Fundamentals of Accounting

What is accounting?

It is a systematic method of distinguishing, recording, measuring, classifying, verifying, summarizing, deciphering, and communicating financial information. It reveals profit or loss for a provided amount, and therefore the value of a firm’s assets, liabilities, and owners’ equity. Some people confuse this subject with mathematics and as a matter of fact, Math is involved in every subject to an extent. On the contrary, this subject majorly focuses on monetary transactions within businesses. Accountants are the people hired by businesses to conduct the process of accounting and analyzing it to assess the performance of an organization. The use of this information is directly proportional to the stakeholders of the business such as owners, shareholders, employees, government etcetera.

What is book-keeping? 

Accounting and book-keeping may appear similar to an untrained eye, but the latter is more concerned with recording financial transactions into the suitable accounts. For instance, an acquittance of goods (products) would be written in the purchases account. Book-keeping helps businesses keep track of every transaction that occurred. 

The purposes of measuring business profit and loss:

One of the most crucial aims of a business is to form a profit. Businesses, therefore, need to be ready to calculate this profit. As mentioned above, the profit-and-loss statement is used to calculate the profit that a business has created. This profit is then compared with the profits of previous years. If the profit within the current year is less than the previous year’s profit, owners and managers will need to undertake steps to resolve the situation by either decreasing expenses or increasing revenue. The profit-and-loss statement, apart from calculating profit or loss, also records the various expenses incurred by the business. Managers will analyze these expenses to look for cost-cutting measures. If a business has been constantly creating a decent profit, managers would want to expand the business by increasing its operations into alternative markets or by increasing its product variety. Business profit also can be used as a juxtaposition with a competitor’s profit. If a business is creating a decent profit however not the precedented amount as its competitors, this gives its managers a reason to take steps to cut back expenses or increase financial advantage in some way, in order to improve the profitability. Managers might cut back expenses by making sure that productivity and effectiveness improve, or they may increase income by advertising uncompromisingly, as an example. The financial statements, in addition, facilitate to estimate a business’ ability to pay the highest returns to its owners relative to its competitors. 

The role of accounting in providing information for monitoring progress and decision making

Every business in this world consists of stakeholders. Stakeholders are the people or institutions interested in the activities of a business and are the potential users of accounting information. They use the information to monitor the progress of the business they have a stake in. This information also helps them to make important economic decisions. Examples of stakeholders are:

  1. The owner(s) of the business: These are the people who own and play an important role in the operations of the business. Their investments may be more than the other stakeholders. They expect to know how well the return on the capital is employed in the business. Is the business growing year after year? They also want to the net monetary value of the business calculated by Statement of financial position.
  2. Potential owner(s): These people own certain parts of the business. They are also known as investors. The entirety of their investment revolves around the return on the amount invested in the business. They are subjected to receive a dividend according to their share percentage. The information comes in handy for these people because they are constantly comparing current or past financial information among businesses to get the highest possible profits.
  3. Business creditors: A lot of transactions conducted within the business world are credit transactions. this implies that payments are made after the trade has taken place. As a result of such transactions, a business could owe cash to a variety of individuals or businesses – known as creditors or trade liabilities. Suppliers and different creditors of the business need to know whether they are paid on time, or at all. Accounting records provide them this information.
  4. Bank managers: To lend businesses, they require accounting records from current and past years. For repayment purposes, they measure and assess the business’ liquidity and financial position in order to ensure the servicing of the loan. In addition, if a business has a lot of existing long-term loans, banks will be reluctant to lend any money at all.
  5. The government: All governments source the majority of their revenue through corporate taxation. A tax which is levied on businesses and is deducted by a certain percentage of the profit made by business. Therefore, accounting information assists governments to calculate the amount of the tax a business has to pay.

The accounting equation

From the large multi-national company down to a corner utility store, every business transaction will have an impact on a company’s statement of financial position. The financial position of a business is measured by the following categories:

  1. Assets: Assets are the economic resources of the entity, tangible or intangible, and embody such things as money, assets (amounts owed to a firm by its customers), inventories, land, buildings, equipment, and even intangible assets like patents and alternative legal rights. Assets entail probable future economic edges to the owner.
  2. Liabilities: These are the amounts owed to others relating to loans, overdrafts, and other obligations arising in the course of the business. The idea of liability is to pay for the goods or services acquired while agreeing to the obligation of paying it after some time.
  3. Owners’ equity: In simple words, it is the difference between assets and liability or what it owes to the owner(s).

The basic accounting equation or formula is:
  Assets=   liabilities + Capital/Equity

For example:

A loan obtained by the bank: $12000
The owner of the business personally invested $100000 into the business

Assets=                     liabilities +     Equity
$112000                      $12000   $100000