Accounting Principles Made Simple
Whether your an Accounting student, a bookkeeper, or a busines executive, this quick look at the big picture will de-mystify Accounting and make your life much easier!Knowing the basics will make it much easier to read Financial Statements and navigate any Accounting Software package.
The Accounting system we use today (aka the double-entry system), was developed in Korea in the 10th century. This framework supports every Accounting system in virtually every country in the world:
Some Accounting programs do a terrific job of hiding the basics, to try and make things "easier".
User-friendly systems are great; however, basic Accounting principles are easy to understand, and there are only a few of them!
This is the shortest article I've ever written, and one of the simplest, even though Accounting has a reputation of being hard.
After this quick read, You will have a grasp of the elusive "big picture", which will serve you well in the business world.
Let's start with Debits and Credits
(You have to start somewhere).Think of a list, where each row (item) has 3 columms - A description and 2 columns to the right of the description (which is where the numbers go).
The Debit is simply the left column, and the Credit is the right column.
When your business collects revenue, or pays a bill, you write that information in the list (aka a journal). This information is then used to create your financial statements, which will help you understand how well your business is doing.
All entries are double-sided.
When you record a transaction, you always create at least two rows in your journal (list) - One row will have a Debit, and one will have a Credit; and your entry must balance.For example, if you receive $10 for carrying groceries, here's the entry you would make in the journal:
Cash...........10.00
Sales.......................10.00
There! The transaction is recorded, the entry balances (Debits equal Credits), and everyone is happy.
There are two primary financial reports.
The Income Statement and the Balance Sheet.Each report has three basic columns in it: A Description, a Debit, and a Credit (just like the journal!).
All the journal entries are used to create the financial statements. If the journal entries balance, the financials statements will also balance, if you put all the journal entries into the accounting system correctly.
Please note! Financial statements don't often look like they have 3 columns. The numbers are usually listed in a single column. Just know that each section of a financial statement is listing either Debits or Credits. This is always the case.
As we move forward, we're going to assume no money was invested into this grocery-carrying business - for simplicity.
The Income Statement is made up of 2 basic items:
Revenue - which are Credits.
Expenses - which are Debits.
So, if the company has more revenue than expenses, they have Net Income, which is a Credit balance.
The Balance Sheet is made up of 3 basic items:
Assets (Debits) like Cash and Equipment.
Liabilities (Credits) like loans and estimated expenses.
Equity (Credits) aka Accumulated Earnings (Accumulated Net Income) - This is the direct connection (between the Income Statement and the
Balance Sheet), that makes the Balance Sheet, um, balance.
Here are some formulas & facts to add perspective
and help solidify your understanding - These formulas work assuming there haven't been any investments into the company:Net Income (since inception) = Total Equity
If this doesn't make sense, re-read the definition of Equity aboue
Net Income (since inception) + Total Liabilities = Total Assets
Total Equity + Total liabilities = Total Assets.
Total Liabilities + Total Revenue (since inception) - Total Expenses (since inception) = Total Assets.
The Balance Sheet accounts (like Cash), shows all activity from inception, while
The Income Statement often shows activity for a month, or a year.
Let's assume the company has been in business for 3 years, earned $10 each year, had no
expenses, and took no money out of the bank. Under these assumptions, the Annual Financial Statements would look like this at
the end of 3 years:
Balance Sheet
as of the end of Year 3
Assets
Cash.................................... 30
Total Assets.......................... 30
Liabilities and Equity
Liabilities............................... 0
Equity.................................. 30
Total Liabilities & Equity.......... 30
Income Statement
for the 12-months ending Year 3
Revenue
Grocery Carrying Service........ 10
Total Revenue....................... 10
Expenses............................... 0
Total Expenses........................ 0
Net Income........................... 10
Balance Sheet
as of the end of Year 3
Assets
Cash.................................... 30
Total Assets.......................... 30
Liabilities and Equity
Liabilities............................... 0
Equity.................................. 30
Total Liabilities & Equity.......... 30
Income Statement
for the 12-months ending Year 3
Revenue
Grocery Carrying Service........ 10
Total Revenue....................... 10
Expenses............................... 0
Total Expenses........................ 0
Net Income........................... 10
That's it! The basics!
Everything else, in Accounting, builds from these simple guidelines. IE: Other complications in the world of accounting will follow these simple rules. Know these rules, and you can sort thru everything else with more ease and confidence.
If you would like further information, or clarification on the basics, please contract us thru our Facebook account. We'd be glad to answer your questions.
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