Accounting Basics

Accounting is the process of recording, summarising, analysing, and reporting the financial transactions of an enterprise. The basics of accounting include:

1. Recording transactions 
2. Classifying transactions
3. Summarising transactions
4. Analysing transactions
5. Reporting

In addition to these basic steps, accounting also involves principles and conventions that guide the recording, classification, and reporting of financial transactions. These include the principles of conservatism, consistency, materiality, and relevance, among others.

Yes, accounting can be a promising career for those with an aptitude for numbers, attention to detail, and an interest in financial analysis. Here are some reasons why accounting can be a good career choice:

1. Job stability: Every business requires an accountant to manage its finances, so there will always be a demand for accounting professionals. It makes it a stable career option.
2. Career growth opportunities: Accounting offers many opportunities for career growth and advancement, such as becoming a CPA, financial analyst, or controller.
3. Competitive salary: Accounting jobs typically offer competitive salaries, and the earning potential can increase with experience, certification, and job title.
4. Work flexibility: Many accounting jobs offer flexibility, including part-time and remote work options.
5. Diverse career paths: Accounting skills can be applied in various industries, including finance, government, education, and healthcare, providing multiple career options.

The basic principles of accounting provide a framework for recording and reporting financial transactions accurately and consistently. Here are the four basic principles of accounting:

1. Accrual principle
2. Consistency principle
3. Going concern principle
4. Prudence principle

The main types of financial statements are:

1. Income Statement
2. Balance Sheet
3. Cash Flow Statement
4. Statement of Changes in Equity

Businesses use these financial statements, investors and lenders to evaluate a company’s financial performance, position, and cash flow.

GAAP stands for Generally Accepted Accounting Principles. It is a set of accounting standards and guidelines that companies must follow when preparing their financial statements. These standards ensure consistency, accuracy, and transparency in financial reporting, making it easier for investors, creditors, and other stakeholders to compare and evaluate financial information. 

When a financial reporting cycle concludes, the entries made to transfer the balances of temporary accounts (revenue, expenses, and dividends) to permanent accounts (assets, liabilities, and equity) are closing entries.

Cash is king. In such a case, you would use the Cash Flow Statement. It gives a true picture of the cash generating capacity of a company. Positive cash flow from operating activities (CFO) indicates that the company can fund its activities by generating enough cash from its day to day operations. Other cash flows to look at are cash flow from financing activities (CFF) and cash flow from investing activities (CFI).

Working capital refers to the amount of cash or liquid assets a company has for its day-to-day operations. It is calculated by subtracting current liabilities (such as accounts payable and short-term loans) from current assets (such as cash, inventory, and accounts receivable).

Negative working capital means a company needs more short-term assets to cover its liabilities. In other words, the company’s current liabilities exceed its existing current assets.

Deferred revenue and accounts receivable are vital balance sheet items in accounting but represent different things.

Deferred or unearned revenue is the money a company receives from a customer before providing a good or service.

On the other hand, money owed to a company by its customers for goods or services already provided is called accounts receivable. Therefore, it is an asset on the balance sheet, representing the money the company expects to receive from its customers.

Both cash basis accounting and accrual accounting has advantages and disadvantages, and the choice of accounting method depends on a business’s specific needs and goals.

Cash basis accounting records transactions when cash is received or paid out. However, it can lead to inaccuracies in financial reporting, as it may not reflect the actual financial position of the company when revenue and expenses are recognised in a different period from when cash is received or paid out.

Accrual accounting records revenue and expenses, irrespective of whether cash has been exchanged. This method accurately reflects a company’s financial position and performance, making it suitable for larger businesses with more complex transactions. However, it can be more challenging to understand and maintain, and it may not provide an accurate picture of a company’s cash flow.

In conclusion, there is no clear winner between cash basis accounting and accrual accounting. Each has its merits and drawbacks, and the choice of accounting method depends on a business’s specific needs and goals.

In accounting, material facts refer to any information or events that could significantly impact a company’s financial statements and its stakeholders’ decisions. Materiality is a relative concept and depends on the context of the situation. A fact is considered material if its omission or misstatement could affect the judgement of a reasonable person relying on the financial statements.

Offset accounting refers to using one account to offset or balance the effects of another account. It is typically done to ensure that financial statements accurately reflect a company’s financial position and performance.

1. Debit the receiver and credit the giver: It applies to personal accounts, which include accounts of individuals, companies, and organisations.
2. Debit what comes in and credit what goes out: It applies to real accounts, which include accounts of assets such as cash, inventory, and equipment.
3. Debit expenses and losses, credit incomes and gains:

Refer our blog for more – What are the Golden Rules of Accounting

Here are some ways to reduce human error in the accounting department:

1. Provide proper training: Ensure that all staff members receive adequate training in accounting procedures and software to reduce errors due to lack of knowledge.
2. Standardise procedures: Standardise accounting procedures and processes to ensure consistency and minimise the risk of errors.
3. Use technology: Implement accounting software to automate processes, reduce manual data entry, and minimise the risk of errors due to human intervention.
4. Double-check work: Encourage staff to double-check their work and establish a framework for oversight and accountability to catch any errors before they become problematic.
5. Conduct regular audits: Conduct audits of financial records to ensure accuracy and identify errors.

Assets = Liabilities + Equity or A = L + E

This is also called the balance sheet equation representing the relationship between assets, liabilities and owner’s equity.

Operating income, or operating profit or earnings before interest and taxes (EBIT), is a financial metric that represents the revenue left over after deducting all of a company’s operating expenses.

Financial statements are formal reports that provide information about a company’s financial performance and position. The most common financial statements include the income statement, balance sheet, and cash flow statement.

An accounting journal is a record or logbook of all financial transactions and events that a business or an organisation has

To calculate depreciation, you can follow any of the methods below:

1. Straight-line depreciation: is the most common method and involves dividing the difference between the original cost and salvage value by the asset’s useful life. The resulting amount is the depreciation that should be recorded each year.
2. Double-declining balance depreciation: This method assumes that the asset depreciates at an accelerated rate early in its useful life and then slows down later. To calculate this type of depreciation, you multiply the asset’s net book value (original cost minus accumulated depreciation) by a percentage twice the straight-line rate.
3. Units-of-production depreciation: It is used when the asset’s usage varies yearly. To calculate this type of depreciation, you divide the total depreciation of the asset by the total number of units the asset is expected to produce during that time. You then multiply that rate by the number of units produced in a given year to calculate the depreciation for that year.

It’s important to note that different depreciation methods may result in different amounts of depreciation being recorded each year. Hence, it is essential to choose the method that makes the most sense for your business and its assets.

Double-entry bookkeeping is a method of accounting where every financial transaction has two entries – a debit entry and a credit entry – that are recorded in the general ledger. Such a system ensures that every debit must have a corresponding credit.

Gross income (Sales – COGS) refers to the total revenue earned by an individual or business before any deductions are made, such as taxes, insurance premiums, and other expenses. It includes all income sources, such as wages, salaries, tips, interest, dividends, rental income, and capital gains. COGS is the cost of goods sold.

Net income remains after all the deductions have been made from the gross income.

The income statement tells you how profitable a company is. It summarises a company’s revenues and expenses over a specified period, typically a month, quarter, or year, and reports the resulting net income or loss.