A brief summary on Accounting

Accounting is keeping financial records, recording income and expenditure, valuing assets and liabilities, and so on. Accountants, unlike bookkeepers, analyze financial records, and decide how to present them. There are several types of accounting:

-Managerial accounting is preparing budgets and other financial reports necessary for management.

-Cost accounting working out the unit cost of products, including materials, labor and all other expenses.

-Tax accounting calculating an individual’s or a company’s liability for tax.

-Creative accounting uses all available accounting procedures and tricks to disguise the true financial position of a company.

And bookkeeping is writing down the details of transactions (debits and credits). Bookkeepers have to record every purchase and sale that a business makes, in the order that they take place, in journals. At a later date, these temporary records are entered in or posted to the relevant account book or ledger. At the end of an accounting period, all the relevant totals are transferred to the profit and loss account. Double-entry bookkeeping records the dual effect of every transaction – a value both receives and parted with. Payments made or debits are entered of the left-hand (debtors) side of an account, and payments received or credits on the right-hand side. Bookkeepers periodically do a trial balance to test whether both sides of an account match.

Actually, bookkeeping is only a part of accounting - the record-making part. And accounting itself includes also analytic and interpretation part, it shows the relationship between the financial results and events, which have created them.

There are three main steps in making records in bookkeeping:

- Recording every purchase and sale that a business makes

- Entering these temporary records in the ledger - a book of secondary, final entry, containing individual accounts.

- Transferring all the relevant totals to the profit and loss account.

The main principle of bookkeeping is double-entry principle. It states that each transaction must be recorded as two separate entries: a value both received and parted with. Payments made or debits are entered on the left-hand (debtor) side of an account, and payments received or credits on the right-hand (creditor) side.

One of the functions of accounting is valuing assets, which are things of value or earning power to a firm. Assets can include cash, receivables, bank deposits, and trade investments: investments in other companies. Such assets are called current assets. Assets including land, plant, buildings, and furniture, are called fixed assets. Assets such as plant and equipment that over time wear out or become outdated are said to depreciate. A charge must be made for this depreciation or amortization in calculating a business’s profitability: the assets are depreciated or amortized by an amount each year. Also there are intangible assets, which may include such things as patents owned by the company, and goodwill, the value of the company as a functioning business or going concern with a client base, experienced management, and other benefits that a start-up may not have.

All the money that a company will have to pay to someone else in the future, including taxes, debts, and interest and mortgage payments is called liabilities. Long-term debts are long-term liabilities. The ratio of a firm’s debt to equity is its gearing or leverage; a firm with a high proportion of debt in relation to equity is highly geared or highly leveraged. Short-term debts and debts to suppliers are among its current liabilities.

In accordance with the principle of double-entry bookkeeping, the basic accounting equation is Assets = Liabilities + Owners’ (Stockholders’) Equity. This can be rewritten as Assets – Liabilities = Owners’ Equity or Net Assets. This includes share capital (money received from the issue of shares); share premium or paid-in surplus (any money realized by selling shares at above their nominal value), and the company’s reserves, including the year’s retained profits. Stockholders’ or shareholders’ equity or net assets are generally less than a company’s market capitalization, because net assets do not record items such as goodwill.

The amount of business done by a company over a year is called turnover. The reduction in value of a fixed asset during the years it is in use (charged against profits) is called depreciation. Debtors or account receivable are the sums of money owed by customers for goods or services purchased on credit. And sums of money owed to suppliers for purchases made on credit are called creditors or accounts payable. The inventory includes the value of raw materials, work in progress, and finished products stored ready for sale. The various expenses of operating a business that cannot be charged to any one product, process or department are called overheads.

There are various possible ways of recording debits and credits, valuing assets and liabilities, calculating profits and losses, etc. But there are about a dozen generally accepted “accounting principles” that accountants must follow in order to present “a true and fair view” of a company’s finances.

The principles are the separate-entity or accounting entity assumption (an enterprise is an accounting unit separate from its owners, creditors, etc.), the continuity or going-concern assumption (the business will continue indefinitely into the future), the unit-of-measure assumption (all transactions and other items to be accounted for must be in a single, supposedly stable monetary unit), the time-period or accounting period assumption (financial data must be reported for particular period, which makes accrual and deferral necessary), the revenue or realization principle (revenue is realized at the moment when goods are sold or when services are rendered). Consequently, the most common accounting system is historical cost accounting, which records assets at their original purchase price, minus accumulated depreciation charges.

Company law specifies that shareholders must be given certain financial information. Companies generally include three financial statements in their annual reports. The profit and loss account or income statement shows revenue and expenditure. The balance sheet shows a company’s financial situation on a particular date, generally the last day of the financial year. The third financial statement has various names, including the source and application of funds statements, and the statement of changes in financial position. This shows the flow of cash in and out of the business between balance sheet dates. Sources of funds include trading profits, depreciation provisions, sales of assets, borrowing, and the issuing of shares. Application of funds includes purchases of fixed of financial assets, payment of dividends, repayment of loans, and – in a bad year – trading losses.

Companies generally include three financial statements in their annual reports.

The profit and loss account or income statement shows revenue and expenditure. It usually gives figures for total sales or turnover and costs and overheads. The first figure should obviously be higher than the second, i.e. there should be a profit. Part of the profit goes to the government in taxation, part is usually distributed to shareholders (stockholders) as a dividend, and part is retained by the company.

The Balance Sheet is a document that shows the totals of money received and money paid out by a company and the difference between them. The balance sheet includes two parts: 1. Assets and 2. liabilities and share capital. Both parts should always be balanced.

The item current assets include cash, marketable securities, accounts receivable and stock-in-trade. Thus these assets appear to be working assets. Current assets are the assets, which a company can convert quickly into cash, usually stock and accounts receivable falling due within one year. Cash includes bills, petty cash fund and money on deposit.

Marketable securities are a short-term investment of surplus or temporary free assets. Normally these assets are allocated into commercial securities or federal bonds. As securities can be required at short notice they are to be easily realized and be subject to price fluctuations as little as possible. The balance sheet shows their nominal cost, their market value is given in brackets.

Account receivables are amounts owed to a business by suppliers of goods and services. Usually customers are allowed a 30, 60 or 90 day’s period of time within which they are to effect a payment. However. Some customers are not able to pay owing either to financial difficulties or contingency. Hence, the amount is to be reduced for the reserve allowance for bad debt.

Stock-in-trade includes raw materials to be used for production and semi-finished goods. The stock-in-trade value is defined either by its cost or cost market value. The preference is given to a lower one.

Capital assets include property, premises, plant and machinery, and equipment. They are not meant for sale but for the goods production, storage and transportation. This category comprises land, buildings, machinery, equipment, furniture and vehicles. Thus, net capital assets reflect the volume of investment made into property, plant and machinery, and equipment. Capital assets lose their value with age and use. The real cost of capital assets may gradually lose their value as a result of obsolescence of machinery. New modern technologies make the old equipment obsolescent. Thus, depreciation is a gradual loss in the value of something, such as a vehicle, a machine or any asset that wears out with use and age. The land cannot be depreciated; its value stays unchanged year after year.

Prepayments and deferred charges include, for instance, insurance against fire prepayment or lease prepayments etc.

Deferred charges are similar to prepayments. For instance, a manufacturer allocates money into research work, positive results of which and profit will be seen many years later. So costs are to be discounted within the years to follow.

Intangibles like patents, goodwill and trademarks are not physical substances and are differently evaluated by various companies or may not be evaluated at all.

The third financial statement has various names, including the source and application of funds statement, and the statement of changes in financial position. This shows the flow of cash in and out of the business between balance sheet dates. Sources of funds include trading profits, depreciation provisions, sales of assets, borrowing, and the issuing of shares. Applications of funds include purchases of fixed or financial assets, payment of dividends, repayment of loans, and – in a bad year – trading losses.

Finally I’d like to speak about the last aspect - aspect of human factor in accounting. Accounting is not completely objective, because it’s not a collection of arithmetical techniques, but a set of complex processes and most accounting reports depend on people’s skills and opinion. So to be professional accountant it’s not enough just to study all rules and order of filing documents. You should feel the inner principles of all these numbers.