Accounting:

Accounting is the recording of financial transactions pertaining to a business. Learn how to

use accounting to summarize, analyze, and report the financial activity of a company.

Branches of Accounting
Following are the branches of accounting

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Financial Accounting
Financial accounting is a specific branch of accounting involving a process of recording,
summarizing, and reporting the myriad of transactions resulting from business operations
over a period of time. These transactions are summarized in the preparation of financial
statements, including the balance sheet, income statement and cash flow statement, which
record the company's operating performance over a specified period.

What is single-entry bookkeeping?

Single-entry bookkeeping is a simple and straightforward method of bookkeeping in which
each transaction is recorded as a single-entry in a journal. This is a cash-based bookkeeping
method that tracks incoming and outgoing cash in a journal.

Double-Entry Bookkeeping
Double-entry bookkeeping is a method of recording transactions where for every business
transaction, an entry is recorded in at least two accounts as a debit or credit. In a double-
entry system, the amounts recorded as debits must be equal to the amounts recorded as
credits

Account:
A record: that holds the results of financial transactions.

Fundamental Elements of Accounting

There are 5 basic elements of accounting which are always present in every accounting
service.
The five basic elements of accounting are as follows:

1. Assets

2. Liabilities

3. Owner’s Equity

4. Revenue

5. Expenses

1. Assets:

Economic resources owned or controlled by a person or company. Assets are the resources
which the businesses use to conduct their activities. An item becomes an asset when you
own it or have the right to use it. Asset provides economical support to your business. For
example, if you run a factory, then the types of machinery of that factory become your
asset. Asset always serves some economic benefit to the business either in terms of cash or
credit.

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 Classification of Assets: Physical Existence
If assets are classified based on their physical existence, assets are classified as
either tangible assets or intangible assets.

 Tangible Assets
Tangible assets are assets with physical existence (we can touch, feel, and see them).
Land

 Non-Tangible Assets
Intangible assets are assets that lack physical existence. Examples of intangible
assets include

 Current Assets:
Current Assets are those assets of a company that are expected to be converted to
cash, sold, or consumed during the normal operating cycle of the business (usually
one year). Current assets are also termed liquid assets and examples of such are:

i. Cash

ii. Cash Equivalents (Cash at Bank etc.)

iii. Short-Term Deposits

iv. Accounts Receivables

Amounts due by customers: to your businesses. Generally these amounts are short
term receivables (30-120 days), and are shown under Current Assets section in the
Balance Sheet.

v. Inventory
Goods held for sale or resale.

vi. Marketable Securities

Vii. Office Supplies

 Fixed Assets/Non-Current Assets:

Fixed/Non-current assets are assets that cannot be easily and readily converted into
cash and cash equivalents. Non-current assets are also termed fixed assets, long-
term assets, or hard assets. Examples of non-current or fixed assets include:

i. Building

ii. Plant & Machinery

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 iii. Office Equipment

iv. Furniture & Fixture

v. Motor Vehicle

vi. Air Conditioners

vii. Library Books

viii. Patents

ix. Trademarks

x. Brand

xi. Copyrights

xii. Trade secrets

xiii. Goodwill
Goodwill exists when a business is valued at more than the fair market value of its
net assets. Goodwill is usually due to reputation, good customer relations etc.

2. Liabilities
Liabilities are a group of items which are obligations to the business. They arise when you
make a purchase or take a loan for the business. To settle these liabilities, you will need to
settle the assets. For example, salary due to the employees while hiring is a liability to the
company and this obligation cannot be avoided if the employee provides his services to
your business.

 Current Liabilities
A liability is considered current if it is due within 12 months after the end of the
balance sheet date. In other words, they are expected to be paid in the next year. If
the company's normal operating cycle is longer than 12 months, a liability is
considered current if it is due within the operating cycle.

 Accounts Payable
Accounts Payable liability is probably the liability with which you’re most familiar.
For smaller businesses, accounts payable may be the only liability displayed on the
balance sheet.
Accounts Payable represents money owed to vendors, utilities, and suppliers of
goods or services that have been purchased on credit. Most accounts payable items
need to be paid within 30 days, although in some cases it may be as little as 10 days,
depending on the accounting terms offered by the vendor or supplier.

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 Short-Term Loans
A Short-Term Loan is a loan that is due and payable within a 12-month timeframe.
Any loans that are due and payable longer than one year would be considered a
long-term liability.

 Accrued Expenses
When using accrual accounting, you’ll likely run into times when you need to record
accrued expenses. Accrued expenses are expenses that you’ve already incurred and
need to account for in the current month, though they won’t be paid until the
following month. Accrued expenses typically include wages and salaries, rental
payments, and utilities.

 Unearned Revenue
Unearned revenue is money that has been received by a customer in advance of
goods and services delivered. When your customer pays you three months in
advance, that money is considered unearned revenue and is classified as a current
liability, where it will remain until the goods and/or services have been delivered to
the customer.

 Long-Term Liabilities
Long-Term Liabilities are debts that will not be paid within a year’s time. These can
include notes payable and mortgages, although the portion that is due within the
year should be classified as a short-term liability.

 Notes Payable
Notes Payable is similar to accounts payable; the difference is the presence of a
written promise to pay. Formal loan agreements that have payment terms that
extend beyond a year are considered notes payables.

 Mortgage Payable
Any Mortgage Payable is recorded as a long-term liability, though the principal and
interest due within the year is considered a current liability and is recorded as such.

 Bonds Payable
Bonds are typically issued by public utilities, hospitals, and local governments. The
entities issuing the bonds formally agree to pay interest on any bonds issued, with
interest typically paid every six months or annually, while also agreeing to pay the
principal amount by a date specified in the formal agreement. Bonds payable are
always considered long-term debt.

 Deferred Tax Liabilities

Deferred Tax Liability refers to any taxes that need to be paid by your business, but
are not due within the next 12 months. If you know that you’ll be paying the tax
within 12 months, it should be recorded as a current liability.

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Owner’s Equity
The term "Equity" means something of value or worth. It can also mean ownership.
Generally, when looking at equity you want to consider the value of something and how
much you owe is on that value. What's left over is equity.
Owner's Equity is an owner's ownership in the business, that is, the value of the business
assets owned by the business owner. It's the amount the owner has invested in the
business minus any money the owner has taken out of the company
Components of Owner’s Equity

1. Common Stock

2. Preferred Stock

3. Retained Earnings

 Common Stock
Common Stock represents the owners’ or shareholder’s investment in the business
as a capital contribution. This account represents the shares that entitle the
shareowners to vote and their residual claim on the company’s assets.

 Preferred Stock
Preferred Stock is quite similar to common stock. The preferred stock is a type of
share that often has no voting rights, but is guaranteed a cumulative dividend. If the
dividend is not paid in one year, then it will accumulate until paid off.

 Retained Earnings
Retained Earnings is the portion of net income that is not paid out as dividends to
shareholders. It is instead retained for reinvesting in the business or to pay off
future obligations.

Revenue
Revenue is income earned by an individual or a business from the sale of any products or
services offered. Revenue—also known as “sales”—is one of two things on an income
statement that dictates how well a business performs, the other being expenses

 Operating Revenues
Operating revenues are generated from a company’s main business activities. In
other words, this is the area of activities that a company earns most of its income
and chooses to operate. Microsoft’s operating revenue comes from software
development and creation because it is a software company.

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Here are some examples of operating revenues:

 Sales
A sale is an exchange of goods for cash or a claim to cash. Sales are typically made by
manufacturers, wholesalers, and retailers when they sell their inventory to
customers. For example, a clothing retailer would record the income from selling a
shirt to a customer as a sale or a merchandise sale

 Rents
Rental income is earned by a landlord for allowing tenants to reside in his or her
building or land. The tenants often have to sign a rental contract that dictates the
details of the rental payments. According to the accrual method of accounting, the
landlord records rental income when it is earned – not paid.

 Consulting Services
Consulting service or professional services include all income from providing a
service to a customer or client. For example, a law firm records professional service
revenues when it provides legal services for a client.

 Non-operating Revenues or Other Income

Other income includes all revenues generated by a company outside of its normal
operations. Usually non-operating revenues are only a fraction of operating
revenues.

Here is an example of non-operating revenues:

 Interest Income
Interest income is the most common form of non-operating income because most
businesses earn small amounts of interest from their savings and checking accounts.
Interest income isn’t only limited to bank account interest. It can also include
interest earned from accounts receivable or other contracts

 Sale of an Asset or Equipment:

This refers to proceeds received for usually a one-time sale of an asset or equipment
that a company no longer needs

Expenses
An expense in accounting is the money spent, or costs incurred, by a business in their effort
to generate revenues. Essentially, accounts expenses represent the cost of doing business;
they are the sum of all the activities that hopefully generate a profit.

 Cost of Goods Sold (CGS)

 Selling and Distribution Expenses

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  Operating, General and Administrative Expenses

 Salaries, wages, and benefits

 Rent expense

 Utilities

 Research and Development

 Printing and Stationery Expense

 Staff Traveling Expense

 Repair and Maintenance Expense

 Insurance

 Legal and Professional Charges

 Communication Expense

 Miscellaneous expenses

 Finance Cost

 Taxation Cost

What is the Accounting Cycle?

The accounting cycle is a series of steps used by an accounting department to document
and report a company's financial transactions. The cycle follows financial transactions from
when they occur to how they affect financial documents. The accounting cycle happens
every accounting period or reporting period for which financial documents are prepared.

Calendar Year:
An entity's reporting year, covering 12 months and ending on December 31.

Fiscal Year:
A business' reporting year, covering a 12-month month period. (Not necessarily ending on
December 31. May be 30th June)

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 Flow Chart of the Accounting Cycle

Accounting Cycle Steps

Usually, there are eight steps in accounting cycle processes. However, you can add or
subtract certain steps when necessary. Use the steps that help you stay organized and
maintain accurate records.

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 1. Identify Transactions
First, separate your business transactions from all of the transactions you made. You
only want to include transactions related to your company in your financial records. For
example, you won’t record your grocery bill as a business expense in your books.

 Transactions:
Exchange of goods or services between businesses or individuals. Can also be other
events having an economic impact on a business.

2. Record Transactions In Your Journal

The journal is where you initially record business transactions. It is a running list of
financial activities, like a checkbook. Track transactions in your journal chronologically as
they happen.
If you use double-entry bookkeeping, record two entries for each transaction. Enter a debit
for one account and a credit for another. The debit and credit should be equal.

 Bookkeeping:
The act of systematically recording the financial transactions affecting a business.

 General Journal:
(GJ) A book or original entry in a double-entry system. The journal lists transactions
and indicated accounts to which they are posted. The general journal includes all
transactions which aren't included in specialized journals used for cash receipts,
cash disbursements, and other common transactions.

3. Post Entries to the General Ledger

The general ledger is also known as the book of final entry. General ledger entries are
changes made to each account in your books. Using your journal, organize transactions into
different accounts. For example, if a customer paid for a product with cash, enter the
transaction under the cash account in your books.

 General Ledger:
(GL) A book in which monetary transactions of a business are posted (in the form of
debits and credits) from a journal. It is the final record from which financial
statements are prepared. The general ledger accounts are often the control accounts
which report totals of details included in subsidiary ledgers.

4. Unadjusted Trial Balance

For your books to be accurate, the debit and credit entries must be equal. Use an
unadjusted trial balance to test if your debits and credits match.

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  Trial Balance:
A listing of all account balances that provides a test of whether total debits equals
total credits

5. Adjusting Entries
At the end of an accounting period, you might have incurred expenses but not paid for them
yet. And, you might have earned income but not collected it yet. Use adjusting entries to
recognize transactions that have occurred but not been recorded.

For example, you earned interest on a bank account balance. You have not recorded the
interest in your books, but it appears on your bank statement. Use an adjusted entry to
recognize the interest in your books.
Unearned Revenue:
Money received by a business before it is earned. It is a liability to your company until it is
earned.

 Prepaid Expenses:
Amounts paid in advance to a creditor or vendor for goods or services. Insurance
premiums are a good example. Prepaid Expenses are a current asset because you
paid for goods or services you have not yet received.

6. Adjusted Trial Balance

Do an adjusted trial balance after making adjusting entries and before creating financial
statements. This step tests to see if the debits and credits match after making adjusting
entries.

7. Create Financial Statements

Once your accounts are up-to-date, create statements. The following are common financial
statements for small business:

 Income Statements compare your profits and losses for the period.
 Balance Sheets determine progress by detailing assets, liabilities, and equity.
 Cash Flow Statements show money coming into and out of the business.

Use your financial statements to measure performance, make improvements, and set goals.
You can also use statements to talk with lenders and negotiate terms with vendors.

8. Close Your Books

The final step in the accounting cycle is to close your accounting books. Closing your books
wraps up financial activities for the period. Do tasks like updating accounts payable,
reconciling accounts, reviewing your petty cash fund, and counting inventory.
When you close your books, you should get your accounting set up for the next period.
Decide which processes are moving your business forward. Create a calendar for

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completing future tasks. File any financial documents from the last period and get rid of old
documents that are no longer useful.

Debit Entry
A debit is an accounting entry that either increases an asset or expense account, or
decreases a liability, Revenue or equity account. It is positioned to the left in an accounting
entry. It is shown as Dr.

Credit Entry
A credit is an accounting entry that either increases a liability, Revenue or equity account,
or decreases an asset or expense account. It is positioned to the right in an accounting
entry. It is shown as Cr.

Account Normal Balance Increase (+) Decrease (-)

Assets Debit Debit Credit
Expenses Debit Debit Credit
Revenues Credit Credit Debit
Liabilities Credit Credit Debit
Owner’s Equity Credit Credit Debit

Accountant's Equation:

The equation that is the basis of the Balance Sheet: Assets = Liabilities + Owners' Equity.

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Forms of Business Organizations

 Sole Proprietorship:
A business owned by one person.
 Partnership
A business having two or more partners
 Corporation
A Separate Legal Entity

Inventory Valuation Methods

 First-In, First-Out (FIFO)

This method is based on the premise that the first inventory purchased is the first to
be sold. The remaining assets in inventory are matched to the assets that are most
recently purchased or produced.

 Last-In, First-Out (LIFO)

Under this inventory valuation method, the assumption is that the newer inventory
is sold first while the older inventory remains in stock. This method is hardly used
by businesses since the older inventories are rarely sold and gradually lose their
value. This results in significant loss to the business.

 Weighted Average Cost

Under the weighted average cost method, the weighted average is used to
determine the amount that goes into the cost of goods sold and inventory. Weighted
average cost per unit is calculated as follows:
Weighted Average Cost Per Unit = Total Cost of Goods in Inventory / Total Units in
Inventory

 Gross Profit:
The amount by which the net sales exceed the cost of goods sold.

 Gross Sales:
Total recorded sales before deducting any sales discounts or sales returns and
allowances

 Audit:
The result of an independent accountant's review of the financial statements and
their foot notes to ensure compliance with generally accepted accounting principles
(GAAP) and to express an opinion on the fairness of the financial statements.

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 Internal Control:
Policies and procedures designed to provide reasonable assurance that a company's
objectives will be achieved. It consists of control environment, risk assessment,
control activities, information and communications and monitoring.

 Depreciation:
The expense recognized in writing off the cost of a plant or machine over its useful
life, giving consideration to wear and tear, obsolescence, and salvage value. Methods
vary. Examples are straight line (SL), accelerated methods such as sum-of-the-years
digits (SYD), and double-declining balance (DDB) methods. Primarily accelerated
depreciation is chosen for a business' tax expense but straight line is chosen for its
financial reporting purposes.

 Break-Even Point:
The volume point of sales at which revenues and costs are equal; a combination of
sales and costs that will yield a no profit, no loss operation.

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