Table Of Contents
II. Accounting Basics
III. Journals, Ledgers, Financial Statements
I don't have a PhD in Business, but I am a CPA with thirty years of experience. By contributing to this free e-book, I hope to grow in my own understanding of business that I may one day somehow attain a semblance of what a PhD knows.
Accounting. Perhaps you have heard this word associated with very difficult study. Accounting doesn't have to be difficult. Accounting conceptually is very simple as long as you get the 100,000 foot view of what accounting is trying to accomplish first.
What is accounting? First a formal definition and then I will share with you my definition.
Formal Definition: Accounting is the practice and body of knowledge concerned primarily with (1) methods for recording transactions, (2) keeping financial records, (3) performing internal audits, (4) reporting and analyzing financial information to the management, and (5) advising on taxation matters. It is a systematic process of identifying, recording, measuring, classifying, verifying, summarizing, interpreting and communicating financial information. It reveals profit or loss for a given period, and the value and nature of a firm's assets, liabilities and owners' equity. Accounting provides information on the (1) resources available to a firm, (2) the means employed to finance those resources, and (3) the results achieved through their use.
My informal definition: Accounting is the systematic recording, reporting, and analysis of financial transactions of a business. The person in charge of accounting is known as an accountant, and this individual is typically required to follow a set of rules and regulations, such as the Generally Accepted Accounting Principles or the International Financial Reporting Standards. Accounting allows a company to analyze the financial performance of the business, and look at statistics such as net profit.
And boiling it down even simpler: Accounting is the recording of financial, property, and money transactions.
The first problem with the study of Accounting can be seen within these three definitions. The body of accounting knowledge is similar to knowledge that only a secret society has. Instead of secret handshakes, secret agendas, and secret meetings, the knowledge of accounting cloaks itself from most people through the sheer volume of information, extensive use of language that is not used by the common person, rules that are not readily apparent as to why they exist, and a cadre of individuals who would like to keep you ignorant so you will pay them handsomely for their knowledge.
As an example of this, when reading the first definition of accounting, people tend to get lost after reading the first sentence. Why is that? Well its partly ego and partly, it is the accountant's nature to get everything exactly right and be as succinctly comprehensive as possible (trying to state everything important while they are on the subject). This not only pertains to financial statements reflecting the companies financial information, but words to communicate how that financial information came about.
Accounting is definitely in need of a more simple makeover in introducing it to people. Accountants need to learn to start with very simple ideas first when educating others about their field and then the more exact understanding of particulars will be easily apparent. The first formal definition above was the first words of a textbook in beginning the study of accounting. This will be my task to try to make accounting much easier so that you can learn to love the educational process.
Now, while the scope of this information I present will not make it immediately easy to journal the entries for a lessee in calculating the present value of a lease or understanding the passive activity loss rules outlined in the Internal Revenue Code, IT WILL make the basic concepts that are needed later to understand the complicated parts of accounting very easy. Accounting is 80% the ability to conceptualize numerical transactions (taking the 100,000 foot view) and 20% memory. Most of the specifics in accounting can be looked up when you are trying to solve accounting problems, although the more you memorize these specifics the faster your work will go, but it's not absolutely required to record accurately your money and property transactions.
Accounting basically asks and seeks to answer four questions of an organization (group) about their transactions. 1. What does the group immediately control? 2. Who besides the group owns what is controlled? 3. How much does the group itself own? 4. Where did all of this come from?
That's it. The stuff that the group in question controls is called Assets. When your friend lets you borrow $100 upon your promise to pay them back, you have $100 in cash (an Asset), but your friend still has some claim to that $100 based on your promise to pay them back (your debt called a Liability). How you account (record the transaction in some books) for that $100 finding its way into your wallet will highlight that your friend still has some claim on you . . . that you are Liable to him.
Instead of describing this example verbally however as I just did, Accounting describes this situation primarily numerically.
So for example, you now have a business. Your buddy has just lent you $100 to get you started in your business.
You need to record the fact that you now have $100 and that you owe your bud $100. Enter now the Balance Sheet.
Your books (your balance sheet) to record this transaction, should look like this: