The magic button — Make Everything OK

The magic button — Make Everything OK

Accounting Basics

Accounting Concepts:  

Accounting is the measurement, processing and communication of financial information about economic entities. The systematic  recording, reporting, and analysis of financial transactions of a business. Accounting is a set of concepts and techniques that are used to measure and report financial information about an economic unit.

Fields of Accounting: 

Accounting can be divided into financial accounting and managerial accounting. Financial accounting focuses on the reporting of an organization's financial information, including the preparation of financial statement, to external users of the information, such as investors, regulators and suppliers; and management accounting focuses on the measurement, analysis and reporting of information for internal use by management. 

Types of Accounts:  

Broadly there are three types of accounts –

                1.    Real Account:
                       The accounts relating to all assets and properties are called real accounts.
                2.    Personal Account:
                       The accounts relating to individuals, firms, associations or companies are known as                              personal account.
                3.    Nominal Account:
                       The accounts relating to expenses, losses, incomes and gains are known as nominal                              accounts.

The Golden Rule: 

Accounting golden rule refers to debit and credit on various types of accounts-

      Real Account: all assets and liabilities fall under Real Account. e.g. cash, bank, building,                loan, creditors, debtors, etc. Hence, Debit what comes in and Credit what goes out.
             
      Personal Account: all accounts relating to individuals, firms, companies etc (by their names)... falls under Personal Account. Hence, Debit is the Receiver and Credit the Giver.
     
      Nominal Account: all accounts relating to incomes and expenses. Hence, Debit all expenses and Credit all incomes.

The Accounting Procedures:

Accounting procedures are rules and standards that are used to prepare, present and report the financial status of a company. It covers how to record financial data, summarize them, preparing financial statements and routine according matters. The recording of financial transactions, so that summaries of the financials may be presented in financial reports, is known as bookkeeping, of which double entry is the most common system. For a fresh look at we can follow the procedure given below-

                               

i.                    Transactions are recorded in the journal entries

ii.                  Journal entries are posted to the appropriate ledger accounts

iii.                A trial balance is constructed

iv.                Adjusted entries are made and posted

v.                  Adjusted trial balance is prepared

vi.                Formal financial statements are produced

Transactions:

An accounting transaction is a business event having a monetary impact on the financial statements of a business. It is recorded in the accounting records of the business. Examples of accounting transactions are:

i.          Sale in cash to a customer

ii.    Sale on credit to a customer

iii.   Receives cash in payment of an invoice owed by a customer

iv.   Purchases fixed assets from a supplier

v.    Record the depreciation of a fixed asset over time

vi.  Investment in another business

vii.  Borrow funds from a lender

viii. Issue a dividend to investors Sale of assets to a third party

Every accounting transaction has to follow the dictates of the accounting equation. which states that any transaction must result in assets equaling liabilities plus shareholders' equity. 
                 
   For example:

• A sale to a customer results in an increase in accounts receivable (asset) and an increase in revenue (indirectly increases stockholders' equity).
• A purchase from a supplier results in an increase in expenses (indirectly decreases stockholders' equity) and a decrease in cash (asset).
• A receipt of cash from a customer result in an increase in cash (asset) and a decrease in accounts receivable (asset).
• Borrowing funds from a lender results in an increase in cash (asset) and an increase in loans payable (liability).

Thus, every accounting transaction results in a balanced accounting equation.

The Accounting Equation:

The accounting equation is the basis upon which the double entry accounting system is constructed. In essence, the accounting equation is:

    

                                     Assets = Liabilities + Shareholders' Equity

The assets in the accounting equation are the resources that a company has available for its use, such as cash, accounts receivable, fixed assets, and inventory.The company pays for these resources by either incurring liabilities (which is the Liabilities part of the accounting equation) or by obtaining funding from investors (which is the Shareholders' Equity part of the equation). Thus, you have resources with offsetting claims against those resources, either from creditors or investors. All three components of the accounting equation appear in the balance sheet, which reveals the financial position of a business at any given point in time.The Liabilities part of the equation is usually comprised of accounts payable that are owed to suppliers, a variety of accrued liabilities, such as sales taxes and income taxes, and debt payable to lenders.

The Shareholders' Equity part of the equation is more complex than simply being the amount paid to the company by investors. It is actually their initial investment, plus any subsequent gains, minus any subsequent losses, minus any dividends or other withdrawals paid to the investors.You can see this relationship between assets, liabilities, and shareholders' equity in the balance sheet, where the total of all assets always equals the sum of the liabilities and shareholders' equity sections.                       

Example

ABC International engages in the following series of transactions:1.      ABC sell shares to an investor for $10,000. This increases the cash (asset) account as well as the capital (equity) account.

2.      ABC buys $4,000 of inventory from a supplier. This increases the inventory (asset) account as well as the payable (liability) account.

3.      ABC sells the inventory for $6,000. This decreases the inventory (asset) account and creates a cost of goods sold expense that appears as a decrease in the income (equity) account.

4.      The sale of ABC's inventory also creates a sale and offsetting receivable. This increases the receivables (asset) account by $6,000 and increases the income (equity) account by $6,000.

5.      ABC collects cash from the customer to which it sold the inventory. This increases the cash (asset) account by $6,000 and decreases the receivables (asset) account by $6,000.

These transactions appear in the following table:

	(Asset)	(Asset)	(Asset)		(Liability)	(Equity)	(Equity)
Item	Cash	Receivables	Inventory	=	Payables	Capital	Income
(1)	10,000			=		10,000
(2)			4,000	=	4,000
(3)			(4,000)	=			(4,000)
(4)		6,000		=			6,000
(5)	6,000	(6,000)		=
Totals	16,000	0	0	=	4,000	10,000	2,000

  
Note how every transaction is balanced within the accounting equation - either because there are changes on both sides of the equation, or because a transaction cancels itself out on one side of the equation (as was the case when the receivable was converted to cash).Recording accounting transactions with the accounting equation means that you use debits and credits to record every transaction, which is known as double-entry bookkeeping.

Example: how transactions effect assets and liabilities:

Transaction Type	Assets	Liabilities + Equity
Buy fixed assets on credit	Fixed assets increase	Accounts payable (liability) increases
Buy inventory on credit	Inventory increases	Accounts payable (liability) increases
Pay dividends	Cash decreases	Retained earnings (equity) decreases
Pay rent	Cash decreases	Income (equity) decreases
Pay supplier invoices	Cash decreases	Accounts payable (liability) decreases
Sell goods on credit	Inventory decreases	Income (equity) decreases
Sell services on credit	Accounts receivable increases	Income (equity) increases
Sell stock	Cash increases	Equity increases

Journal Entries: An accounting journal entry is the method used to enter an accounting transaction into the accounting records of a business. The accounting records are aggregated into the general ledger, or the journal entries may be recorded in a variety of sub ledgers, which are later rolled up into the general ledger. This information is then used to construct financial statements as of the end of a reporting period.
When you create an accounting transaction, at least two accounts are always impacted, with a debit entry being recorded against one account and a credit entry against the other account. The total of the debits and credits for any transaction must always equal each other, so that an accounting transaction is always said to be "in balance." Thus, the use of debits and credits in a two-column transaction recording format is the most essential of all controls over accounting accuracy. At a minimum, an accounting journal entry should include the following:

i.  The accounts into which the debits and credits are to be recorded
ii. The date of the entry
iii. The accounting period in which the journal entry should be recorded
iv. A unique number to identify the journal entry
v. It may be necessary to attach extensive documentation to the journal entry, to prove why it is being recorded; at a minimum, provide a brief description of the journal entry.

Examples:

Arnold Corporation sells a product to a customer for $1,000 in cash. This results in revenue of $1,000 and cash of $1,000. Arnold must record an increase of the cash (asset) account with a debit, and an increase of the revenue account with a credit. The entry is:

	Debit	Credit
Cash	1,000
Revenue		1,000

Arnold Corporation also buys a machine for $15,000 on credit. This results in an addition to the Machinery fixed assets account with a debit, and an increase in the accounts payable (liability) account with a credit. The entry is:

	Debit	Credit
Machinery - Fixed Assets	15,000
Accounts Payable		15,000

 Journal entries are called book of primary or original entries, i.e. record of all transactions. It is a date wise record of all transactions with details of the account to be debited or credited with the volume of transactions. To make journal entries we can follows the instructions given below:

i.                     Identify the accounts affected by the transaction

ii.                   Classify the accounts as real, personal or nominal accounts

iii.                  Find out the rules of debit and credit for these accounts (golden rule)

iv.                 Finally identify which account will be debited and/or credited

Example: Journal entries-

Brad has following transactions for the Month of January 2014,

i.                     Purchased goods for cash Tk. 10,000 date 1.1.2014

ii.                   Purchased stationery for cash Tk. 500 date 12.1.2014

iii.                  Purchased furniture for cash Tk. 2,000 date 13.1.2014

iv.                 Sold goods for cash Tk. 100,000 date 17.1.2014

v.                   Sold goods to James Tk. 4,000 date 21.1.204

vi.                 Paid rent Tk. 800 date 24.1.2014

vii.                Paid salary of Tk. 8,000 date 31.1.2014

	Journals
Date	Particulars	Debit	Credit
1.1.2014	Purchase a/c                                      Dr             To Cash [Being goods purchased for cash]	10000	10000
12.1.2014	Stationery a/c                                                                                    Dr             To Cash [Being stationeries purchased for cash]	500	500
13.1.2014	Furniture  a/c                                                                                     Dr             To Cash [Being furniture purchased for cash]	2000	2000
17.1.2014	Cash       a/c                                                                                       Dr             To Sales [Being goods sold for cash]	100000	100000
21.1.2014	James     a/c                                                                                      Dr             To Sales [Being goods sold to James on credit]	4000	4000
24.1.2014	Rent        a/c                                                                                      Dr             To Cash [Being rent paid for cash]	800	800
31.1.2014	Salary     a/c                                                                                      Dr             To Cash [Being salary paid for cash]	8000	8000

Find the examples of journal entries linked herein:      < http://goo.gl/6Oi00V>, <https://goo.gl/oRQgg7>, <http://goo.gl/r2Oune >, <https://www.youtube.com/watch?v=0R0SNfYgmjc>

T Accounting (Ledger Posting and Trial Balance):

T account is a graphic representation of a general ledger account. The name of the account is placed above the "T" (sometimes along with the account number). Debit entries are depicted to the left of the "T" and credits are shown to the right of the "T". The grand total balance for each "T" account appears at the bottom of the account. A number of T accounts are typically clustered together to show all of the accounts affected by an accounting transaction. The T account is a fundamental training tool in double entry accounting, since you need to see how one side of an accounting transaction is reflected in another account.

          
Example:

In the following example of how T accounts are used, a company receives a $10,000 invoice from its landlord for the July rent. The T account shows that there will be a debit of $10,000 to the rent expense account, as well as a corresponding $10,000 credit to the accounts payable account. This initial transaction shows that the company has incurred an expense as well as a liability to pay that expense.

The bottom set of T accounts in the example show that, a few days later, the company pays the rent invoice. This results in the elimination of the accounts payable liability with a debit to that account, as well as a credit to the cash (asset) account, which decreases the balance in that account.

The T account has two primary uses, which are:

• To teach accounting, since it gives a more clear representation of the flow of accounting transactions through the accounts in which transactions are stored.
• To clarify more difficult accounting transactions, for the same reason.

The T account concept is especially useful when compiling more difficult accounting transactions, where you need to see how a business transaction impacts all parts of the financial statements.

                  More Examples:   refer to Brad Account (journal entries);

Trial Balance
Sl. No.	Name of Accounts	Debit	Credit
1.	Sales Account		104000
2	Cash Account	78700
3	Purchase Account	10000
4	Salary Account	8000
5	James Account	4000
6	Furniture Account	2000
7	Rent Account	800
8	Stationery Account	500	---------------
		104000	104000

General Ledger: 

A general ledger contains all the accounts for recording transactions relating to a company's assets, liabilities, owners' equity, revenue, and expenses. The statement of financial position and the statement of income and comprehensive income are both derived from the general ledger. A trial balance is a list of all the General ledger accounts (both revenue and capital) contained in the ledger of a business. This list will contain the name of the nominal ledger account and the value of that nominal ledger balances on a particular place. The value of the nominal ledger will hold either a debit balance value or a credit balance value. The debit balance values will be listed in the debit column of the trial balance and the credit value balance will be listed in the credit column. The trading profit and loss statement and balance sheet and other financial reports can then be produced using the ledger accounts listed on the trial balance. The name comes from the purpose of a trial balance which is to prove that the value of all the debit value balances equal the total of all the credit value balances. Trialing, by listing every nominal ledger balance, ensures accurate reporting of the nominal ledgers for use in financial reporting of a business's performance. If the total of the debit column does not equal the total value of the credit column then this would show that there is an error in the nominal ledger accounts. This error must be found before a profit and loss statement and balance sheet can be produced.