definition of accounting
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Definition of Accounting Accounting Basics for Attorneys November 15, 2012TRANSCRIPT
Disclaimer:
• The views expressed in this presentation are my own and not necessarily those of the Kentucky Society of Certified Public Accountants, the American Institute Certified Public Accountants and the Internal Revenue Service.
• The information is not a substitute for consultation with an expert and the creator is not liable for problems arising from following the advice on the site.
• The laws and regulations are subject to change over time and recent changes after the date of this representation may not be reflected on this presentation
What is Accounting ?
“the language of business”
•large international corporation•single person•home based business•government agency•non-profit
vehicle for reporting financial information about a business entity to many different groups of people
Definition of Accounting
Accountancy is the process of communicating financial information about a business entity to users such as shareholders and managers. The communication is generally in the form of financial statements that show in money terms the economic resources under the control of management; the art lies in selecting the information that is relevant to the user and is reliable. The principles of accountancy are applied to business entities in three divisions of practical art, named accounting, bookkeeping and auditing. (Elliot, Barry & Elliot, Jamie: Financial Accounting and Reporting, Prentice Hall, London, 2004 p.3)
Definition of Accounting (continued)
The American Institute of Certified Public Accountants (AICPA) defines accountancy as “the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof. (Accounting Terminology Bulletin No.1 Review and Resume)
There are three types of accounting
• Tax Accounting
• Managerial Accounting
• Financial Accounting
Tax Accounting
• Tax Accounting helps determine how much is owed to the government for taxes
• The government sets the rules for determining taxes
• Taxes :– Tax Authorities : Federal - State - Local– Taxes : Business Corporate (Net Profit,
Property) – Individual (Payroll, Sales, Property)
Managerial accounting
• Designed to help people inside the business make decisions
• There are no rules
• Report is customized and designed to meet needs of users inside the business.
Financial Accounting
• Designed to help people outside of the business make decisions (creditors, investors, suppliers, customers, governments, labor unions)
• Multi purpose reports (one set of financial statements meets the need of all users outside the business)
• Follows the rules of GAAP (Generally Accepted Accounting Principle)
Assets and Equity
• Accounting “accounts for” two things: –the business assets and–the equity in those assets
• Definition of assets by International Accounting Standard Board (IFRS Framework):
“An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the enterprise”
• An asset generally is something that the business owns and holds the legal title to.
• Example: building, equipment, furniture
Assets and Equity (cont.)
• Definition of equity by International Accounting Standard Board (IFRS Framework) F.49(c):
“equity capital is the owners’ interest on the assets of the enterprise after deducting all its liabilities.”
• Equity represents ownership.
Liabilities
• Definition of liabilities by International Accounting Standard Board (IFRS Framework) F. 49(b):
“A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.”
• Liabilities are debts and obligations of the business.
• Liabilities represent creditors’ claim on interest of ownership of business assets.
Assets = Liabilities + Owner’s Equity
ASSETS =• Cash• Inventory• Building• Equipment• Furniture• Supplies• Vehicle
LIABILITIES(creditors’ ownership of interest of
assets)
+
OWNER’S EQUITY(investors’ ownership of interest of
assets)
The Accounting Equation
Debits and Credits
• Debits and Credits are the two fundamental aspects of every financial transaction in the double-entry bookkeeping system in which every debit transaction must have a corresponding credit transaction(s) and vice versa.
• In financial accounting or bookkeeping,
“Dr” (Debit) means left side of a ledger account
and“Cr” (Credit) is the right side of a ledger account
The Five Accounting Elements
• To determine whether one must debit or credit a specific account, we use the modern accounting equation approach which consists of five accounting elements.
• Five accounting elements:– Asset– Liability– Equity– Income/Revenue– Expense
• The Modern Extended Accounting Equation :
Asset + Expense = Liability + Equity + Income/Revenue
The Five Accounting Elements
• (Gross) Income/Revenue: is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. (The International Accounting Standard Board, IFRS Framework F.70)
• Expense: decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. (The International Accounting Standard Board, IFRS Framework F.70)
The Five Accounting Elements
Increase Decrease
Asset Debit Credit
Expense Debit Credit
Liability Credit Debit
Equity / Capital Credit Debit
Income / Revenue Credit Debit
Debit Credit
Asset + -
Expense + -
Liability - +
Equity / Capital - +
Income / Revenue - +
• An increase (+) to an asset or expense account is a debit (Dr).
• An increase (+) to a liability, equity or income/revenue account is a credit (Cr).
Recording The Transactions• All accounts must first be classified as one of the five
accounting elements. • Each transactions will consist of at least one debit to a
specific account and one credit to another specific account.
• Each transaction must be equal (balance).• Each transaction recorded in a general ledger or
t-account.
Bank (Asset)
Dr. Cr.
Equity
Dr. Cr.
Recording The Transactions(1)X made an initial investment of $ 20,000 cash to start the X Law
Office, PLLC and open a business bank account.
Journal Entry
Dr. Cr.
Cash (Bank) $20,000
Equity/Capital X $20,000
Bank (Cash) – (Asset)
Dr. Cr.
(1) $20,000
Equity / Capital X
Dr. Cr.
(1) $20,000
Recording The Transactions(2)X decided to obtain the loan from Bank Z to finance the entire
purchase of $ 5,000 in office furniture and equipment.
Journal Entry
Dr. Cr.
Office Furniture & Equipment $5,000
Loan from Bank Z $5,000
Office Furniture & Equipment (Asset)
Dr. Cr.
(2) $5,000
Loan Bank Z (Liability)
Dr. Cr.
(2) $5,000
Recording The Transactions(3)X Law Office, PLLC paid $ 5,000 for security deposit for leasing an
office space
Journal Entry
Dr. Cr.
Security Deposit $5,000
Bank (Cash) $5,000
Bank (Cash) - (Asset)
Dr. Cr.
(1) $20,000
(3) $5,000
$15,000
Security Deposit (Asset)
Dr. Cr.
(3) $5,000
$5,000
X Law Office, PLLC Assets = Liabilities + Owner’s Equity
Assets:
Bank/Cash $ 15,000
Security Deposit $ 5,000
Office Furniture &
Equipment $ 5,000
_______
Total Asset $ 25,000
Liabilities:
Loan Bank Z $ 5,000
Equity:
Equity/Capital X $ 20,000
_______
Total Liabilities
and Equity $ 25,000
Cost vs. Benefit
The accounting system considers cost versus benefit. This means when the business designs the accounting system, the cost of producing the information will not want to exceed the benefit of having the information.
Legal and regulatory considerations override the cost and benefit analysis. The business is obligated to comply with any legal and regulatory considerations that are applicable to the business.
What are the law office typical industry characteristics (based on
our law office clients’ experience) ?• IOLTA Account• Retainer• Reimbursement (Business to Business)
– Income Reimbursement – Expense Reimbursement (mark-up is optional)
• More than a year account receivable / billing collection (cut off date at the end of fiscal year and necessary adjustment journal entry).