Many people are daunted the thought of accounting. While accounting does use some foreign terminology and can be very complex, this article is designed to help you get a basic understanding of the accounting process. The accounting process involves all the steps that take place between a single transaction and the completion of financial statements at the end of an accounting cycle. Included in this article are lots of useful links to pictures and websites that will help you to better understand the accounting process.
The first step in the accounting process is recording journal entries and naturally this requires a transaction. It is important to understand that not every transaction will involve cash. In today’s business world, nearly every service or good that is transacted is done so on some form of credit. This means that you might walk out of a store with a forty dollar piece of equipment and at that exact moment you have not yet paid a single dollar. Instead you used a credit card and you will pay for that purchase at some later point. In accounting, it is important to record transactions when they happen, regardless of when the transaction will be paid for with cash. This is known as accrual accounting.
Once the transaction occurs, a journal entry must be recorded. A journal entry should be put into a table with each entry taking up two rows. Each row will list an account affected by the transaction. In accounting, every transaction will affect two different accounts (and in cases more). If you buy supplies for your business on credit, the journal entry should record a debit to your supplies account, meaning that now you have more assets (in supplies) and a credit to your accounts payable account because you now owe money to businesses that sold you the supplies. In every journal entry one of the accounts will always be debited and one will always be credited. Click here to see what a journal entry should look like.
At the end of a month, quarter, or year, you will need to prepare financial statements. By that time you should have a nice long list of journal entries. The next step is to create T-accounts or ledger accounts by taking each account and listing all the debits and credits to that account. Simplified T-accounts will look like this.
After the T-accounts are created, the information must be transferred to a trial balance. The trial balance is a simple table listing each account and the current balance of that account. Asset accounts (cash, accounts receivable, equipment, building, land, etc) almost always have a debit balance while liability and equity accounts (accounts payable, notes payable, owner’s equity, etc) have credit balances. When completed, a trial balance will look like this. In a trial balance, the debit and credit side will always balance out with equal totals.
Often, a trial balance will need to be adjusted, which means things like depreciation, prepaid expenses, and accrued expenses are accounted for in the proper accounting period.
Using the trial balance, financial statements are prepared. The first statement is the income statement. It will list the service revenue (money that is brought in from services provided or products sold) followed by all the expenses incurred during that financial period. Using the total from the income statement which is found by subtracting expenses from revenue, the owner’s equity statement is prepared. Finally, the balance sheet is completed by listing all the assets, liabilities, and owner’s equity. Assets will always equal the liabilities and equity, which is why this statement is called a balance sheet. These statements should be completed in the order mentioned above because information needed for the equity statement and balance sheet come from the previous statement. All of this may sound very complicated, but viewing samples of each of these should help you to understand what types of accounts are recorded in each statement. Click on the links below to view.
Income statement, owner’s equity statement, balance sheet.
The accounting process is completed when all accounts are closed and “reset” for the new financial cycle. This involves working with a work sheet that condenses all the financial statements onto one table.
There is no doubt that accounting can be very difficult and complex. Hopefully this article has helped you to grow in your knowledge of the subject. Most likely, you will still have a few questions, but using the links and other external information you can continue to expand your knowledge. As with anything, know that accounting, especially at a business level, has both legal and ethical ramifications. Be sure to consult a certified public accountant with concerns.
