Each industry in today’s business world operates with its language; likewise, accounting is the primary language of finance and related businesses. It helps business owners understand the financial situation by transmitting the necessary financial data. It helps translate the fundamentals of accounting into a completely tangible report.
The scope of accounting makes it crucial for business owners and beginners to understand the meaning of accounting. This article is a part of our definitive guide – basic accounting principles that explain the importance and basic fundamentals of accounting. Let us get started right away!
Meaning of Accounting
As defined in our A-Z accounting glossary, accounting is a cycle or process that includes recording, summarizing, analyzing, and reporting of data related to financial transactions. There are various components of accounting that one has to understand to know the actual meaning and the basic fundamentals of accounting.
Record – Keeping
The primary function that accounting seeks to accomplish is recording the various transactions within a business. Accounting is also known as bookkeeping that recognizes transactions and prepares them as records.
The process of bookkeeping only deals with the recording/registering part and nothing otherwise. It further helps maintain a few books to record each transaction. Each bookkeeping procedure is carried out systematically for smooth functioning and clear understanding.
There are three basic methods of recording, namely:
- Establish a record-keeping system.
- Monitor each financial transaction.
- Compile reports to provide a final set of financial statements.
Raw financial data is an outcome of recording transactions; Also known as the preliminary data that is not of much significance to the business or organization. Since raw financial data does not play an essential role in the decision-making process, it is divided into various categories. Thus, recording transaction is followed by the process of summarizing.
Company affairs are a vital responsibility of the management. Business owners must be familiar with the various operations carried out within the business with their money. To understand the know-how of business operations and effectively manage the outcomes, owners receive financial reports. Reports are usually generated and handed over at the end of each quarter, and once annually, summarizing all their performance.
After all, the results obtained so far are analyzed. Once the process of recording and summarizing is completed, it is imperative to come to conclusions. The management team of an organization or business has to analyze both the positive and negative points.
How does one analyze the results? Accounting entails the concept of comparison that enables accounting professionals to compare earnings, savings, sales, equity, etc. to analyze and determine the organization’s growth and performance.
Business Accounting Basics
The accounting function of any business revolves around the term ALOE, which plays a significant role in the accounting world and helps understand the meaning of each functionality. It is what the acronym “A-L-O-E” means.
Accounting Equation: A – Assets = L – Liabilities + O E – Owner’s Equity
Assets are those that carry value and converts into cash when sold. These are the items that belong to the owner of the business or organization. Some of the examples of assets are car, house, office, etc.
Anything you own becomes a liability. For instance, the loan is taken to, but an asset is considered as a liability.
The total amount of cash that an owner invests in a business is known as owner’s equity. The investment doesn’t need to be made in the form of money. Most large business owners invest in the way of stocks.
Objectives of Accounting
As mentioned earlier in the article, accounting is a language for transactions. The human brain can’t store infinite information. Wherein, accounting takes charge of keeping records of all transactions within a business through the accounting system.
P&L (Profit & Loss)
The sustenance of any business depends on income generation. Making profits is very important while running a business. The profit and loss accounting chart enable bookkeeping professionals to determine whether a company is running under profit or loss.
Optimum Utilization of Resources
Resources play a crucial role in enabling a business to function smoothly. Optimum utilization of resources helps a company succeed in the long run. Reports are one of the key resources that provide timely records of various business activities. Resource utility makes it easier for the owners to take notes of each detail before investing or depositing money.
Although business sustainability depends on its profits, it is not the only factor that interests a business owner. It is essential to know how much a business owes its creditors and what amount one has to pay to its debtors. Enterprises focus on preparing statements that include all the financial reports. These statements are termed as a balance sheet that helps understand the estimations of financial position.
Records of financial reports help in the process of decision making. The precise financial information helps owners understand the business functionalities.
Basic Fundamentals of Financial Accounting
1. Accounting Process
The accounting process, also known as the accounting cycle, is a series of procedures involved in gathering, processing, and reporting financial information. Usually, financial data is presented as reports in the form of financial statements. Before preparing statements, accountants need to gather all the transactions carried out within a business.
Later, accountants have to record and arrange them accordingly to obtain the value that is to be reported. The process of accounting or the cycle doesn’t end with the generation of financial statements. Various other steps must be carried out to set up an ideal accounting system for the next process.
Steps Involved in Accounting Process
- Defining & Analyzing Transactions
- Recording Journals
- Posting in the General Ledger
- Unadjusted Trial Balance
- Input Adjustments
- Trial Balance Adjustments
- Financial Statements
- Final Entries
- Post-Closing Trial Balance
- Reverse Entries (Optional Step)
2. Reconciliation Statement
It is a document that begins with the company’s account balance records, carries out addition and subtraction of settlements in the additional columns, and uses the adjustments to access the records of the same account held by a third party. The intention of creating a reconciliation statement is to provide independent verification of the correctness of the balance in the company’s performance and to clarify the differences of accounting versions.
The differences are detailed in the reconciliation statement that helps determine what is valid, what is invalid, and if one requires adjustments. These statements are useful for both internal and external auditors. Internally prepared remarks enable auditors to precisely focus on the reconciling items that are a significant component of the financial statements.
A reconciliation statement is generated in various situations. It may include:
- Bank accounts
- Account Debit
- Accounts Receivable
- Accounts Payable
3. Accounting for Depreciation
Depreciation is an accounting method that allocates the cost of physical or tangible assets over the expected life span. Depreciation is important to understand the amount of asset value spent by a business. It helps enterprises earn income from an asset while spending a portion of its cost each year the asset is used.
In case depreciation on accounts is not considered, it can drastically affect the profits of a business. Businesses can depreciate assets in the long run for accounting and taxation; however, according to the IRS (Internal Revenue Service). Companies are required to spread the costs out over time while depreciating assets.
4. Preparing Final Accounts
It is categorized as the accounts that are prepared at the end of the fiscal year. It provides an accurate ideology of a business’s financial situation to the business owner, management, or other interested individuals. Financial statements are recorded primarily in a journal and later transferred to the ledger. In the end, the final account is prepared. In general, the final account includes the following components.
- Trading Account
- Manufacturing Accounts
- Profit & Loss Account
- Balance Sheet
5. Accounting for Private Transactions
It is one of the significant concepts of basic fundamentals of accounting. Accounting for private transactions are carried out in the following financial situations.
- Bills of Exchange
- Joint Venture
- Sale of Goods on an Approval or Return Basis
When preparing general-purpose financial statements, several guidelines need to be followed. They must be understood by both the accountants preparing them and the users of these reports. These guidelines are called Generally Accepted Accounting Principles or GAAP based on basic accounting principles and concepts.
We hope this article has helped you understand some of the basic fundamentals of accounting. For more accounting information, check out our blog section on the Imprezz official website. Imprezz is a small business accounting software that helps several business owners in India to grow effectively.
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