect relation with the organization
Several government agencies such as SEC and tax authorities need financial information to implement their prudential regulations and to compute tax
Investors or shareholders
Financial information is greatly helpful for shareholders and investors to analyse business’s financial position
Creditors or account payable
Creditors evaluate business financial leverage and it’s profitable so as to evaluate credibility and default rate of the business using information given by the financial statements
Lenders curious to know whether business is in profit or not, what’s its financial position and how much the business has been financially leveraged
Based their buying decisions on the company’s financial performance and position
Media and general public
Use financial information obtained from financial statements to analyse the financial performance a business
Rating agencies rate and rank an entity on the basis of financial information extracted from financial statements
An accounting cycle is the sequence in which financial data is recorded until it becomes the part of financial statements at the end of accounting period. In other words, it’s a sequence of steps to record financial information in precise manners. For example accounting cycle is preparing journals, preparing ledger accounts, preparing trial balance, passing adjusting entries and at the end of accounting period preparing financial statements ( such as Income statement, Balance sheet, Cash flow statement etc)
Accounting cycle includes these major steps:
1. Identifying the financial transaction
2. Preparing the documents for transactions such a sales invoice
3. Journalizing the transactions
4. Posting the transactions from journal to ledger account
5. Preparing the trial balance to check the accuracy of accounts
6. Adjusting the entries if there are mistakes or omissions in recording transactions in any book of accounts
7. Preparing financial statements (such as Income statement, Balance sheet, Cash flow statement etc)
8. Posting closing entries to ledger account
9. Preparing 'after closing trial balance' to check the debit balance is equal to credit balance
Profit oriented or commercial entities are those entities/organizations whose main aim of carrying out business is to earn profit for the owners of the business organization
- Sole Proprietorship
- Companies or Corporate
Non-profit oriented entities are those business entities or concerns whose main purpose of doing business is not to earn profits for the owners / sponsors but to provide benefits to the general public or to carry out a social cause
- NGOs Non-Government Organizations
This concept forms the basis of accounting principles or concepts. It implies that for the purpose of accounting ‘the Business is treated independently from the Owners'.
This means that although anything owned by the business belongs to the owner(s) of the business and anything owed by the business is payable by the owner(s) but for accounting purpose we assume that the business is independent of its owners
If a business purchases a machine or piece of equipment, it will own and obtain benefits from that Equipment. Likewise, if a business borrows money from ‘someone’ it will have to repay the money. This Someone includes even owner of the business. The treatment of business independently from its owners is called the ‘Separate Entity Concept’
Wherein only one aspect of a financial transaction is recorded
An Entry-passing technique or a system of recording financial information in accounts wherein dual aspects of every financial transaction are recorded in the accounts
Example of Double Entry
Good sold for cash. In this case, increase in sales (revenue) will be recorded in sales account and increase in cash will be recorded in cash account. Therefore, there are two aspects or effects of this transaction first one is an increase in sales or revenue and second is an increase in cash, both will be recorded.
In accounting commitments are the funds that are set aside or earmarked to pay expenses or for some other business events or projects in future, generally, to purchase goods or service. Thereby, converting the commitments into business expenses. Commitments can also be created for the cash inflows of business, for example commitment for the future sales of goods or service and other incomes.
Important to remember that commitments are not liabilities and therefore, they are not reported in balance sheet as liabilities, but they might be included in financial statement notes. The main purpose of commitments is to plan and evaluate future cash flows of a business entity
As we know every financial transaction has two effects. We have to record the both aspects of a transaction. Double entry simply implies that each transaction should be recorded twice in the books of accounts, for example purchased equipments for $2500, here, equipments should be recorded in equipment account and cash in cash account. Therefore, there are double aspects of this transaction
Also known as Equity, Shareholders’ Equity, paid in capital. Capital represents the investment in business by the owner or owners (more than one owner as in partnership and corporate business) to run the business and earn return on it. Capital may show the total book value of assets an entity owns (if the company has not financed its assets from liabilities). In other words the business can finance or purchase asset either from capital or liabilities. The use of liabilities to finance assets is called financial leverage
Assets are tangible or intangible resources controlled by an entity and posses the future economic benefits for the entity. Assets are presented in balance sheet at their book value or carrying value. Examples of assets include building, vehicle, machinery, cash, copyrights, trademarks, investments etc
Expenses are costs expired during an accounting period or gross outflow of economic benefits which can be measured in money for getting services or goods. Technically, expenses are events by which assets are decreased or liabilities are increased
Examples of expenses
Purchase of goods or services, rent, employee wages or salaries, factory lease and depreciation expenses, heating and electricity expenses, repair and renewal of machinery and plant, freight and demurrage expenses etc.
The gross inflow of economic benefits that can be measured in terms of money for providing services or goods. Technically, incomes or revenues are events by which assets are increased or liabilities are decreased.
Examples of incomes
Sale of goods or services, commission, discount received, profit on the sale fixed asset etc.
Balance sheet is a financial statement that summaries and reports the financial position of a business at a point in time. It does not supply enough information or detail to an organisation.
For example: Seeing only balance sheet does not ensure that we can get all details of debtors or creditors. The only way to get more information is by going through journals and ledger accounts
Expenditures encompass both capital expenditures and revenue expenditures whereas expense is the other name of revenue expense which is shown in income statement
Not all financial transactions are cash transactions regardless of that they are all economic events
By cash transactions we meant, money is paid or received at time of transaction, for example business purchased good on cash or sold goods on cash
On the other hand, credit transaction implies that money is paid or received after some time of transaction, for example business purchased goods on credit or sold goods on credit
Budget is the statement of planned expenses and incomes which would be incurred or earned during a period of time
An accounting concept which dictates that revenues and costs/expenses should be recorded as they are earned or incurred and they shouldn't be recorded when money is received or paid.
In other words, according to this concept or principle an accountant of business should record expenses and revenues in the books of accounts when these expenses and revenues are incurred or earned not when the money is paid as expense or money is received as income
If a business purchases goods on credit, it should record this transaction at the date of purchase not the time of payment of money it owes and same treatment with revenues is expected
For example, a business has to pay $2000 as telephone prepaid charges but at the end of accounting period, business has only used the service for $500 and remaining $1500 pertaining to the next year. In this case, business has to record only $500 as expense because it has incurred only that amount of expense
A business sell goods on credit for $200, it should record that $200 as income even the business is still unpaid for the sale of goods
A system of accounting wherein transactions are recorded and reported when the money is paid or money is received.
A system of accounting wherein transactions are recorded and reported when they occur not when money is paid or received. If a business follows accrual principle, it is said to be using accrual accounting.
Cash accounting is a system of accounting wherein transactions are recorded and reported when the money is paid or money is received.
In contrary to that, accrual accounting is a system of accounting wherein transactions are recorded and reported when they occur and not recorded when money is paid or received. If a business follows accrual principle, it is said to be using accrual accounting.
Business sold goods on credit and money will be received after a month
The follower of accrual accounting will instantly record this transaction as sales or revenue in its books of accounts. On the other hand, other business that uses cash accounting will record this transaction as sales or revenue after a month
In barter system, goods and services are directly exchanged for other goods or services without the use money or any other medium for the transaction. For instance person “A” will give person “B” some oranges to acquire mangos from person B
Capital expenditure is the amount of money spent on either buying fixed assets or improving the earning capacity of these assets for example purchase of equipments, machinery, plant, installing new motor in machinery etc.
On the other hand, all expenditures other than capital expenditures are referred as revenue expenditures and they are also known as expenses
Revenue expenditures are day to day expenses of a running business that don’t provide economic benefits for a long period of time, for example they benefit business financially for less than a year. Examples of revenue expenses are: selling expenses, administrative expenses, financial charges etc.