ACCOUNTING

Lesson Standards

BMT-IBT-8

Understand, interpret, and use accounting principles to make financial decisions.

BMT-IBT-9

Develop effective money management strategies and understand the role and functions of financial institutions.

What is accounting? The systematic recording, reporting, and

analysis of financial transactions of a business.

The person in charge of accounting is known as an accountant or the bookkeeper in a smaller business.

Accounting allows a company to analyze the financial performance of the business, and look at statistics such as net profit.

THE 8 STEP ACCOUNTING CYCLE

As a bookkeeper, you complete your work by completing the

tasks of the accounting cycle. It’s called a cycle because the accounting

workflow is circular: entering transactions, manipulating the transactions through the

accounting cycle, closing the books at the end of the accounting

period, and then starting the entire cycle again for the

next accounting period.

TRANSACTIONS

Financial transactions start the process. Transactions can include the sale or

return of a product, the purchase of supplies for business activities, or any other financial activity that involves the exchange of the company’s assets, the establishment or payoff of a debt, or the deposit from or payout of money to the company’s owners.

JOURNAL ENTRIES

The transaction is listed in the appropriate journal, maintaining the journal’s chronological order of transactions.

The journal is also known as the “book of original entry” and is the first place a transaction is listed.

POSTING

The transactions are posted to the account that it impacts.

These accounts are part of the General Ledger, where you can find a summary of all the business’s accounts.

TRIAL BALANCE

At the end of the accounting period (which may be a month, quarter, or year depending on a business’s practices), you calculate a trial balance.

WORKSHEET Unfortunately, many times your first calculation of the

trial balance shows that the books aren’t in balance. If that’s the case, you look for errors and make

corrections called adjustments, which are tracked on a worksheet.

Adjustments are also made to account for the depreciation of assets and to adjust for one-time payments (such as insurance) that should be allocated on a monthly basis to more accurately match monthly expenses with monthly revenues.

After you make and record adjustments, you take another trial balance to be sure the accounts are in balance.

ADJUSTING JOURNAL ENTRIES

You post any corrections needed to the affected accounts once your trial balance shows the accounts will be balanced once the adjustments needed are made to the accounts.

You don’t need to make adjusting entries until the trial balance process is completed and all needed corrections and adjustments have been identified.

FINANCIAL STATEMENTS

You prepare the balance sheet and income statement using the corrected account balances.

CLOSING THE BOOKS

You close the books for the revenue and expense accounts and begin the entire cycle again with zero balances in those accounts.

As a businessperson,

you want to be able to gauge your profit or loss on month by month, quarter by quarter, and year by year bases.

To do that, Revenue and Expense accounts must start with a zero balance at the beginning of each accounting period.

In contrast, you carry over Asset, Liability, and Equity account balances from cycle to cycle.

DEBITS AND CREDITS*Click on picture to watch the video.

EXAMPLES OF PAGES IN A LEDGER

Debits and Credits

In bookkeeping under General Accepted Accounting Principles (GAAP), debit and credit refer to type of account and entries to accounts.

Entries to the left side of the an account are debits (DR), and accounts with left sided balances (asset accounts and expense accounts) are debit accounts.

Entries to the right side of the an account are credits (CR), and accounts with right sided balances (liability accounts, owners' equity accounts, and revenue and profit accounts) are credit accounts.

Understanding debit and credit is essential for bookkeeping and analysis of balance sheets.

Understand the meanings of the terms "debit" and "credit" with respect to bookkeeping.

Debits either increase a debit account or decrease a credit account. ○ For example, a debit entry may record an

increase in an asset, an expense, or a decrease in a liability.

Credits either increase a credit account or decrease a debit account. ○ For example, a credit entry may record an

decrease in an asset, an increase in a liability, or a revenue or profit.

Simple rules to remember:

Debit all expenses and losses, credit all incomes and gains

Debit all assets, credit all liabilities

Debit the receiver, credit the giver

Set up the balance sheet with all debit accounts on the left and credit accounts on the right.

For illustration, assume that ABC Company has $5000 cash, $7000 inventory, $3000 capital stock, and $9000 surplus. The balance sheet would be as follows:

Set up the ledgers (the books for record-keeping) for each account.

For our example, the ledgers would appear as follows:

For each transaction, consider what is being exchanged for what, which debit account it affects and whether the effect is to increase or to decrease.

Does it change the amount of cash, the amount of receivables, the inventory, amount of properties, or an expense?

If the transaction increases a debit account, record a debit entry in that debit account, and simultaneously a credit entry in an appropriate credit account.

If the transaction decreases a debit account, record a credit entry in that debit account, and simultaneously a debit entry in an appropriate credit account.

Suppose the company in our example has subsequently sold on credit $4000, which cost it $2800, and incurred various expenses totally $500 paid in cash. The $4000 sold on credit increases Accounts Receivables, and is therefore a debit entry. For simplicity, let us log all profit and loss as credit or debit in the Surplus account. Thus, the debit entry of $4000 under Receivables would have a corresponding credit entry of $4000 under Surplus. The cost of goods sold of $2800 decreases the inventory, and is therefore a credit entry. It will have a corresponding $2800 debit entry from Surplus. The $500 expenses paid in cash decreases Cash account, and is therefore a credit entry. It will have a corresponding $500 debit entry from Surplus. These entries are recorded as follows:

Calculate the ending balance in each account and update the balance sheet.

The example given would be as follows:

TIPS Remember that debits mean left side and credits mean right

side. Liabilities, which are credit accounts, include accounts

payable (money owed to other businesses or individuals), notes payable and long-term debt (money the company promises to pay on a future date), and unearned fees (money received in advance).

Asset accounts, which are debit accounts, include cash, accounts receivable (money owed by others for goods sold on credit), inventory, prepaid expenses, plants and equipments, office supplies, and investments.

Owners' equity, a credit account, include capital invested by the original investors and retained earnings and surplus.

Remember that for every transaction, The Sum of Debits = The Sum of Credits. The left side of the balance sheet must balance the right side: Assets + Expenses = Liabilities + Owners' Equity + Revenue/Profit.

BASIC ACCOUNTING TERMS

ASSETS Assets are things of value used by the business

in its operations. Fixed Assets are assets held on a long term basis,

such as land, buildings, machinery, plant, furniture and fixtures. These assets are used for doing business and not for re-sale in normal course of operation.

Current Assets are assets held on a short term basis such as debtors (account receivable), bills receivable (notes receivable), stock (inventory), temporary investment in securities, cash and bank balances. Normally the short term refers to an accounting year.

LIABILITIES These are the obligations or debts that the

enterprise must pay in money or services at sometime in the future.Long term liabilities are those that are usually

payable after a period of one year, for example, a term loan from financial institution or debentures (bonds) issued by the company.

Short term liabilities are obligations that are payable within a period of one year, for example, creditors (accounts payable), bills payable (notes payable), cash credit overdraft from a bank for a short period.

CAPITAL

Investment by the owners for the use in the business

SALES

total revenues from goods sold and/or services sold or provided to customers.

Sales may be cash sales or credit sales.

REVENUES

These are the amounts the business earns by selling it products or providing services to customers.

These are called 'sales revenues'. Other items and sources of revenues

common to many businesses are: sales, fees, commission, interest, dividends,

royalties, rent received, etc.

EXPENSES

These are costs incurred by a business in the process of earning revenues.

Generally, expenses are measured by the cost of assets consumed or services used during an accounting period.

The usual items of expenses are: ○ depreciation, rent, wages, salary, interest,

costs of heat, light and water, telephone, etc.

EXPENDITURE

The amount of resources consumed. Usually, it is of long term in nature. Therefore, its benefit is to be derived in

future.

LOSS

The gross decreases in the assets or gross increases in the liabilities.

It is the excess of expenses over revenues.

It represents reduction in owners' equity due to inability of the firm to recover the assets used in the business.

INCOME

Income is the increase in the net worth of the organization either from business activity or other activities.

Income is a comprehensive term, which includes profit also.

In accounting income is the positive change in the wealth of the business over a period of time.

PROFIT

The excess of revenues over expenses during an accounting year.

It increases the owner’s equity.

DEBTORS/ACCOUNTS RECEIVABLE Debtors (accounts receivable) are

persons and/or other entities who owe to an enterprise an amount for receiving goods and services on the credit.

The total amount due from such persons and/or entities on the closing date is shown in the balance sheet as the account receivables on the asset side.

CREDITORS/ACCOUNTS PAYABLE Creditors (accounts payable) are

persons and/or other entities who have to be paid by an enterprise an amount for providing the enterprise goods and/ or services on credit.

The total amount standing due to such persons and/or entities on the closing date is shown on the balance sheet as accounts payable on the liability side.

References

http://www.investorwords.com/48/accounting.html

Lita Epstein from Bookkeeping For Dummies

http://dilipchandra12.hubpages.com/hub/Basic-Terms-in-Accounting