“Accounting is the art of recording, classifying and summarizing significantly and in terms of money; transactions and events which remain part at least, of a financial character, and interpreting the results thereof.”
~ American Institute of Certified Public Accountants
MEANING OF ACCOUNTING
Accounting is a systematic process of :
- Interpreting, and
- Communicating financial information.
Accounting information can be based on resource availability, how the available resources have been put to use and the results achieved.
Accounting is also known as the language of business. It acts as a medium of communication between the entity and the users of accounting information.
Now, one might wonder, who uses the accounting information?
Users of accounting information have been classified into internal and external users.
Internal users include:
- Owners (i.e. the entrepreneur, himself)- As owners contribute to the capital and take up maximum risk, they are naturally interested in knowing the profitability of their businesses. Financial statements give information related to the financial position of the entity.
- Management – As they make key decisions for the business, such as decisions related to selling price, cost controls, investment, and diversification, they also require financial statements.
- Employees and workers of the organization – As employees and workers are entitled to a bonus at the year-end, they would also like to gather information about the profitability of the enterprise.
External users include:
- Banks and financial institutions – since they provide loans to enterprises, they ask financial statements to know if the entity can repay the loan in time or not.
- Investors and potential investors as they inquire about the entity’s profitability.
- Creditors who supply goods or services on a credit.
- Government and its authority for the collection of taxes from the business.
- Consumers as they buy goods or avail services of the enterprise.
- The public wants to see if the business is running well since it makes substantial contributions to the economy in several ways, for instance, by creating employment opportunities.
However, the entrepreneur who runs the business must have a basic idea of accounting, because the users of accounting information demand true and fair financial statements. This applies to all kinds of entrepreneurs.
Many accounting processes have been digitized. This makes things easier to work from home entrepreneurs.
4 accounting basics that work from home entrepreneurs should know:
1. The double-entry system of accounting
The double entry system talks about 2 aspects of accounting, namely debit and credit. It is a system where every entry has a corresponding opposite entry in another account.
It is used to satisfy the accounting equation:
Assets = Liabilities + Capital
We record transactions under the double-entry system as debit and credit.
For instance, when an asset is purchased by the entrepreneur, the asset account is debited and the cash/bank (used to pay for purchasing the asset) is credited.
Thus, the double-entry system records the double-sided aspect of accounting
2. The golden rules of accounting
Under the traditional system of accounting, asset, liabilities, and capitals are categorized:
- Real account
- Personal account
- Nominal account
The golden rules of accounting suggest treatment for different accounts.
Hence, there are three golden rules of accounting:
|Type of account||Golden rules applicable|
|Real account||Debit what comes into the business
Credit what goes out of business
|Personal account||Debit the receiver
Credit the giver
|Nominal Accountant||Debit all expenses and losses
Credit all incomes and gains
3. Preparation of financial statements
The financial statements are prepared to exhibit the profitability and financial position of the business, truly and fairly. The financial statements of the trading account, profit-and-loss account and balance sheet are prepared.
The basics behind the preparation of financial statements are:
- A distinction has to be made between capital and revenue receipts and payments
- They should separate the income and expenses of a particular period from that of other periods. This helps us calculate any prepaid expenses or outstanding liabilities.
Now, the question is, what comprises “financial statements“? Let’s explore!
Financial statements consist of:
1. Trading account
At the end of the year, it is necessary to find out the net profit or net loss of a business. For this, the entrepreneur should estimate the gross profit or gross loss.
Gross profit is the difference between the selling price of the goods and the cost of goods sold. It is usually ascertained by preparing a trading account. The items to include in the trading account are:-
On the debit side:
- Opening inventory
- Purchase account
- Sales returns
- Expenses such as wages, carriage inwards, all direct manufacturing-related expenses
On the credit side:
- Closing Inventory
- Sales (cash and credit)
- Purchase returns
2. Profit and loss account
The profit-and-loss Account enables a reader to form correct ideas about the profit earned or loss suffered by the firm for the period during which the form operated. It starts off with gross profit on the credit side; if there is a gross loss, we shall write it on the debit side. After this, on the debit side of the profit-and-loss Accounts. The entrepreneur follows the golden rule of a nominal Account, as a profit-and-loss Account is classified as a nominal account.
The expenses that will be entered on the debit side of the profit-and-loss Account are:
- Rent and taxes for office
- Lighting for office
- Audit fees
- Printing and stationery
- Postage, telegrams, and telephone charges
Selling and distribution expenses
- Sales associate salaries and commission
- Warehouse expenses
- Packing expenses
- Freight and carriage on sales
- Export duties
- Maintenance of vehicles for the distribution of goods
- Bad debts
- Commission to agents, etc.
3. Balance sheet
“A statement which balances the assets and liabilities of a firm or an institution at a certain date”.
The balance sheet is relevant for a particular point in time. Hence this is the significance of the words “as on” when a firm presents its balance sheet to the users of accounts. The words used are:
“Balance sheet at XYZ Ltd as on 31st March, 20xx”.
The financial year starts on 1st April and ends on 31st March, every year.
4. Tally-Accounting Software
A tally is accounting software that helps entrepreneurs, belonging to different industries. It is useful for small and mid-sized firms.
The said software provides business functionalities including inventory count, sales, purchases, accounting for finances, point of sales, manufacturing, job costing, payroll, and branch management.
It makes accounting easy, as everything is digitalized. For instance, cash and fund management can be done online with the help of the MIS reporting module to facilitate decisions regarding bank loans, credit limits, and capital investments.
The new entrepreneurs should use a tally for recording accounting transactions to avoid mistakes.
Thus, an entrepreneur needs to understand and use the accounting rules and procedures to record, classify, summarise, analyze, interpret and communicate financial information to the users of such information.
We hope you like our blog and learned about the basics of accounting very well. Stay tune with Blogger Bunny for more such informative blogs. Also, visit our blog Important Skills for Entrepreneurship.