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Introduction to Accounting Principles
The Role of AccountingEdit
Accounting is concerned with the uses of a business's financial information. It deals with:
- Bookkeeping - recording financial activities and transactions that take place in a business
- Summarizing and organizing this information in order to make it useful
- Analyzing and interpreting the information in the form of financial statements
- Communicating the results to the business and other parties
Accounting provides a means of analyzing, controlling and improving a business's performance, as well as being an aid to planning and decision-making. Information found as a result of accounting is used by the management of a business, along with other external parties, including suppliers, competitors, future investors, and the government.
The Accounting EquationEdit
- Resources put into a business by its owner(s) (also referred to as Equity)
- Resources that a business owns
- Obligations that a business owes to other parties
The accounting equation is: Assets = Capital + Liabilities
On the left side is the resources that are in and owned by the business. This must equal the right side, which shows who supplied these resources - either the owner (capital) or other businesses (liabilities).
Every business transaction includes items that fall under each of these three categories. As a result, the accounting equation can be applied to every financial transaction.
Double Entry BookkeepingEdit
Every transaction affects two things. For example, imagine you go to the local shop and buy a chocolate bar. Your capital (money) will go down, as you have exchanged it for the chocolate. Also, your asset (chocolate bar) will go up. The converse is true from the shop's point of view - their stock has gone down, and their cash has gone up.
So, for every transaction, there is:
- A DEBIT. Debit refers to an increase in the asset side of the accounting equation or a decrease in the equity/liability side of the accounting equation. For example, you receive a payment for services provided, which increases the cash balance (debit cash).
- A CREDIT. Credit refers to a decrease in the asset side of the accounting equation or an increase in the equity/liability side of the accounting equation. Using the same example as above, the other side of the transaction recording receiving a payment for services provided would increase revenue (credit revenue).
In the first example above, your asset account is debited with the chocolate bar, and your cash account is credited with how much you paid for it.
The Double Entry SystemEdit
A business will record each transaction in its books, which contain all the accounts where transactions have occurred throughout the accounting period. Because every transaction affects two things, we need to show this in the books where the two things have changed, therefore two accounts show the same transaction. This is why the process is called double entry bookkeeping.
Transactions which occur are entered into a set of accounts in the accounting books. An account is where all financial activities regarding a particular asset or liabilitity, or capital, is recorded. For example, there will be an account for office equipment, where all the financial activities regarding office equipment are entered.
In terms of bookkeeping at A Level you only need to know simple account layouts known as T Accounts. Each account is shown separately in a different T account, and in accounting books each T account will be shown on separate pages. The T account divides the page into two halves.
|Left-hand side||Right-hand side|
|Debit entries||Credit entries|
For every transaction, there is a debit and a credit entry. For example, imagine you pay your £30 rent. The two T accounts - Bank and Rent - would show the following: