Basic Accounting Concepts for Non-Accounting Background Consultants
- What is Accounting and Why Accounting?
- Single Entry System of Accounting Vs Double Entry System of Accounting.
- Different Types Of Accounts.
- Three Main Accounting Rules.
- Accrual basis of Accounting Vs Cash Basis of Accounting.
- What is GAAP?
- What are Critical Financial Statement?
What is Accounting?
Accounting is the process of recording financial transactions pertaining to a business.
Why Accounting?
You can think of accounting as a big machine that you put raw financial information into records of all your business transactions, taxes, projections, etc. that then spits out an easy to understand story about the financial state of your business.
Accounting tells you whether or not you’re making a profit, what your cash flow is, what the current value of your company’s assets and liabilities is, and which parts of your business are actually making money.
Single Entry System of Accounting Vs Double Entry System of Accounting
What is Single Entry System Accounting?
The single entry system is a method of recording financial transactions where only one entry is marked for either a debit entry or credit entry for a specific operation. For example, if a customer pays cash to the enterprise, either cash account will be credited, or debtor account will be debited.
What is Double Entry System Accounting?
The double entry system ensures that for every single debit entry, a corresponding credit entry must be recorded while every credit entry is completed by filing a similar debit entry, which means that each entry has an opposite entry.
Single Entry System Vs Double Entry System
| Single Entry System | Double Entry System | |
|---|---|---|
| Duality | Based on Duality | Not Base on Duality |
| User | Large Corporation | Sole Proprietors & Partnerships |
| Costs Involved | Costly | Cheap |
| Accounts Maintained | Personal, Real & Nominal Accounts | Simple Personal Accounts |
| Detection of Errors | Essay to Detect Errors | Difficult to Detect Errors |
| Preparation of Trial Balance | Useful | Not Useful |
| Profit and Loss Account | Useful | Not Useful |
Different Types Of Accounts
Balance Sheet Accounts
- Assets
- Liability
- Equity
P & L Accounts
- Expense
- Revenue
Main Accounting Rules
Personal Account Rule:-
Debit the Receiver
Credit the Giver
Real Account Rule:-
Debit What Comes In
Credit What Goes Our
Nominal Account Rule:-
Debit All Expenses and Losses
Credit All Incomes and Gains
Accrual basis of Accounting Vs Cash Basis of Accounting
Accrual basis accounting
Accrual accounting is a method of accounting where revenues and expenses are recorded when they are earned, regardless of when the money is actually received or paid. For example, you would record revenue when a project is complete, rather than when you get paid. This method is more commonly used than the cash method.
Cash basis accounting
The cash basis of accounting recognizes revenues when cash is received, and expenses when they are paid. This method does not recognize accounts receivable or accounts payable.
| Accrual Accounting | Cash Accounting |
|---|---|
| Recognizes expenses when they’re billed (eg. when you’ve received an invoice) | Recognizes expenses when cash has been spent |
| Recognizes revenue when it’s earned (eg. when the project is complete) | Recognizes revenue when cash has been received |
| Taxes paid on money that you’re still owed | Taxes are not paid on money that hasn’t been received yet |
| Required for businesses with revenue over $5 million | Mostly used by small businesses and sole proprietors with no inventory |
What is GAAP?
Generally Accepted Accounting Principles (GAAP)
Generally accepted accounting principles (GAAP) refer to a common set of accounting principles, standards, and procedures issued by the Financial Accounting Standards Board (FASB). Public companies in the United States must follow GAAP when their accountants compile their financial statements. GAAP is a combination of authoritative standards (set by policy boards) and the commonly accepted ways of recording and reporting accounting information. GAAP aims to improve the clarity, consistency, and comparability of the communication of financial information.
GAAP helps govern the world of accounting according to general rules and guidelines. It attempts to standardize and regulate the definitions, assumptions, and methods used in accounting across all industries. GAAP covers such topics as revenue recognition, balance sheet classification, and materiality.
The ultimate goal of GAAP is ensure a company’s financial statements are complete, consistent, and comparable. This makes it easier for investors to analyze and extract useful information from the company’s financial statements, including trend data over a period of time. It also facilitates the comparison of financial information across different companies.
General Concepts of GAAP
- Principle of Regularity
- Principle of Consistency
- Principle of Sincerity
- Principle of Permanence of Methods
- Principle of Non-Compensation
- Principle of Prudence
- Principle of Continuity
- Principle of Periodicity
- Principle of Materiality / Good Faith
- Principle of Utmost Good Faith
Four Basic Financial Statements
Income statement:-
Presents the revenues, expenses, and profits/losses generated during the reporting period. This is usually considered the most important of the financial statements, since it presents the operating results of an entity.
Balance sheet:-
Presents the assets, liabilities, and equity of the entity as of the reporting date. Thus, the information presented is as of a specific point in time. The report format is structured so that the total of all assets equals the total of all liabilities and equity (known as the accounting equation). This is typically considered the second most important financial statement, since it provides information about the liquidity and capitalization of an organization.
Statement of cash flows:-
Presents the cash inflows and outflows that occurred during the reporting period. This can provide a useful comparison to the income statement, especially when the amount of profit or loss reported does not reflect the cash flows experienced by the business. This statement may be presented when issuing financial statements to outside parties.
Statement of retained earnings:-
Presents changes in equity during the reporting period. The report format varies, but can include the sale or repurchase of shares, dividend payments, and changes caused by reported profits or losses. This is the least used of the financial statements, and is commonly only included in the audited financial statement package.
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