Basics of Accounting – Meaning and Basics Concepts

Welcome to the world of Accounting 101 – where numbers tell a story and financial clarity reigns supreme. In this blog, we’ll break down accounting into bite-sized pieces, making it accessible to everyone.

Accounting is more than just crunching numbers; it’s the tool that helps businesses keep track of their money, make smart decisions, and stay on the right side of the financial road. Join us as we simplify the Basics of Accounting, giving you the tools to understand the financial side of any business. Whether you’re a future accountant, a small business owner, or just someone who wants to level up their financial know-how, this guide is your roadmap to mastering the basics of accounting. Let’s dive in!

What is Accounting?

Accounting is like the financial storyteller for businesses and individuals. It’s the way we keep track of, write down, and share all the money-related activities we’re involved in. When people or companies want to really understand where they stand financially, they do accounting.

An accountant is a money expert who helps out companies and individuals. They keep an eye on things like profits, losses, expenses, and incomes. It’s an accountant’s job to make sure that everyone knows how well they’re doing financially and that they’re following all the money rules.

Accountants don’t just look at the past; they also help plan for the future. They work with companies to figure out how to manage money better, set budgets, and make smart financial decisions. So, when a company’s bosses need advice on what to buy or where to invest, they turn to their trusty accountant for guidance.

What are the Three Fundamental Concepts of Accounting?

Before diving into accounting, it’s important to know a few basic ideas. The three fundamental concepts of accounting are:

1. Accruals Concept:

The idea behind the accruals concept is pretty straightforward. It says that a business should recognize its earnings when it actually earns them, and its expenses when it uses up its resources. This means a company doesn’t only look at the cash it gets or spends.

For instance, imagine your company sells a product. Instead of just considering the production cost, you also need to think about other things like customer support and shipping. The accruals concept reminds us to look at the bigger picture when figuring out profits, losses, and revenue.

Auditors, the financial checkers, usually make sure that a company follows this concept when preparing its financial statements. They want to see the whole story, not just the money coming in or going out.

2. Going Concern Concept:

In the accounting world, we always assume that a business is going to keep running in the future. This means we sometimes move expenses or income to later times, depending on the situation. For instance, a company might decide to delay paying back a loan until the next few months, believing they’ll still be in business.

Without the going concern concept, we’d have to account for all the possible future costs right now. This could be tough, especially for businesses that rely on credit or loans to keep going. The going concern concept helps companies plan for the future without getting overwhelmed by all potential costs hitting them at once.

3. Economic Entity Concept:

The economic entity concept is like having a clear line between business and personal transactions. It says that a business’s money matters should be completely separate from the owner’s personal money matters. Auditors, the financial checkers, make sure there’s no mixing of business and personal transactions in a company’s money records.

If anyone, even the owner, starts using the company’s money for their personal stuff, it’s a big no-no. It’s called embezzlement, and it’s both legally and professionally not okay. The economic entity concept helps keep things fair and square, making sure everyone plays by the rules when it comes to business money.

What are the Basics of Accounting?

To grasp the basics of accounting, let’s break it down into three main parts and the words we use for them. The simple components of accounting are:

1. Records:

Before diving into accounting, companies need a clear way to keep track of things. They set up basic accounts to store information, and these accounts fall into a few categories:

• Assets: These are things the company owns that have future value, like cash, inventory, land, or equipment.
• Liabilities: These are the legal financial responsibilities or debts a company has. It includes things like loans, mortgages, or amounts to be paid.
• Equity: Also called shareholder’s equity, this is the money that goes back to the shareholders after everything the company owns is sold, and all debts are paid off.
• Expenses: These are the costs a business faces to make money, like employee wages, payments to suppliers, or equipment depreciation.
• Revenue: This is the money a company makes from its regular operations, including income from sales. It’s the starting point for calculating profits after subtracting costs.

Understanding and organizing these records is the backbone of accounting, helping companies keep a clear picture of their financial health.

2. Transactions:

In the accounting world, there’s a lot of recording going on. Some transactions come from various parts of a company, while others are created by the accountant. These transactions get noted down in those accounts we talked about earlier. Here are some important business transactions:

• Sales: This is when a company sells stuff, and it’s recorded in their books as a credit to the sales account and a debit to cash or accounts receivable. Usually, an invoice is created and sent to the customer, showing how much, they owe.
• Purchases: When a business buys things it needs, these transactions are recorded too. If it’s a cash purchase, it’s a debit to the inventory account and a credit to cash. If it’s on credit, the credit entry goes to accounts payable, and the debit entry is in the inventory account. Purchase orders and supplier invoices are often part of this process.
• Receipts: This is when a company gets paid for the goods or services it provided. The transaction gets noted in the seller’s journal as a credit to accounts receivable and a debit to cash.
• Employees’ Compensation: Keeping track of how many hours employees work is crucial. This information helps with tax deductions, figuring out gross wages, and other deductions, leading to the final amount employees get paid – their net pay.

These transactions are the nuts and bolts of accounting, helping businesses keep tabs on the money coming in and going out.

3. Financial Statements:

After all the company’s money movements for a certain time are done, the accountant gathers all that info and puts it into three important documents known as financial statements. Here’s what they are:

• Income Statement: This paper tells you about the money the company made and subtracts all the costs to figure out if they ended up with a profit or loss. It helps see how well the company is growing and running efficiently.
• Balance Sheet:This document spills the beans on what the company owns (assets), what it owes (liabilities), and what’s left for the owners (equity) at a specific moment. It’s like a snapshot of the company’s money situation, helping figure out if they can pay their bills.
• Statement of Cash Flows:This one gives the lowdown on where the company’s cash came from and where it went during a certain time. It’s super useful when the profit on the income statement doesn’t match the actual cash change.

These financial statements are like a report card for the company, giving a clear picture of how well they’re doing financially.

As we conclude our exploration into the fundamental principles of accounting, remember that mastering these basics is key to financial success in the business world. Just like a sturdy foundation supports a building, a strong understanding of these principles provides stability and opens the door to greater financial achievements.

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In our upcoming articles, we’ll explore more about accounting, breaking down complexities in simple terms. There’s always more to discover, and we’re here to make financial understanding easy for everyone. Happy learning!