3 Ways To Answer WHAT IS ACCOUNTING?
When they are asked “What is Accounting?”, many people answer only considering a single dimension. But here in this post, I’m going to answer this question from three different dimensions:
- Accounting is the process of maintaining a system to record financial transactions and other financial information
- It also refers to a field of study.
- It is also a profession.
Alternate Accounting Definition:
It can be defined as the recording of financial transactions along with reporting these transactions in the form of financial statements. This process involves:
- Recording Financial transactions
- Classifying financial transactions into different heads,
- Posting the transaction in Trial balance,
- Transferring the data to books of accounts, and then
- Closing the books.
The first two stages are a part of financial accounting and all the others come in the domain of financial reporting.
Basic Accounting Terms:
Now that we discussed accounting definition, it’s time to move on to some accounting basics:
Events that might have a monetary impact on the financial statements of an organization are called business transactions.
Example; Suppose Meon Ltd purchased a printer for $170. This’s a business transaction because it has a monetary impact of $170 on the financial statements of Meon Ltd. Their Cash balance got reduced by $170 and Assets got increased by $170. You might have witnesses that this business transaction has two effects. In fact, every business transaction has two effects.
An entry of a business transaction in the books of the entity that shows a debit balance and a credit balance. As we discussed in the above example, every business transaction has two effects, a debit, and a credit. These effects are recorded in the form of an accounting entry or a journal entry. Now, let me introduce you to debits and credits.
an accounting entry that:
Increases assets or expenses, or
Decreases liabilities or capital/equity.
An accounting entry that:
- Increases liabilities or capital/equities, or
- Decreases assets or expenses.
One way to memorize debit and credit is to think of these as the opposite of each other.
You might be wondering, what are assets? What is the definition of a liability? What is equity? Or How to define an expense? That’s why I’m answering all these questions:
What are the Assets?
Assets are resources owned by an entity that can generate economic benefits in the future.
Examples: Cash, Machinery, Property, Plants, Equipment, Debtors, etc.
What is a Liability?
A liability is an obligation of the entity arising from a past event/business transactions.
Examples: Creditors, Loans, Interest payable etc.
What is an Expense in Accounting?
An expense is the use of assets to generate revenues. For example, a business might purchase raw material to convert it to finished goods for selling. This way they used their assets (Cash) to generate revenue (By selling the finished goods).
What is Equity or Capital?
Equity is the amount of injection by owner/owners into a business. It can also be called as Capital.
When the owners withdraw money from their business for personal use, it’s called “Drawings”.
You can understand the backbone behind accounting by looking at some accounting concepts. We are discussing each of these accounting concepts briefly:
Separate Entity Concept
Separate entity concept also called as economic entity concepts state that “Business transactions of the entity must be recorded and processed separately from the owner(s)”.
Accrual concept enforces us to account for a business transaction at the time it actually occurs. For example, if a Desktop is sold for $130 on 25 Dec 2018 for credit. Assume year end is 31 Dec 2018, and the buyer committed to pay the amount on 5th Feb 2019. Should we record the transaction on 25th Dec or 5th Feb? The answer is 25th Dec, this is what the accrual concept of accounting guides us to do.
Matching concept guides us to record expenses in the same period in which revenues are generated because of these expenses. This way, your income will ‘match’ with your revenues.
Consistency concept tells us to carry the same accounting policy from the current year to the next year and so on.
Other concepts are Going Concern and Materiality etc.
What are Accounting Principles?
The rules and procedures that a company must follow to record and report financial statements are called accounting principles. These principles vary from one region to another. In the US, we use Generally Accepted Accounting Principles or GAAP.
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