ACCOUNTING AND BOOKKEEPING
WHAT IS ACCOUNTING?
Accounting is the process of recording, classifying and summarizing financial information collected by bookkeepers for analysis and interpretation. It provides guidance in making business decisions and provides useful economic information to interested parties and users who depend on these results.
WHAT IS BOOKKEEPING?
Bookkeeping is the detailed and accurate recording of all transactions which take place in a business. It is necessary to record the date, nature and value (in money terms) of the transaction. Bookkeeping records provide the information from which financial accounts are prepared.
Role of the bookkeeper
Source documents arise as a result of transactions. It is the task of the bookkeeper to convert financial data gathered from source documents into useful economic information. This is done by:
identifying source documents resulting from the transactions
recording and summarizing details in journals
classifying the information from the journals in the ledger.
Once the information has been collected, recorded and arranged in a meaningful way by the bookkeeper, it is used by the accountant to prepare accounting reports. These reports assist management in planning for and controlling an organization and are also communicated to outside users such as shareholders and potential investors to assist with economic decision - making.
Objectives of bookkeeping
Bookkeeping is the process of maintaining a clear, concise and permanent record of all transactions as they occur, to assist the owner/s of the business to ascertain:
amounts owing to the business by debtors
amounts owed to creditors
amounts of losses and gains in a particular accounting period and the reasons for these
flow of cash and goods, both into and out of the business
nature and amount of what the business owns or what is owed to the business (assets)
nature and amount of what the business owes (liabilities)
the amount of owner's equity (capital, proprietorship) that the owner has invested in the business
the overall financial standing of the business at a give 323h73d n date.
FUNCTION OF ACCOUNTING
Accounting is concerned with the economic activities of a business. Accounting involves gathering information, processing it and reporting on it to management and other interested users. This information is used to evaluate past economic events, control current economic activities and make economic decisions and plans for the future.
The Nature of Business Activity
Financing Activities
All businesses must start with financing. Simply put, money us needed to start a business. Accounting has its own unique set of treminology. In fact, accounting is often referred to as the language of business. The discussion of financing activities brings up two important accounting terms: liabilities and capital stock.
A liability is an obligation of business; it can take many different forms. When a company borrows money at a bank, the liability is called a note payable. When a company sells bonds, the obligation is termed bonds payable. Amounts owed to the government for taxes are called taxes payable.When a business purchases goods or services on credit, the accounts payable account records these transactions.
Capital stock is the term used by accountants to indicate the amount of stock sold to the public. Capital stock differs from liabilities in one very important aspect.those who buy stock in a corporation are not lnding money to the business, as are those who buy bonds in the company or make a loan in some other form to the company. Someone who buys stock in a company is called a sockholder, and that person is providing a permanent form of financing to the business. In other words, there is not a due date at which time the sockholder will be repaid. Normally, the only way for a sockholder to get back his or her original investment from buying stock is to sell it to someone else. Occasionally, a corporation buys back the stock of one of its stockholders. Someone who buys bonds in a company or in some other way makes a loan to it is called a creditor. A creditor does not provide a permanent form of financing to the business. That is, the creditor expects repayment of the amount loaned and, in many instances, payment of interest for the use of the money as well.
Investing Activities
There is a natural progression in a business from financing activities to investing activities. That is , once funds are generated from creditors and stockholders, money is available to invest.
An asset is a future economic benefit to a business. For example, cash is an asset to a company. The finished products and the raw materials are called inventory and are another valuable asset of a company.
An asset represents the right to receive some sort of benefit in the future. The point is that not all assets are tangible in nature, as are inventories and plant and equipment. For example, when a business sells goods or services on credit, the accounts receivable asset collect this transactions. As a second example, assume that a company acquires from an inventor a patent that will allow the company the exclusive right to manufacture a certain product. The right to the future economic benefits from the patent is an asset. In summary, an asset is a valuable resource to the company that controls it.
Operating Activities
Once funds are obtained from financing and investments are made in productive assets, a business is ready to begin operations. Every business is organized with a purpose in mind. The purpose of some business is to sell a product, other companies provide services or could sell both products and services.
Accountants have a name for the sale of products and services. Revenue is the inflow of assets resulting from the sale of products and services. When a company makes a cash sale, the asset it receives is cash. When a sale is made on credit, the asset received is an account receivable. So, the revenue it represents the amount of sales of products and services for a specific period of time. Also, costs must be incurred to operate a business. Empoyees must be paid salaries and wages. Suppliers must be paid for purchases of inventory and the utility company has to be paid for heat and electricity. The government must be paid the taxes owed it. All of these are examples of important operating activities of a business. Accountants use a specific name for the costs incurred in operating a business. An expense is the outflow of assets resulting from the sale of goods and services.
FINANCING ACTIVITIES
Raising money to start
the business
Money raised through financing is neede for investing
Some profits are returned
to creditors and owners.
while other profits are reinvested
in productive assets
OPERATING
ACTIVITIES INVESTING ACTIVITIES
Generating revenues(and
profits) Buying assets
via sales assets are used
to generate revenues
A Model of Business Activities
Companies are functioning into an economic environment. There are multiple links between companies and suppliers, clients, employees, state and shareholders due to the exchange of goods and services, on one hand and money, on the other hand. The following diagram reveals the real flow (exchange of goods and services), the financial flow (payments and receipts in cash) and the capital flow (shareholders' contribution to the business capital).
REAL FLOW
FINANCIAL FLOW
CAPITAL FLOW
Case study:
Analyze the following transactions and classify them into one of these three cathegories of flows:
During the first financial year, the following transactions occurred:
Over the years, the accounting profession evolved without a defined set of guiding principles. Confusion often arose as different firms used varying methods to correct similar problems. This made comparison of financial reports between companies and over time difficult, as information was interpreted in different ways by different people. For these reason, c conceptual framework, in the form of a number of concept statement, is being developed to provide a set of guiding principles for the accounting profession.
Accountants themselves have developed traditional ways of doing things. This is reflected in the Accounting Conventions, which are generally accepted accounting principles which have been used for many years. These conventions (or accepted practices) include those described below.
The entity concept (business - entity concept). Under the business entity concept, for accounting purposes, every business is conceived to be and is treated as a separate entity, separate and distinct from its owner or owners and from every other business. Businesses are so conceived and treated because, in as far as a specific business is concerned, the purpose of accounting is to record its financial position and profitability. Consequently, the records and periodically report its financial position and should not include either the transactions or assets of another business or the personal assets and transactions of its owner or owners. To include either distorts the financial position and profitability of the business. For example, the personally owed automobile of a business owner should not be included among the assets of the owner's business. Likewise, its gas, oil and repairs should not be treated as an expense of the business, for to do so distort the reported financial position and profitability of the business.
It should be also made a clear distinction between accounting and legal entities. In some cases the two coincide. For example, corporations, trusts and governmental agencies are both accounting and legal entities.
The proprietorship is an accounting entity, as indicated by the fact that all assets and liabilities of the business unit are included in its financial statements. The business proprietorship is not a legal entity (is not legally separated from its proprietor). He is legally liable both for his personal obligations and for those incurred in his business. For accounting purposes, the proprietor as an individual and his business enterprise are separate entities. A corporation is a legal entity (the shareholders are not responsible from the legal point of view for the company's debts or obligation), separate from the persons who own it.
As a general rule, we may say that any legal or economic unit which controls economic resources and is accountable for those resources is an accounting entity.
The substance over form principle
When assets are recorded, it is respected first the economic - financial point of view and after this, the juridical interfierence.
The going - concern assumption (continuity of activity convention). An underlying assumption in accounting is that an accounting entity will continue in operation for a period of time sufficient to carry out its existing commitments.
The assumption of continuity leads to the concept of the going - concern. In general, the going concern assumption justifies ignoring immediate liquidating values in presenting assets and liabilities in the balance sheet. The going - concern principle assumes an indefinite life for most accounting entities.
Accrual convention (the independence of financial year principle). This principle states that any transaction should be registrated in the moment when it happens and not in the moment of paying or receiving the money.
For example, a company sells merchandises in its total value of $400, on January, the 2nd 2002 and will receive the money later on a certain maturity date, which is March, 3rd 2003. The accrual convention says that the company should registrate the transaction in the moment it was generated (on January, the 2nd 2002) and not in the moment it will receive the money (Accounts Receivable) which is March, 3rd 2003.
Consistency. The same procedures used to collect accounting information should be used each fiscal period; in the absence of this standard it is not possible to make decisions and comparisons.
Periodicity (the time period principle). Statements of the operation's financial condition must be reported periodically. So, this principle assures the requirement to measure operating progress and changes in economic position at relatively short time intervals during the indefinite life of the business entity. The intervals are called "accounting period of time" or just "accounting year".
In each accounting period (usually a year, but the reports may be made quarterly or even often) it is necessary to present the beginning financial position (though the beginning balance sheet) and a final financial position (determined at the end of the period) though the ended balance sheet.
Dividing the life of the enterprise into time segments and measuring changes in financial position for these short periods is a difficult process. The tentative nature of periodic measurements of net income should be understood by those who rely on periodic accounting information. The need for frequent measurements creates many of the accounting most serious problems.
The most common reporting is the financial year, which in our country and in Europe could be the same with the calendaristic year (Jan 1st - Dec 31st) and in UK lasts from April the 1st to March 31st .
Prudence (conservatism). This standard requires that all losses are to be shown in financial records if there is a reasonable change that such problems will occur; gains and related financial benefits, however should not be reflected in records until really occur. Further on, in accounting will registrate elements for the minimum value between book value and inventory value.
This principle is important since many accounting decisions do not have a single "right" answer. Therefore, a choise between alternative assumptions is necessary. This concept guides the accountant faced with alternate measurement to select the option with the least favorable impact upon the net income and financial position within the current accounting period.
The money measurement concept. This principle means that money is used as the basic measuring unit for financial reporting.
Money is the common denominator in which accounting measurements are made and summarized. The USD, or any other monetary unit (ROL) represents a unit of value. Implicit in the use of money as a measuring unit is the assumption that the USD (ROL) is not a stable unit of value. The prices of goods and services in economy changes over time. When the general price level (the average of all prices) increases, the value of money (that is, its ability to command goods and services) decreases.
According to the stable USD (ROL) concept, subsequent changes in the purchasing power of money do not affect the amount used for the evaluation of the event when it was recorded in the accounts.
The cost (historical cost) concept. A fundamental concept of accounting, closely related to the going concern principle, is that an asset is commonly entered in the accounting records at the price paid to acquire it. This price is called acquisition cost because it means resources used in order to bring the assets in the patrimony. This cost is the basis for all subsequent accounting records related to the asset aquired.
For example, if a business pays $50,000 for land to be used in carrying on its operations, the purchase should be recorded at $50,000. It makes no difference if the buyer and several competent outside appraisers think the land "worth" at least $60,000. Its cost $50,000 should appear on the balance sheet at that amount. Furthermore, if five years later, due to the booming real estate prices, the land's market value has doubled, this makes no difference either. The land cost $50,000 and should continue to appear on the balance sheet at $50,000 even though its estimated market value is twice that. The real value of an asset may change in time, during the revaluation procedure. The accounting records do not necessarily reflect all the changes in the asset value.
In accounting assets are initially recorded at their cost. This is also referred to as an asset's historical cost. This amount is ordinarily unaffected by subsequent changes in the value of the asset. In ordinary usage by contrast, the value of an asset usually means the amount for which it currently be sold.
Thus, the amounts at which assets are shown in an entity's account do not indicate the sale values of the assets. If the asset is sold at a price above or below historical cost, in the accounting books must be recorded three types of information:
the historical cost written off from the books;
the market value or the price obtained by selling the asset;
the proceeds (differences) between historical cost and market value as an increase in revenues or expenses.
The most common mistake made by persons who read accounting reports is that of
believing there is a close correspondence between the amounts at which an asset appears in these reports and the actual value of the asset.
To emphasize the distinction between the accounting concept and the ordinary measuring of value, the term "book value" is used for the historical cost amounts as shown in the accounting records and the term "market value" for the actual value of the asset as reflected in the market place.
Double entry. This principle is based on the fundamental accounting equation:
ASSETS = LIABILITIES + OWNER'S EQUITY
Each transaction supposes at the same time at least two changes in the patrimony substance. That means that minimum two accounts are going to be used in connection, in order to reflect a business transaction (because for each item is used one account to reflect its existence and its changes). The accounts used should be affected in different ways, because they reflect two images of the same patrimony (assets and equity or assets and liabilities etc.).
Double entry applied for the accounts, used as a concept, can be summarized in the correspondence existing between:
DEBIT CREDIT
Anyway, each phenomenon that occurs should be first analyzed from two points of view : what is it? and where does it come from? And then registered with the inherent changes that produces on the fundamental accounting equation.
Materiality. The term materiality refers to the relative importance of an item or event. Disclosure of relevant information is closely related to the concept of materiality; what is material is likely to be relevant.
We must recognize that the materiality of an item is a relative matter, what is materiality of an item is a relative matter, what is material for one business may not be material for another. Materiality of an item may depend not only on its amount but also on its nature. In summary, it can be stated the following rule: an item is material if there is a reasonable expectation that knowledge of it would influence the decision of prudent users of financial statements.
The full - disclosure principle. Adequate disclosure means that all materials and relevant facts concerning financial position and the results of operations are communicated to the users. This can be accomplished either in the financial statements or in the notes accompanying the statements. Such disclosure should make the financial statements more useful and less subject to misinterpretation.
The following information generally should be disclosed:
terms of major borrowing arrangements and existence of large contingent liabilities.
contractual provisions relating to leasing arrangements, employee pension and major proposed asset acquisition.
accounting methods used in preparing the financial statements.
changes in accounting methods made during the latest period.
other significant events affecting financial position, including major new contracts for sale of goods or services, laborer strikes, shortages of raw materials.
The matching principle. This is a fundamental principle for determining the net
income of a company and preparing an income statement.
Revenue, the gross increase in net assets resulting from the production or sale
of goods and services, is offset by expenses incurred in bringing the firm's output to the point of sale. So, incurred expenses must be matched with, and deducted from, revenues generated.
The recognition of revenue, accordingly to the realization principle is made
"when it is earned". In a manufacturing business, the earning process involves: (a) acquisition of raw materials, (b) production of finished goods, (c) sale of the finished goods and (d) collection of cash from credit customers.
In cash accounting revenue is considered realized only when cash is collected
from customers.
In accrual accounting revenue should be recognized at the time of the sale of
the goods or the rendering of services.
The measurement of expenses occurs in two stages:
measuring the cost of goods and services that will be consumed or expire in generating revenue and
determining when the goods and services acquired, have contributed to revenue and their cost thus become an expense.
The second aspect of the measurement process is often referred to as "matching
costs and revenues" and is fundamental to the accrual basis of accounting.
Costs are matched with revenues in two major ways:
In relation to the product sold or service rendered.
If goods and services can be related to the product or service that constitutes the output of the enterprise, its costs become an expense when the product is sold or the service rendered to customers. The cost of goods sold in merchandising firms is a good example of this type of expense.
In relation to the time period during which revenue is earned.
Some costs incurred by business cannot be directly related to the product or service output of the firm. These "period costs" are considered expense in that period when they contribute to revenue.
The realization principle (recognition principle). The realization principle is the accounting rule that defines a revenue as an inflow of assets, not necessarily cash, in the exchange for goods and services and requires the revenue to be recognized at the same time, but not before it is earned. The principle also requires that the amount of revenue recognized be measured by the cash received plus the cash equivalent (fair value) of any other asset or assets received.
The objectivity principle. This principle is the accounting rule that wherever possible the amounts used in recording transactions be based on objective evidence rather than on subjective judgments.
The objectivity principle supplies the reason transactions are recorded at cost, since it requires that transaction amounts be objectively established. Whims and fancies plus, for example, something like an opinion of management that an asset is "worth more than it cost" have no place in accounting. To be fully useful, accounting information must be based on objective data. As a rule, costs are objective, since they normally are established by buyers and sellers, each striking the best possible bargain for himself or herself.
Considering its procedures or instruments used in the accounting practice, the method of accounting science represents an assembly of general, common and specific procedures. Some of the general procedures are: observation, classification, analysis and synthesizing. Common procedures are: documentation, evaluation, calculus and physical counts for inventory, while the specific procedures are: balance sheet, account and trial balance.
The accounting information processing cycle includes these procedures with their interaction.
THE ACCOUNT
The account is the basic unit used in accounting to summarize business transactions. Accounts are classified as follows:
assets
liabilities
owner's equity
Assets are economic resources owned or controlled by an entity as a result of past transactions, which are expected to be of benefit in the future. Examples of assets are:
cash (refers to coin, currency, cheques etc.)
accounts receivable. When a business sells goods or services on credit, the
Accounts Receivable account records these transactions.
land
office equipment
office furniture.
A separate account is kept for each type of asset.
Liabilities represents economic entity's future obligation as a result of past transactions.
Examples of liabilities are:
accounts payable. When a business purchases goods or services on credit,
the Accounts Payable account records these transactions. It is the opposite
of the Accounts Receivable account.
mortgage
A separate account is kept for each type of liability.
Owner's Equity is the owner's claim on the assets of the business. Owner's equity is increased with revenue and decreased by expenses or an owner's withdrawal.
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