Accounting Basics

There are a few (and only a few) things you need to understand in order to make setting up your accounting system easier. Debits and Credits These are the backbone of any accounting system. Understand how debits and credits work and you'll understand the whole system.Every accounting entry in the general ledger contains both a debit and a credit. Further, all debits must equal all credits.If they don't, the entry is out of balance. Debits and Credits vs. Account Types Account Type Assets Liabilities Income Expenses Debit Increases Decreases Decreases Increases Credit Decreases Increases Increases Decreases

Accounting Basics - 5 Basic Accounting Types: Assets Liabilities Equity Income and Expenses

Balance Sheet Accounts The three so-called Balance Sheet Accounts are Assets, Liabilities, and Equity. Balance Sheet Accounts are used to track the changes in value of things you own or owe.

Assets is the group of things that you own. Your assets could include a car, cash, a house, stocks, or anything else that has convertible value. Convertible value means that theoretically you could sell the item for cash. Liabilities is the group of things on which you owe money. Your liabilities could include a car loan, a student loan, a mortgage, your investment margin account, or anything else which you must pay back at some time. Equity is the same as "net worth." It represents what is left over after you subtract your liabilities from your assets. It can be thought of as the portion of your assets that you own outright, without any debt. Income and Expenses Accounts The two Income and Expense Accounts are used to increase or decrease the value of your accounts. Income is the payment you receive for your time, services you provide, or the use of your money. Expenses refer to money you spend to purchase goods or services provided by someone else.

Account Types
There are a total of 13 basic account types.They are Seven Asset Accounts

Cash

Use this account to track the money you have on hand, in your wallet, in your piggy bank, under your mattress, or wherever you choose to keep it handy. This is the most liquid, or easily traded, type of asset. Bank This account is used to track your cash balance that you keep in institutions such as banks, credit unions, savings and loan, or brokerage firms - wherever someone else safeguards your money. This is the second most liquid type of account, because you can easily convert it to cash on hand. Stock Track your individual stocks and bonds using this type of account.With these types of assets, you may not be able to easily convert them to cash unless you can find a buyer, and you are not guaranteed to get the same amount of cash you paid for them. Mutual Fund This is similar to the stock account, except that it is used to track funds. Currency If you trade other currencies as investments, you can use this type of account to keep track of them. Accounts Receivable This is typically a business use only account in which you place outstanding debts owed to you. Asset For personal finances, use this type of account to track "big-ticket" item purchases that significantly impact your net worth. Three Liability Accounts

Credit Card Use this to track your credit card receipts and reconcile your credit card statements. Credit cards represent a short-term loan that you are obligated to repay to the credit card company.

Accounts Payable This is typically a business use only account in which you place bills you have yet to pay. Liability Use this type of account for all other loans, generally larger long-term loans such as a mortgage or vehicle loan. This account can help you keep track of how much you owe and how much you have already repaid. One Equity Account

Equity It represents what is left over after you subtract your liabilities from your assets, so it is the portion of your assets that you own outright, without any debt. One Income Account

Income Income is the payment you receive for your time, services you provide, or the use of your money. One Expense Account

Expense Expenses refer to money you spend to purchase goods or services provided by someone else.

Trial balance
Trial balance is a list of balances of all the ledger accounts within a ledger. Usually the trial balance is prepared every month. This only done after all the transactions are recorded in the ledger.

Purpose of Trial Balance: The main purpose of creating a trial balance is to check the correctness of all transactions recorded in accounts. But the preparation of trial balance also helps to easily consolidate the final account statements. How is Trial Balance prepared? Trial balance lists the debit, credit accounts for a given ledger for a month. Trial balance is created in two columns one with all the debit balances and the other with all the credit balances. If the total of the debit column does not equal the total of the credit column then there is an error in the ledger accounts. The assets, expenses will be recorded under the debit balances. Liabilities, equity and revenue will be recorded under the credit balances. Limitations But there is no guarantee that if the trial balance is fine, the ledger accounts are correct. There might be some omissions in the ledger accounts, or even a duplicate entry is also a possibility. Some times there will be ledger entries that are wrong when looked into individually. But while doing a trial balancing there might have be other wrong entries that have compensated these errors. Trial balancing can easily trace the wrong posting of amounts in a different account. So trial balancing is also time consuming, but this will ensure that the debit and credit balances are corrected every month.

Introduction to Adjustment Entries

In accounting adjustment entries are made in the journal at the end of the accounting period. These types of entries are made in accrual based accounting based on the revenue recognition principle. Adjusting entries are made for income or expenses occurred in a previous time period at the time of preparing the financial statements or on the balance day. Two Scenarios for adjustment entry:

Accruals: In this scenario the income or expenses accrued but not recorded in the accounts. For example, if the payment for a machinery that is acquired in this month is paid the next month, an adjustment entry is made in this months account about the expenses next month. Deferrals:

In this scenario the income or expense is recorded but need to be deferred at a later time. For example, if the EMI payment is made for year in the month of January itself, a deferred entry must be made for every month by dividing the total amount by 12. In a case of payments received before the goods are delivered also requires an adjustment entry. First the cash received is recorded then a deferral adjustment entry is made on the day the goods are invoiced. Importance of adjustment entries: So at the end of financial year the neat and clean balance sheet has to be presented to the stock holders. Not only to know the cash flow for the financial period, but also to calculate the profit and loss precisely adjustment entries are must. Even though adjustment entries are known as balance day entries, it can be done at the right time to avoid income and expense confusion.

Classification of Assets on Balance Sheet

Balance sheet is a statement of accounting that gives the financial position of the company at the end of a specific time period. The balance sheet also helps to know the financial position of the company at the given instance. Usually balance sheet is based on three criteria's. First one is the assets, then the liabilities finally the equity owned by stock holder or the owner of the company. Assets are the resource acquired by the company that can be expressed in terms of cash. Mostly assets are considered to pay the debts in case of any financial crisis in a company. So, shareholders also look at assets with much importance while investing in stocks. In case of banks, they give more credit or allocate loans based on the assets acquired by a company. Asset Classifications Classification of Assets:

In a balance sheet the assets are classified as current assets, investments, property plant and equipment, intangible assets, and others. Current Assets: Current assets are the one that is expected to convert to cash within the current operating time period of the company. These include cash, temporary investments, and accounts receivable, inventory, receivables etc.

Investments: Long term investments that are not going to be sold in near future are considered as an investment. These include investments in bonds, stocks, land that is not used by the company, pension funs, even some insurance are also considered as investments.

Property, plant and Equipment: This type of assets are also known as Fixed assets. Fixed assets are purchased with aim of using it on a long term to increase the profit of a company. These include the fixtures, buildings, machines, land that is used by the company, tools, and automobiles. Depreciation is also calculated for these assets that are negated from the profit of the company. Intangible assets: Intangible assets are those whose value cannot be calculated physically. But, they are very important to the very existence of a business. These include copyrights, brand name, patents, trademarks etc. The assets that cannot be classified in any of the above category can be added to the balance sheet under "other assets".

Classification of Liabilities on Balance Sheet

A liability is an obligation for a company or an individual to settle a debt, avoiding which could lead to legal action. There are two types of liabilities, Current and long term liability that are organized in a balance sheet. Liability Classifications Current Liabilities:

The liabilities that can be settled within a normal operation cycle of a business are known as the current liabilities. Most of the current liabilities should be settled within a year's time using the current assets. Since all the current liabilities will be because of the purchase of a product or service that is recorded under accounts payable. The liabilities that are due to acquiring machinery, property for the business operations are also considered as current liabilities. Even the income tax, property taxes, salaries, telephone bills are also comes under this category. A long term liability that will be paid within an operational cycle is also termed as a current liability.

Long-Term Liabilities:

The liability that cannot be settled within a year of the balance sheet date is known a long term liability. Long term liability includes loans, bonds, notes, mortgages that will exceed one year for payment. In a balance sheet these liabilities are shown on the right considered as capital assets. So the assets and liabilities form the major part of a balance sheet to know the liquidity of a business. The right balance between these two make a business more profitable. If the liabilities are very less than the assets a company owns, it is considered a profit making company.

Closing Entries
Closing entries are the entries used to transfer the balances of the temporary accounts to permanent accounts. The temporary accounts in accounting are revenue, expenses, and dividend accounts. In a normal accounting process, the balances of these accounts or the income statement accounts will start with zero from the new accounting period. How is closing entries made? At the end of the reporting period, the credit accounts or revenue accounts are closed by making a debit entry for the balance. For all the debit accounts or expense accounts a credit entry is made for the balance in the general ledger. While making a closing entry a new temporary account known as income summary is created. So all the outstanding revenues and expenses balances are transferred to this income summary account. Finally all the balances have to be in a permanent account. So after the closing entries have been made about the temporary account balances in the income summary, it will be closed in the Retained Earnings. Since the balance in the income summary account is the difference between sales and expenses in turn its owner's equity. So by making the closing entries, rough idea about the profit and losses can be got. To know the details about the profit and losses the balance sheet has to be referred. In small firms the closing entries decide the profits or revenues earned by a company.

General ledger
General Ledger is the prime accounting document through which all the accounting activity takes place, where the double entry bookkeeping is followed in common. It is used to keep the track of accounts on a permanent basis. Contents of General Ledger: Usually the general ledgers should include the date, description and balance or total amount for each account. Some of the basic accounts contained would be Assets, Liability, Owner's equity, Revenue, Expense, Gains, and Losses. It will have subsidiary ledgers to provide details about the accounts. General ledger in its usual form will have the T-accounts type with the debit on the left and credit on the right side. Here the amounts are posted as credits and debits on these pages. Even some companies have extra columns to record the account balance after every transaction. The transactions recorded in the sales daybook, purchases daybook, cash book and general journals daybook are put together in the general ledger. Advantages of General Ledger: The balance sheet and the income statement are both got from the general ledger. It is easy to know the account balance, as account balances are noted after every transaction. Chart of Accounts, Trial balance is also derived from the General Ledger. So nothing in account is without the general ledger. It serves as a reference to the accountants in preparing all other accounting statements.

Income Statement
Income statement otherwise known as profit and loss statement or earnings statement, operating statement or statement of operations, is a company's financial statement that indicates how the revenue is converted into net income. This statement clearly indicates the profitability of the company. Income statement is divided into two major sections they are Revenues and Profits, Expenses and Losses. Revenues & Profits: While calculating the revenues and profits they are classified based on the primary revenues, secondary revenues. Revenues generated from the primary activity of the company are considered

as primary revenues. Say for a manufacturer the revenue generated from manufacturing and selling is the primary revenue. The secondary revenues that are generated outside the prime activity like the interest of the cash, rent for building are taken as revenue from secondary activity. The revenue generated by selling long term assets or legal suits are Gains to the company. Expenses & Losses: Expenses are also divided into two categories the expense incurred for primary activity, expenses incurred for secondary activity. Sales commission for a retailer would be a primary expense for a retailer. Third party manufacturing cost would be a primary expense for a manufacturer. The expense on secondary activity would be the interest on bank loans etc. But loosing a legal suit for a land or property would be included as a loss to the company in the income statement. Even though the income statement has all the criteria to know the profitability of a company, there is some uncertainty regarding the income statement. Income statement may have the cost that is not up to date as the transactions have to record then and there. Costs may have varied in an operational period due to so many reasons like, economic slowdown or sudden rise in prices. Estimates are better to get the approximate revenues to expenses of a company.

Journal Entries
A journal entry made in accounting is nothing but recording of transactions into accounting journal. The entries are made everyday for the transaction of that day, so it is also called as "Day Book". Contents of a Journal Entry: The journal entry may vary in contents depending on the companies' requirement. But some of the common entries made are entry number; batch number; recurring entry, non-recurring entry, date, accounting period, description. How a journal entry should be? There will be numerous journal entries that can be either a debit or a credit entry. To make it clear a column is named as debit the other as credit. Here, if the total of the debits and credits are equal then it is a "balanced journal". Otherwise the entry is said to be an "unbalanced journal".

Advantages of Journal entry In a journal entry the omission of transactions are limited, since they are recorded in the chronological order. Second advantage is that all entries are made with a related description to supplement the transactions. Since all the debit and credit amounts are written side by side chances of recording wrong amounts is less. Only with a single entry the whole history about the transaction can be got. So in a business, if all the transaction is recorded in a single journal, it will look weird. Say, if an everyday transaction and a once in a way transaction has the entry in a single will make things difficult. Most companies have a separate journal for everyday transactions to make it more useful for the business.

Owner's / Stockholders Equity

Owner's equity is known as the capital account. It is calculated by negating the liabilities from the assets. This is mainly used for a sole proprietorship firms as the owner's equity goes up, so does the right of the owner on the business. Stock holders equity is similar to the owners equity. This term is used for large corporations where an owner is also a stock holder. But the owner will have more percentage of stocks. In a balance sheet the owners or stockholders equity is organized in the following order. First is the paid-in capital, then the "retained earnings" and finally the "treasury stock" is listed in a balance sheet. Paid-in Capital: Paid in capital is the capital contributed by the investors by purchasing the stocks of the company. Usually the stock is quoted a rate by the company but investors interested in the company purchase shares at a higher price. Normally paid in capital comprises of the capital stock also. Retained earnings: Retained earning is the net income or profit that is not given to the share holders but is invested in the same business. It is also known as called earned surplus or accumulated earnings or unappropriated profit. Retained earnings are calculated by negating the dividend paid out to the shareholders from the net income. Retained earning that are appropriated and used in the business will be in the balance sheets. This is displayed in the bottom of a balance sheet under the equity section. The unappropriated earning is given as dividends.

Treasury Stock: Treasury stock or the reacquired stock is the stock purchased back by the company that floated the stock. Reasons: A company may opt to give shares instead of dividends to the stockholders. Even if the shares are undervalued they are bought back. To avoid the threat of acquisition by another company.

Cash Flow Statement

Cash Flow Statement is otherwise known as Statement of cash flows is one of the important financial statement used in bookkeeping. It is mandatory for a full set of financial statements to fulfill the Financial Accounting Standards. This statement gives detailed information about the cash generated in a business and how it was spend in a give time frame. The time period for the Statement of cash flows can be chosen by the businesses as they wish. Usually this period would be given as the heading of the cash flow statement. Purpose of Cash Flow Statement: Statement of cash flows clearly tells how the changes in the balance sheets accounts, income affect the cash flow. Cash flow is often analyzed down to the operating, investing, and financing activities. It also helps to identify activities that generate revenues to the company or a business based on the expenses incurred. The Statement of cash flows refers to cash in and cash out on the specific activities. Activities considered: Operating Activities include converting items from the income statement to cash. Investing Activities like the purchase or sales of assets are also recorded. Payment, purchase of bonds or stocks or dividends is considered as "Financial Activity". The non cash activities like depreciation, write offs on bad debts are considered as "Supplemental Activities" it is given in the foot notes alone. Advantages of Cash Flow Statement:

Cash flow statement is used to know the liquidity of a business at a glance. It provides additional information to evaluate changes in assets, liabilities and equity. Operating performance of a company can be improved by comparing with other companies method of accounting. Helps the investors in ascertaining the probability of future cash flows.

Accounts Receivables - Benefits and Methods

Account receivables are the credit owed by a customer to a company or a business. An invoice is generated for the product or a service purchased by a customer. But the customer is given the flexibility to pay the amount at a later point of time and this kind of transaction is recorded as Accounts receivables. But when the customer does not pay the credit owed to a company it is considered as Bad Debts. Accounts receivables is a debit account, but the amount is credited to the sales account. Accounts Receivable Methods: There are two methods followed in bookkeeping for account receivables, one is the allowance method, other one is the direct write off method. In the allowance method, a bad provision account or liability account is created. This account consists of all the possible bad debt accounts that a seller expects non payment of the credit. In some companies a percentage is fixed for the total debtors of the company. So bad provision accounts are revised based on the criteria set by the companies. In direct write off method, a single entry is used to debit the amount from the bad debt expense account and crediting the amount to account receivables. The large firms usually follow the allowance method to know the credit losses immediately. But in case of small business, the write off method is followed, since the transactions are limited. The direct write off method benefits the small businesses, where credit losses can be shown at later time for tax purposes. Benefits: Accounts receivable has the advantage of projecting higher sales in the income statement. In the balance sheet, Account receivables are considered as current assets, since payments are considered due within a year. But when the amount is not paid it is debited as bad expenses from the income statement. The balance sheet shows a lesser amount of credit being paid by the debtors.

Golden Rules Of Accounting

Golden Rules of Accounting:

A good accounting system is to find the information about a transaction in a single entry. By looking into the nature of an element, the elements affected by the transaction we decide on what to debit and what to credit. Any account that is affected by transaction has to either debited or credited. To do this we have a set of rules used to apply the debit and credit. The accounts are widely classified into three categories they are Real, Personal and Nominal Accounts. So we will see how debits and credits act on these accounts. Real Accounts - Debit what comes in, Credit what goes out. Nominal Accounts - Debit all expenses and losses, Credit all incomes and revenues. Personal Accounts - Debit the receiver, Credit the giver. Real Accounts: The real accounts related to accounts that are intangible like assets, reserves, capital, and liabilities whose balances are carried to next operational cycle are real accounts. The accounting rule that is used for this type of accounts are "debit what comes in" and "credit what goes out". Say, if a building is bought from a person, debit the amount from the building account (real account) and credit it to the person account (personal account). Other scenario would be to sell a product on credit to a person, so credit the amount to product account(real account), debit it from the persons account(personal account). Nominal Accounts: The Nominal accounts are temporary accounts which are closed at the end of each year by moving their balances to Permanent accounts. Accounts that come under this type are expenses, gains, revenues, losses. The balance of these accounts becomes assets or losses at the end of year and moved to permanent accounts. The accounting rule that is used for this type of accounts is "Debit all expenses and losses" and "credit all incomes and gains". While paying the salary to the employees in cash, the amount is debited from the salary account (nominal account). If a discount is got from a company then it is credited to the discounts account. Personal Accounts: The Personal accounts are accounts that are related to a person or an organization. The accounting rule that is used for this type of accounts is "debit the benefit receiver" and "credit the benefit giver". If some cash was paid to a person X. Then according to the rule the amount is debited from the person "X" accounts (personal account) and credit to the cash account. If a product is bought on credit from a company "Y", then the amount is credited to company "Y" account (personal account) and debited from the product account (Real Account). So these are the "debit and credit" golden rules applied for accounting.

Bank reconciliation | Bank Statement

Bank reconciliation is a process of matching the accounting details with the bank statements. Companies record the transaction like checks written, receiving payments, service charges paid in a general ledger of the company. So in the same checking account the bank will also record the transaction done by the company. Why to do Bank reconciliation: Most banks send statements to its clients on a monthly basis. So most companies check their ledger with the transactions recorded in the bank statement. Loss of checks can be found out easily by checking the statement or even the amount can be added to the ledger. Errors committed in cash received, are rectified while doing bank reconciliation. This process ensures that none of the transaction is missed out in the banks statements and vice versa. For sure this is a tedious and a time consuming process to manually check each and every entry. Especially the bank service charges deduction may be only on the bank statement, it cannot be found in the company ledger. Most important is the interest charges credited by the bank will be in the bank statement, but not in companies' ledger. Apart from checking the amounts, even the timing at which the transaction was done is important. Say if a check was deposited at the end of the month the transactions will be in the ledger, but not in the current month's bank statement. Bank reconciliation can avoid from check bounces, undue credit reduction from a bank. Bank reconciliation has more advantages than disadvantages. All companies no matter big or small do bank reconciliation to set right the accounts on a monthly basis. Instead of breaking the head while preparing final statements, bank reconciliation would be the best alternative. Nowadays with online banking the banking reconciliation becomes simpler with advanced bookkeeping software. Most bookkeeping software's are designed to integrate with the online bank statements.

Chart Of Accounts
Chart of accounts is the list of accounts adopted or used by a company. The choice of having different types of accounts in the chart of accounts depends on the company. It varies from company to company, as the organizational makeup is different for each company. Some common chart account followed in balance sheets are Assets, Liabilities, Owner's (Stockholders') Equity. Assets: Assets are the resources acquired by the company that can be expressed in terms of cash. Following are some of the common asset accounts included in the chart of accounts. The current

assets are the assets that will be converted to cash within a year or in the current operating cycle of a company. The second types of asset accounts are Long term investments accounts that are for investment that will not be disposed in near future. The third types of accounts are the fixed assets that are purchased with aim of using it on a long term to increase the profit of a company. The fourth types of asset accounts are for the intangible assets, whose value cannot be calculated physically like the trade marks, patents etc. Liabilities: A liability is an obligation for a company or an individual to settle a debt. There are only two commonly account for liabilities. Current liability accounts are for accounts that can be settled with the current operational cycle. Long term liability account is for liabilities that would take more than a year to settle. Owner's (Stockholders') Equity: Owner or stockholders equity is calculation by negating liabilities from assets. There are organized in three types they are paid-in capital, retained earnings, treasury stock. Paid in capital is contributed by investors by buying the stocks above the normal value. Retained gain is the net income or profit that is not given to the share holders but is invested in the same business. The last type of accounts is Treasury stock, which is the stock purchased back by the company.