1. Accounting Basics: Introduction
  2. Accounting Basics: History Of Accounting
  3. Accounting Basics: Branches Of Accounting
  4. Accounting Basics: The Basics
  5. Accounting Basics: The Accounting Process
  6. Accounting Basics: Financial Statements
  7. Accounting Basics: Financial Reporting

Accrual vs. Cash Basis Accounting

Deciding when an economic event occurs and an accounting transaction should be recorded is a matter of judgment. Accrual accounting looks to match revenues and expenses based on the business cycle of the firm rather than with the actual inflows and outflows of cash. (For more on this see, The Essentials of Cash Flow.)

Although cash basis statements are simpler and make good sense for many individual taxpayers and small businesses, it can result in misleading financial statements for larger entities. Accrual accounting seeks to match the revenues earned during a period with the expenses incurred to generate them, regardless of when cash comes in or goes out. (For details see, When should a company recognize revenues?)

Different types of business will have different rules/practices for the recognition of revenues and expenses. A retail store will record sales when the transaction occurs, a contractor working on complex project like a building may record revenue at set milestones in the contract. Matching expenses with revenue will also follow a set of rules so as not to skew profit or loss over various time periods more than is warranted.

 

The Difference Between Accounting and Bookkeeping

Bookkeeping is the recording of all the economic activity of an organization — sales made, bills paid, capital received — as individual transactions and summarizing them periodically (annually, quarterly, even daily). Except in the smallest organizations, these transactions are now recorded electronically; but before computers they were recorded in actual books, thus bookkeeping.

Accounting professionals design the accounting systems used by bookkeepers. More importantly, they establish the internal controls to protect company resources, the application of accounting standards governing the preparation of financial statements, management reports and tax returns based on that data. This also applies to the filing of required accounting reports with the SEC and other agencies for larger, public and private companies where required.

External auditors who verify the accounting records and express an opinion on financial statements are also accountants, as are management, tax and forensic accounting specialists. (To learn more, see, Accounting Not Just For Nerds Anymore.)

 

Double-Entry Accounting

The economic events of a business are recorded as transactions and applied to the various accounts on the organization’s chart of accounts. For example, the cash account tracks the amount of cash on hand; the sales account records sales made. Even small companies have hundreds of accounts; large companies may have thousands. The advent of computerized accounting systems available for even the smallest businesses has made this part of the process more streamlined over the years.

The transactions are posted in journals, which were (and for some small organizations, still are) actual books; nowadays, of course, the journals are typically part of the accounting software. Each transaction includes the date, the amount and a description including the other party to the transaction.

 

Debits and Credits

In accounting, debit means one thing: left-hand side. Credit means one thing: right-hand side. When you receive cash, you increase the Cash account by debiting it. When you spend, you decrease Cash by crediting the account on the other hand, when you make a sale you credit the Sales account; when someone returns what you sold, you debit sales. In today’s world, most of this nuts and bolts work is done by the organization’s accounting system, but trained personnel are still required to make sure things are done correctly. This is also a key reason for internal and external auditors.

 

Division of duties

A key principle of accounting is the division of duties, especially in smaller organizations, in order to prevent fraud. For example, the same person shouldn’t be recording the receipt of cash and also handling cash deposits.

 

Accounting Basics: The Accounting Process
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