There are four basic accounting concepts. The concepts specify and explain the guidelines that should be followed when managing the accounting of a business. Below there is a list of the these four basic accounting concepts and a brief summary of each concept.
1. Accruals Concept
Accounting
The accruals concept states that revenue from transactions and transactions which cause liabilities are accounted for when they occur, even if cash or property has not actually been exchanged between the entities involved in the transaction. For example, a dentist, Dr. Payne orders and receives 6 months worth of toothpaste for 0 in January. Even if he does not pay for the toothpaste until February, Dr. Payne should still record the 0 liability in January and not wait until February, since he owns the goods and is liable to pay for them to the supplier. On its turn the supplier will be accounting for the sale of toothpaste to Dr. Payne.
Accounting Theory - Basic Accounting Concepts
2. Consistency Concept
Once certain accounting method has been applied by the accountant, this methods must be applied throug all the further periods for the accounting purposes. The accounting method should only be changed if there is a valid reason that requires the change. For example, if the accountant starts recording transactions using the double-entry accounting method in January, he or she should continue applying the double-entry method for the remainder of the accounting period. He or she should not begin applying the double-entry method and suddenly switch to the single-entry accounting method mid-accounting cycle for no identifiable, valid reason. This means that all the accounting methods and procedures must be applied consistently to ensure comparability of information among periods.
3. Going Concern Concept
When the accounting of a business is being managed, it should be assumed by the accountant that the business is viable and will still operational in the foreseeable future. If the accountant has any reason to believe that the business will not remain viable in the foreseeable future, he or she must state the reasons for coming to that conclusion in the financial reports of the business. If the accountant has an opinion that the company will not remain in business and there are no sufficient evidence to proof the opposite, the accountant may simply include a disclaimer in the financial reports stating that he or she believes, but cannot show evidence to prove that the business will not remain viable.
4. Prudency Concept
Liabilities are accounted for in the balance sheet even if they is only a possibility for such liabilities to occur, despite they are potential. However, revenues are accounted for in the financial statements only if the business has title for such revenue and has already collected or will collect cash or other assets in the future. If there is a doubt about this or there is no strong legal basis to recognize revenue, it is not accounted for in the accounting books. This concept helps to ensure that businesses make provisions for potential losses, not just realized losses, and do not erroneously include revenues that are simply anticipated, but not yet earned.
Accounting Theory - Basic Accounting Concepts
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The convention of relevance emphasizes the fact that only such information should be made available by accounting as is relevant and useful for achieving its objectives. For example, business is interested in knowing as to what has been total labor cost? It is not interested in knowing how much employees spend and what they save.
Accounting
(2) Objectivity
Accounting Conventions and Accounting Concepts
The convention of objectivity emphasizes that accounting information should be measured and expressed by the standards which are commonly acceptable. For example, stock of goods lying unsold at the end of the year should be valued as its cost price not at a higher price even if it is likely to be sold at higher price in future. Reason is that no one can be sure about the price which will prevail in future.
(3) Feasibility
The convention of feasibility emphasizes that the time, labor and cost of analyzing accounting information should be compared vis-à-vis benefit arising out of it. For example, the cost of 'oiling and greasing' the machinery is so small that its break-up per unit produced will be meaningless and will amount to wastage of labor and time of the accounting staff.
Accounting Concepts
(1) Materiality
It refers to the relative importance of an item or event. Those who make accounting decisions continually confront the need to make judgments regarding materiality. Is this item large enough for users of the information to be influenced by it? The essence of the materiality concept is : the omission or misstatement of an item is material if, in the light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying on the report would have been changed or influenced by the inclusion or correction of the item.
(2) Accounting period
Though accounting practice believes in continuing entity concept i.e. life of the business is perpetual but still it has to report the 'results of the activity undertaken in specific period (normally one year). Thus accounting attempts to present the gains or losses earned or suffered by the business during the period under review. Normally, it is the calendar year (1st January to 31st December) but in other cases it may be financial year (1st April to 31st March) or any other period depending upon the convenience of the business or as per the business practices in country concerned.
Due to this concept it is necessary to take into account during the accounting period, all items of revenue and expenses accruing on the date of the accounting year. The problem confronting this concept is that proper allocation should be made between capital and revenue expenditure. Otherwise the results disclosed by the financial statements will be affected.
(3) Realization
This concept emphasizes that profit should be considered only when realized. The question is at what stage profit should be deemed to have accrued? Whether at the time of receiving the order or at the time of execution of the order or at the time of receiving the cash. For answering this question the accounting is in conformity with the law (Sales of Goods Act) and recognizes the principle of law i.e. the revenue is earned only when the goods are transferred. It means that profit is deemed to have accrued when 'property in goods passes to the buyer' viz. when sales are affected.
(4) Matching
Though the business is a continuous affair yet its continuity is artificially split into several accounting years for determining its periodic results. This profit is the measure of the economic performance of a concern and as such it increases proprietor's equity. Since profit is an excess of revenue over expenditure it becomes necessary to bring together all revenues and expenses relating to the period under review. The realization and accrual concepts are essentially derived from the need of matching expenses with revenues earned during the accounting period. The earnings and expenses shown in an income statement must both refer to the same goods transferred or services rendered during the accounting period. The matching concept requires that expenses should be matched to the revenues of the appropriate accounting period. So we must determine the revenue earned during a particular accounting period and the expenses incurred to earn these revenues.
(5) Entity
According to this concept, the task of measuring income and wealth is undertaken by accounting, for an identifiable Unit or Entity: The unit or entity so identified is treated different and distinct from its owners or contributors. In law the distinction between owners and the business is drawn only in the case of joint stock companies but in accounting this distinction is made in the case of sole proprietor and partnership firm as well. For example, goods used from the stock of the business for business purposes are treated as a business expenditure but similar goods used by the proprietor i.e. owner for his personal use are treated as his drawings. Such distinction between the owner and the business unit has helped accounting in reporting profitability more objectively and fairly. It has also led to the development of "responsibility accounting" which enables us to find out the profitability of even the different sub-units of the main business.
(6) Stable Monetary Unit
Accounting presumes that the purchasing power of monetary unit, say Rupee, remains the same throughout. For example, the intrinsic worth of one Rupee is same and equal in the year 1,800 and 2,000 thus ignoring the effect of rising or falling purchasing power of monetary unit due to deflation or inflation. In spite of the fact that the assumption is unreal and the practice of ignoring changes in the value of money is now being extensively questioned, still the alternatives suggested to incorporate the changing value of money in accounting statements viz., current purchasing power method (CPP) and current cost accounting method (CCA) are in evolutionary stage. Therefore, for the time being we have to be content with the 'stable monetary unit' concept.
(7) Cost
This concept is closely related to the going concern concept. According to this, an asset is ordinarily recorded in the books at the price at which it was acquired i.e. at its cost price. This 'cost' serves the basis for the accounting of this asset during the subsequent period. This' cost' should not be confused with 'value'.
It must be remembered that as the real worth of the assets changes from time to time, it does not mean that the value of such an assets is wrongly recorded in the books. The book value of the assets as recorded do not reflect their real value. They do not signify that the values noted therein are the values for which they can be sold. Though the assets are recorded in the books at cost, in course of time, they become reduced in value on account of depreciation charges. In certain cases, only the assets like 'goodwill' when paid for will appear in the books at cost and when nothing is paid for, it will not appear even though this asset exists on name and fame created by a concern.
Therefore, the values attached to the assets in the balance sheet and the net income as shown in the Profit and Loss account cannot be said to reflect the correct measurement of the financial position of an undertaking, as they do not have any relation to the market value of the assets or their replacement values. This idea that the transactions should be recorded at cost rather than at a subjective or arbitrary value is known as Cost Concept. With the passage of time, the market value of fixed assets like land and buildings vary greatly from their cost.
These changes or variations in the value are generally ignored by the accountants and they continue to value them in the balance sheet at historical cost. The principle of valuing the fixed assets at their cost and not at market value is the underlying principle in cost concept. According to them, the current values alone will fairly represent the cost to the entity.
The cost principle is based on the principle of objectivity. The supporters of this method argue so long as the users of the financial statements have confidence in the statements, there is no necessity to change this method.
(8) Conservatism
This concept emphasizes that profit should never be overstated or anticipated. Traditionally, accounting follows the rule "anticipate no profit and provide for all possible losses. For example, the closing stock is valued at cost price or market price, whichever is lower. The effect of the above is that in case market price has come down then provide for the 'anticipated loss' but if the market price has gone up then ignore the 'anticipated profits'.
Critics point out that conservation to an excess degree will result in the creation of secret reserve. This will be quite contrary to the doctrine of disclosure. However, conservatism to a reasonable degree may not come in for criticism.
Accounting Equation
Dual concept may be stated as "for every debit, there is a credit." Every transaction should have two sided effect to the extent of same amount. This concept has resulted in Accounting Equation which states that at any point of time the assets of any entity must be equal (in monetary terms) to the total of owner's equity and outsider's liabilities. This may be expressed in the form of equation:
A-L = P
where
A stands for assets of the entity;
L stands for liabilities (outsider's claims) of the entity; and
P stands for Proprietor's claim (Capital) on the entity.
(The form of presentation of equation A-L = P is consistent with the legal interpretation of financial position. Thus it emphasizes that properly speaking the proprietary claim is the balance after providing for outsider's claims against the business from the total assets of the business).
Accounting Conventions and Accounting Concepts
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A lot of people do not really know what forensic accounting is about. Forensics accounting is actually the practice of utilizing accounting, auditing, and investigative skills to conduct examination into a company's financial statements in legal matters.
Forensics Accounting consists of three main areas, for example, litigation support, investigation and dispute resolution. Litigation support involves the factual presentation of financial issues related to existing or pending litigation. In such circumstances, the forensic accounting professionals are normally responsible to quantify the damages sustained by the parties involved in legal disputes before these cases are brought to the court.
Accountant
Investigation comes in when criminal matters have occurred, such as falsification of financial statements, internal theft, securities fraud, insurance fraud, bribery, and so on and so forth. Further actions are taken after detailed investigation is conducted.
What is Forensics Accounting and What Does a Forensic Accountant Do?
On the other hand, when a dispute has been brought to the court, the forensic accountant may act as an expert witness for the related matter. They will also be responsible for preparing necessary evidence. Forensic accountants are specialized accountants. They can also be called forensic auditors or investigative auditors.
They are specialized in investigating and interpreting white collar crimes which always relate to criminal financial transactions in the company, i.e. money laundering. Most of the time, they also get involved in investigating securities fraud, contract disputes and other illegal business activities such as bribery and embezzlement.
Forensic accountants utilize their knowledge in accounting and finance as well as company law and commercial law in their daily routine. They are also well equipped with all the updated business information, government legislation, financial reporting systems, accounting and auditing standards, and litigation processes and procedures when they are carrying out their task.
Furthermore, besides the required knowledge, it is essential for them to have two important skills, for example, investigative techniques as well as evidence gathering skills in performing their task.
Forensic accountants have played an important role in assisting the government as well as the public to detect accounting scandals and financial crimes caused by individuals, companies and organized crime networks. Unlike accountants and auditors, when forensic accountants conduct audits, they are actively looking for signs of fraud and they use their investigative skills to determine whether a business activity or a financial transaction is illegal.
Forensic accountants are part of the extension of the legal team and they are responsible for preparing and reviewing financial evidence. Their responsibilities are as follows:
Investigating and analyzing financial evidence, especially in complex or potential criminal financial transactions
Developing computerized applications to analyze, compare and interpret financial facts and figures
Transforming their findings into reports to the related people for their financial decision
Assisting in legal proceedings, including preparing supporting documents and acting as expert witnesses during trials
What is Forensics Accounting and What Does a Forensic Accountant Do?
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A casualty loss is the damage, destruction, or loss of property resulting from an uncontrollable event that is sudden or extraordinary. It can also be an order of the government to destroy or remove a structure for safety reasons because of a disaster. These losses are considered a valid casualty, whether it is personal or business property, if they are as a direct result of a particular event that is sudden, unpredicted or destructive. These events could be caused by fire, flood, earthquakes, theft or other similar events.
When accounting for an individual casualty or theft loss deduction, you must consider several conditions in order to qualify. Aside from selecting the itemize deduction option, you must establish proof of ownership and value of the items loss. To determine the validity of your casualty or theft loss and claim the deduction, you must complete the form for Casualties and Thefts. The completed form must be filed with your tax return.
Accounting
It is difficult to establish credibility for this deduction especially if you have no record of ownership and value of the property - a receipt of purchase or other documentation. For uninsured property or a gift, perhaps the proof to ownership and value can be established by the person who gave the gift. In the event of a theft, it makes sense to file a police report as documentation to establish your loss.
Accounting - Casualty or Theft Losses
A casualty or theft loss, as a result of a car accident or vandalism, can be established as a valid loss deduction by using insurance and appraisal documentation. However, for insured property that is considered a loss, a claim must be filed with the insurer even if the value of the property is not expected to be recovered from the insurer.
If your loss was the result of an unanticipated, abrupt disaster, your records were probably destroyed by the devastation. You can reconstruct your records to determine ownership and the value of the property through records such as insurance and appraisal documents. Appraisal fees are not considered a loss, but accounting for these fees is permissible as a miscellaneous deduction.
An invalid casualty or theft loss is deliberate damage or destruction of property caused by the person seeking gain or reimbursement. An invalid loss can also be neglect, failing to make necessary repairs to property, or carelessness, such as failing to secure valuables by leaving keys in an unlock car.
Repairs are not normally a valid deduction, but the cost of repairing and cleaning up the property to bring it back to the condition before the disaster is a valid deduction. The cost of repairing damage (only) to leased property, such as a car, caused by a casualty disaster is also a valid deduction. To establish the condition of your property before a disaster, its smart to video tape your property in advance and keep the tape in a secure place away from the property.
The amount of your deduction usually does not equal your loss. Certain conditions and calculations are mandatory when accounting for this deduction that will reduce the amount of your claim. The reductions include insurance reimbursements and other adjustments that may affect your claim. IRS accounting practices require that you reduce each loss according to a three-step process. First, by the 0 floor amount, 10% of your AGI and the decrease in the property's fair market value as a result of the damage or original cost. This could eliminate your entire deduction if it is a small claim..
Accounting for a loss that occurred in a Presidential declared disaster area, gives you the choice of claiming your loss in the year it happened or in the previous year by amending your tax return for that year. Choosing the prior year will quickly make your refund available to you.
The receipt of a reimbursement that is not used to replace your property may be considered a taxable gain. To suspend the gain, you must replace the property with a comparable one and it must be at least the same value as your reimbursement. The replacement must be made within a two-year period, which starts the last day of the year the gain is realized. You must replace the property within four years of your reimbursement, or request a one-year extension, if your loss occurred in a Presidential declared disaster area, in order to avoid a taxable gain.
Accounting - Casualty or Theft Losses
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For many of us our only involvement with the subject of accounting is simply the balancing of our checkbooks. Some people might even go one step further and input all of their transactions into their favorite software program. There are even a great many of us who simply do not balance their checkbooks at all! But there are many individuals out there who work in the accounting industry for a living. Some professionals work in large accounting firms where anyone barely knows who you are in the whole scheme of things. These professionals might even work with web based accounting software. Other professionals own their own accounting practice and simply prepare the basic tax returns or assist in the preparation of an assets and liabilities chart.
There are many different ways to go about keeping track of the crunching of numbers that accountants do. Some people who tend to be somewhat from the old school thought of doing things. These individuals merely do their accounting computations with a pad of paper and a pencil. Although this way of doing things may seem strange and slow for those of us who were raised during the technology boom, those who utilize their pencil and paper swear by it. You will never hear them complaining that they just lost all of their data because the computer froze and they had to start all over. Always having a hard copy of your work is one of the benefits to employing this method rather than using an accounting management system.
Accounting
For those professionals who are more computer savvy, they simply use some sort of accounting software. With this specialized computer program, the users are able to just type in the information that the computer is asking for next and the software generates a perfectly complete tax return. This can come in quite handy and can save valuable time, especially when it comes to preparing the more complex returns. This is generally when you are dealing with a partnership return, a trust return or even someone who has several rental properties they manage.
Accounting - Using a Pencil and Paper to a Complex Accounting Management System
When it comes to saving time and money, one of the best ways to go about doing this is through the use of web-based bookkeeping. When using web-based accounting software, people who work for your company all around the country can have ready access to your accounting. Plus there are no setup fees and you also get to keep your initial costs lower.
No matter what method of bookkeeping you or your company uses, there is really no correct way. When it comes to getting the job done, the best you can do is to use whatever system makes you the most comfortable. Even if that means using a pencil and a pad of paper!
Accounting - Using a Pencil and Paper to a Complex Accounting Management System
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A bachelor degree in accounting is at least one of those degrees that have a clear and precise purpose. Almost all students who get a bachelor degree in accounting go on to become accountants. This is why this particular degree is actually one of the more popular ones. Ironically, however, it is not one of the easier ones. So just what is involved in getting a bachelor degree in accounting?
The old saying that you had better be good with numbers to be an accountant can't be any more true. You had better be a whiz with numbers if you want to be a good accountant. If you want to be a great accountant, you had better be able to think outside the box as well. More on that later.
Accounting
A bachelor degree in accounting is really to prepare somebody to become a CPA, or Certified Public Accountant. This is very similar to somebody who wants to go into law and having to pass the bar. If you want to be a CPA, you also have to take an exam and it's not easy. You pretty much have to know your tax laws inside and out, aside from knowing every aspect of accounting from debits and credits to debt to equity ratio.
Bachelor Degree - Accounting
Your first year as an accounting major begins with two semesters of basic accounting. This is where you do learn your basic debits and credits, how to do a ledger, journal, etc. The basics of accounting are, for the most part, pretty easy. But if you can't get through your first two semesters you're not going to have a chance at what comes next. From year two through your last year in college, you will learn the most advanced accounting principals. Probably the most important skill you will need to be able to get through these years, in addition to being good with numbers, is logic. The reason is that in accounting, everything has to balance. One side must equal the other. This basically comes down to logically working through every entry.
In addition to these advanced accounting courses, as if they're not hard enough, you're also going to have to take other math related courses such as statistics, probability and in some schools, even calculus, at least for one semester.
In addition to math related courses, you're also going to have to take financial courses. This makes sense since accounting is not just about numbers but also about running a business. So courses like economics, finance and business management are not uncommon for an accounting major to take.
Earlier we talked about thinking outside the box. The reason this is important is that a lot of accounting is figuring out creative ways to report income and expenses so that they make a company's tax liability as little as possible, within the law.
Many people think accountants have boring jobs, but the truth is, accountants have to be some of the most creative minds in our world in order to deal with all the changing tax laws and keep a company from losing its shirt. Yes, getting bachelor degree in accounting is not as easy as some people might think.
Bachelor Degree - Accounting
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There are three major functional areas in accounting, which need to be considered in modern day accounting for any business. The three are financial, cost and management accounting.
The first area, namely financial accounting, is primarily useful for ascertaining the results of the business on a periodical basis; for example, one year. This will help to determine the future course of action in the long term. In economical terms, financial accounting treats money as a factor of production.
Accounting
Cost and management accounting are tools to enable management to take decisions on a day-to-day basis. Cost and management accounting are not useful for their own sake. These two functions assist management in the conduct of the business along with other key factors involved in running of the business. Key factors could be demand, supply, competition, availability of raw material, logistics etc.
Accounting - Three Major Areas
The second area, namely cost accounting, seeks to ascertain the value of direct costs and indirect costs involved in production . From this value, management can make an informed decision regarding the improvement of production performance. In economic terms, cost accounting is a measure of economic performance. This information gives management a clear indication of economic performance of the production resources of the business.
Costing also helps the sales manager in setting prices. But since costing is a measure of economic performance, it cannot be considered as an absolutely accurate basis for setting prices. This is because selling prices are more of an economic decision. It would not be amiss to mention here that prices depend basically on market factors. Prices depend more on demand, supply and competition and less on costs. For example, high demand coupled with lack of competition would mean that business could charge higher prices for its products, well above the costs.
The third area, namely management accounting, is closely interrelated with costing accounting. Although it has evolved from cost accounting, management accounting has a broader role to play in management decisions. It measures economic performance of the business enterprise as a whole, vis-a-vis the economic environment in which the business operates. This function of accounting seeks to combine the financial and cost information in a broader aspect.
Finally, management accounting is instrumental in assisting and advising management in making important business decisions. It makes management aware of the economic implications and consequences of their decisions. In economic terms, it implies a close study of money as an economic resource, while simultaneously treating it as a measure of economic performance. This enables management to measure it as an economic factor of production, e.g. the rate of return on capital employed.
It is thus seen that accounting has a distinct role to play in three different areas, which are equally vital. With the advent of computerised accounting, it has become very easy for management to monitor the accounting information on the tips of its fingers. Financial accounting programs enable financial statements and various cost and MIS statements to be produced almost instantly at push of a button. Now, only the laborious part of accounting is data entry. Financial managers must ensure that meaningful data is input into the system to produce meaningful information. Proper categorisation must be done and keying errors avoided at all costs, ensuring providing accurate financial information to management.
Accounting - Three Major Areas
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When learning accounting for the first time, the terms 'debit' and 'credit' can be a bit confusing. Why? Because when you go to the bank and deposit money, the teller will tell you, "I am crediting your account X amount of dollars," but if you are taking money our of your account, the teller will tell you, "I am debiting your account X amount of dollars." Also, with debit machines all over the place, and credit cards in everyone's pocket, the two accounting terms take on a whole new meaning.
However, what we've learned about these two words so important in the accounting world, debit and credit, have to be unlearned quickly. Why? Because in accounting, the term debit is used to describe a bank account and that money owed are actually credit accounts - the exact opposite of what we've been taught elsewhere.
Accounting
In accounting terms, neither credits nor debits are 'bad', but they need to equal each other in order to balance themselves out in the end. Every itemized transaction, no matter if it's a deposit or a bill to be paid has both a debit and credit posted in the accounting world. This is what is called 'double-entry accounting' - so when you go to the bank, and the teller says, "I am crediting your account X amount of dollars," she is also debiting an entry of a similar amount without telling you this. The same goes for when the teller tells you, "I am debiting your account X amount of dollars," - the accounting will show that a credit of the same amount is being made elsewhere at the same time.
Learning Accounting: Debit and Credit Basics
The easiest way to figure out debits and credits in accounting terms is to figure out the following: what did you receive, and where did it come from. The debit is what you received, and the credit is where you received it from, in accounting terms. So for demonstration sake, let's say you bought a CD with your credit card. The CD is what you got, so it will be a debit in the accounting world, and the credit will be applied to the liability you carry on your credit card for the exact same amount.
The bank can easily confuse people learning about credits and debits in the accounting sense of the words, especially when discussing liability. For instance, when you put money in the bank, the bank's liability to you increases, and since liabilities are credits, they are crediting your account (in accounting terms). And when the bank lowers their liability to us (by us taking money out of the bank) the banks are debiting the liability account, from an accounting perspective.
Basically it comes down to being able to figure out what you got and where exactly it came from; if you can figure these out for every transaction, then you've got the accounting terms of credit and debit down pat.
Learning Accounting: Debit and Credit Basics
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Depreciation is the accounting practice of spreading the costs of fixed assets over their useful economic life. Fixed assets are items that a business needs to purchase for long term use, things such as buildings, machinery, equipment, furniture and tools. Depreciation is a non-cash or bank expense that allows for a provision to be made for the replacement of any fixed asset, thus enabling a business to maintain its future operations.
The characteristics of depreciation are:
Accounting
It is related to depreciable fixed assets only.
It is a fall in the book value of a depreciable fixed asset.
It is the permanent and continuous decrease in the book value of an asset.
Accounting - Depreciation
The main causes of depreciation are:
Physical wear and tear over a period of time i.e. over a number of accounting periods.
Changes in the economic environment faced by a business.
Expiration of legal rights.
The need for charging depreciation in accounting records can arise as a result of any of the following objectives:
To ascertain the true results of the business operations.
To ascertain the true cost of production.
To present a true and fair view of the financial position of a business.
To accumulate funds for replacement of assets.
To comply with legal requirements.
To calculate the depreciation charge three important things must first be determined:
The original cost of the asset.
An estimate of its economic useful life.
An estimate of its residual value.
Depending upon their own preferences, businesses are free to choose from a number of methods when calculating depreciation. Two of the most common methods are as follows:
Straight-Line method - Here the depreciation charge is the same each year.
Amount of depreciation= Original cost-Residual value
Estimated useful life
Reducing Balance method - This is a slightly more complicated but more realistic method of calculating depreciation. When using this method the depreciation charge is higher in the early years when it is thought that most assets lose most of their value.
Annual depreciation= Depreciation rate x Book value at the beginning of each year
Where the book value is the Original cost less the Accumulated depreciation
The first step in the procedure of recording transactions is to journalize and the second step is to post the transactions in the ledger. Ledger is known as the 'principal or chief' book of accounts. In ledger the financial information is classified by its nature and relevance.
The statement which records the transactions at one place relating to a particular subject is known as account. The book which contains all the accounts is known as ledger and the procedure of writing up the accounts is known as posting.
Accounting
The ledger is the most important book of account and is the destination of the entries made in the Journal or Sub-divided Journals. It is a collection of all the three types of accounts --Personal, Real and Nominal. If you are faced with questions like:
Accounting Ledger and How to Write Ledger
- How much a particular customer owes you?
- What is the amount payable by you to anyone of your suppliers?
- What is the amount of goods purchased by you during specific period ?
- How much sales you have affected during, say, last three months?
- What has been your expenditure on, say, labor during the period?
Then the quicker and easier way of ascertaining the relevant information is to turn to your ledger, find out the balance of the Customer's A/c or Supplier's A/c or Purchases A/c or Sales A/c or Wages A/c.
How to write Ledger
In ledger we maintain accounts. Each account is allotted one or more pages depending upon the requirement. Ledger is usually ruled in anyone of the following two alternatives. First alternative is followed in those cases where balance is required to be ascertained after every transaction e.g. Banks.
Second alternative is followed in those cases where balance is required to be ascertained only periodically, say after a month or quarterly. In your study of book-keeping and accountancy T- shape accounts will be used (alternative-two).
The transactions are entered in the ledger accounts in order of dates. Every entry must be dated which must be shown in the column meant for date. This is the first column on the left of each side of the account.
Record the relevant amount on the left-hand side of the account which, according to the journal is to be debited and record the amount on the right-hand side of the account which, as per journal, is to be credited (use 'amount columns' for this purpose). In ledger account each entry on the debit (left-hand) side commences with the word "To" and one the credit (right- hand) side with the word "By". In the 'particulars column' reference is made to the other account involved for providing cross reference. In the 'folio column' would be entered the page of the journal (or page of the relevant sub-divided journal) from which entry has been posted and in the folio column of journal, the page number of the ledger is written on which the relevant account appears.
Following the above procedure of recording the entries in the ledger will in fact amount to this The account receiving the benefit in shape of cash or goods will receive the debits and the account imparting i.e. giving away the benefit will receive the credits.
Accounting Ledger and How to Write Ledger
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In layman's terms, what is the income statement? We will look at the various components of the income statement: revenues, cost of goods sold, expenses and net income. Income statements are helpful, because they will give you some history of the business in order to budget for future operations and assess risk of future cash flows. An income statement is also known as a profit-and-loss statement.
The nature of the income statement is that it is a reflection of operations over a period of time, i.e., "for the month ended June 30, 2006", or "for the year ended December 31, 2006". This is different from the balance sheet, which reflects a certain point in time. Income statements contain what is known as "temporary" accounts and the balance sheet contains "permanent" accounts. Temporary accounts such as sales revenues and expenses are "closed out", net income/loss is determined and this net amount ends up in an owner's equity account. The accounts are closed at the end of one period, reopened and reused for the next period.
Accounting
The income statement is revenues less cost of goods sold, less expenses, equals the net income or loss. Revenues are the sales of items normally sold in your business; what are you selling? Do you sell goods? Do you sell services? It is the selling price times the number of items sold. Sales are usually shown as net sales and some adjustment to sales would include sales discounts, sales returns and allowances.
Accounting - Explaining The Income Statement
If the business sells goods, the next part of the income statement would be the cost of goods sold section. If the business sells services, it won't have this section. Because this is such a large part of expenses for a retail establishment, while it is an expense, it is broken out separately from other expenses. The business will need to know how much inventory it started with and how much inventory it had during the end of the period. Additionally, it will need to know how much inventory was purchased during the period. There are a number of ways to value inventory, such as Fifo (first in, first out), Lifo (last in, first out), average cost, specific identification, etc. Since we are taking a high-level glance at the income statement, it is just important at this time to note that, because of subjectivity of inventory methods, this can be more of an art than a science. Beginning inventory plus goods purchased equals goods available for sale; goods available for sale minus ending inventory will give you the cost of goods sold.
Expenses are outflows of cash necessary to the operation of the business. Some expenses are easily identified, such as rent or mortgage, utilities, office salaries, supplies, etc. and these are referred to as selling and administrative expenses. Selling expenses are costs related to selling goods, such as the salesperson's salaries, shipping, freight, advertising, etc. Research and development costs are also valid expenses. If you own the building, vehicles, or equipment, there are depreciation costs. That just means if you own an asset that lasts for a couple of years, you can write off part of the cost of that asset as a depreciation expense for a certain number of years. Like inventory costs, there are a number of ways to subjectively determine depreciation, such as straight line, accelerated depreciation methods, etc. so there isn't just one possible answer to determine depreciation costs.
To determine net income or loss, you take revenues minus cost of goods sold minus expenses. If this number is positive, it is net income. If this number is negative, it is net loss. This amount is closed to an equity account, such as an owner's capital account for a sole proprietorship or stockholder's equity for a corporation.
Expenses and/or income outside the realm of usual business operations should be included in its own separate section. For example, the business is a shoe store and they sell one of their buildings or part of their vacant lot, which creates an inflow of money. This is not what you would expect a shoe store to do. In order to make income statements comparable by year, this special income will need to be shown in a separate section above net income.
So, at a high level we've looked at the income statement, defined the components of revenue, cost of goods sold, expenses and net income. We've pointed out areas such as inventory valuation and depreciation where different methods can be used which will determine different financial amounts. Businesses need to select their methods carefully and stick with them for consistency. It is not totally impossible to change these valuation methods, but it would require special disclosures, etc. Once we understand the basics of the income statement, it will help us understand income statements from a number of different companies, regardless of the nature of their business.
Accounting - Explaining The Income Statement
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The movie, "Innocence of Muslims," that mocks and insults the Prophet Muhammad caused demonstrators to attack a US consulate in Libya, killing one American, and breached the walls of the US Embassy in Cairo. Angry protests over the film by a US producer, directed and produced by an Israeli-American real-estate developer who characterized it as a political effort to call attention to the hypocrisies of Islam. It has been promoted by Terry Jones, the Florida pastor whose burning of Qurans previously sparked deadly riots around the world. In Benghazi, Libya, several dozen gunmen from an Islamist group, Ansar al Sharia, attacked the consulate with rocket-propelled grenades to protest the film, a deputy interior minister for the Benghazi region told the Al-Jazeera network. A government brigade evacuated the consulate, after which militants set it on fire, said the minister, Wanees Sharef. One State Department officer was killed in the attack in Benghazi, Secretary of State Hillary Clinton said Tuesday night. Mrs. Clinton said the State Department was working with Libyans to secure the compound and protect Americans in Libya. To the east, in Cairo, a crowd of some 2000 people gathered at the Embassy to protest the video. Some of them climbed the embassy walls late Tuesday, pulling down and burning an American flag. Hours after nightfall, dozens of young men remained standing on top of the embassy walls, shouting into megaphones. One of the youths climbed up the flagpole to ...
HR in accounting is important because the people here are employed in order for the organization to successfully measure the efficiency and the effectiveness of the activities in the personnel management level. In addition to that, they will also help the company to measure the utilization of people in all the areas of the organization. They can aid the company to understand the human resource value and the costs, which is why there is a need to understand and define the whole concept of HR in accounting.
HRA has been defined as something that involves the identification of the human resources and how to measure the data associated with them. The collected data will then be communicated to the interested parties. Some companies do not know about HRA efficiency and so they choose not to implement this practice. However, the HR in accounting has a lot to do with the success of the organization. They have many roles to play and when executed well, the business will definitely be productive.
Accountant
One of the many roles of the HRA is that this furnishes the cost or value information when it comes the decision making in the management. These decisions are about acquiring, developing, allocating and maintaining the people in the company so that the business will be able to attain and sustain cost effectiveness. Another is that the HRA allows the management personnel to easily monitor the use of human resources. If you have a large company to manage, you know that it is hard for you to supervise all the employees that you have. This is why you need the HR in accounting. They will serve as your eyes and ears in order for you to be assured that you are using your human resources efficiently.
Understanding the Role of HR in Accounting
Being your guide in human resources, you will be provided with effective and sound basis regarding control on the company's human assets. You can quickly determine whether the said asset is appreciated, conserved or depleted. Therefore, you will be given an idea as to whether or not you should do something about your HR or if you are doing good already in this particular department. The HRA also helps in the development of the principles in managing the company. This is done by means of classifying the financial risks and consequences regarding a wide variety of processes.
In general, the HR in accounting is a management tool that has been designed to help the senior management when it comes to understanding the benefits and costs of their HR decisions. As a result, there are greater chances that the company will make really good choices in the end. HR in accounting if not done can bring risks into the organization. This is because the management will be making decisions that they think might improve the profitability of the company in the short run. However, what they do not know is that taking such decisions might have severe repercussions in the coming years. Hence, the HRA is a great method that the management can practice so that they can avoid expensive mistakes in the future.
Understanding the Role of HR in Accounting
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Accounting is the heart and soul of business. It includes all areas of business from small local businesses to giant global corporations. Accounting is the defining essence of trade, and includes all areas of commercial practice. Accounting training is therefore particularly important for aspiring businesspeople. If you're looking at a future in finance and/or accountancy, accounting training at a good business school is essential.
Basic accounting training
Accounting
Accounting training is inevitably linked with financial management. The basic training in accounting is the bedrock of further studies and qualifications. It's also the primary training for critical technical management skills. The basic training levels are based on accountancy. Typically, the academic stream progresses from basic accountancy to advance diploma level, followed by further tertiary qualifications.
What You Need To Know About Accounting Training
Career development and accounting training
If you look at the world's most successful businesspeople, you'll find that all of them are engaged in some form of accounting, whatever area of business they're in. They've become experts in commodities, financial products, and above all their markets, which are good examples of accounting in practice. You'll also notice that they're extremely adept at working with the nuts and bolts of commercial practices, conversant with everything from reporting to financial analyses, which are parts of advanced accounting.
These are just some of the developments of accounting training in a career. In practice, training in accounting is extremely useful for job mobility across all areas of business, and can be used as a good basis for career moves. The range of skills in accounting is valuable in all areas of business, and there are many senior positions for which accounting training is essential.
If you're starting your career, a good business management course in accounting is critically important. This training is indispensable in establishing a firm qualifications base for your career. If you check out the entry requirements for most forms of advanced business and financial training, accounting training requirements are inevitably part of the prerequisites.
Hints and tips
There are several very valuable areas of training which can be used by students as excellent "on the job training". If you're currently working in any of the financial, banking, or mercantile industries, you can use your training to enhance your job opportunities. If you're prepared to do extra work, this can provide immediate rewards. Speak to your managers, explain your training needs, and volunteer for jobs which will give you practical experience in things like accountancy, taxation, and finance. You'll find you will get your manager's support. By doing this, you're not only getting qualifications, you're getting excellent additions to your CV while you're training.
When you get your qualifications, you'll also have highly competitive practical experience to help you get jobs. You'll definitely be able to progress rapidly to better paid jobs. If you consider the sheer number of different types of well paid jobs which require accounting training, you can see that you're already well on the way in your career.
Accounting training is perhaps the most useful area of training for anyone interested in getting a quick start in a financial, business or banking career. Don't miss the opportunity to get this invaluable career advantage.
What You Need To Know About Accounting Training
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Accounting is considered to be high profile in nature due to the complexities involved. It includes a vast maze of tasks like recruitment, competitive work efficiency, perfect time management and financial resources. These tasks demand precision of high grade and this is sought to be achieved by the organizations by outsourcing accounting professionals. Outsourcing is such a sought after option that organizations anywhere in the world can't seem to be doing without it. The major reason behind this is management of the tax season which is grueling and often details are overlooked in the rush. Accounting business outsource process handles these business parameters at lower rates in efficient way and thus assists companies to arrive higher growth curves. Though other parameters do assist in the success of an organization, accounting is yet described its actual backbone.
Accounting business outsource process is effective in minimizing the workload of an organization, paving way towards earning massive profits. Financial advisers now know that it is better to outsource the accounting experts who are adept in their tasks quite well. A reason behind this is affordable charges compared to ones charged according to the per diem system by the accountants in US. Their acumen comes forth while making data entries, creation of annual financial reports, tallying transactions etc. and organizational training imparts further cutting edge in their accounting skills. In this process, professionals are hired for their specialization in managing the business alliances and thereby rendering financial investments profitable from every angle. Extracting maximum profits from minimum possible resources of an organization is one of the attributes that defines the brilliant work of these accountants. Outsourcing accounting work in this way, undoubtedly unleashes the growth potential of an organization.
Accountant
The professionalism of these accountants comes forth while handling the difficult tax session. Plus, the resources like manpower and financial reserves already saved are diverted towards other important sectors of any company. A number of tasks like compilation of financial expenses, calculation of tax are performed by them with a precision that is unmatchable by any means. This ensures a timely filing of taxes by the business heads and you are also assured of innumerable techniques which assist you in reducing tax legally. These accountants have a complete hold on various nuances of projects, handled by the organizations and possess a perfect sense of time management. Since even a minor error can pave way towards a perfect disaster, it is imperative on the part of company heads to be quite selective while choosing any preferred outsourcing company. A meticulous background research in this case proves to be advantageous for the company and only a certified association should be contacted to handle crucial projects.
Accounting Business Outsource Process - Manage Your Accounting Tasks in Easier Ways
Accounting business outsource process is a surefire path towards progress and prosperity of any business venture. A contract based system is followed by the outsourcing firms whereby expenses are charged according to the amount of work done. One is sure to arrive grandly in the market arena with an active assistance of certified accountants who offer cost effective options to the companies for their projects. Information about these brilliant experts can be procured from the internet and consultancies, providing you with a complete profile of the outsourcing firms as well as the professionals working in these organizations.
Accounting Business Outsource Process - Manage Your Accounting Tasks in Easier Ways
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If you have an ambition is to become a successful accountant and want to choose accounting field as your career path after graduation. Then, you need to start planning for your career path and working toward the success of achieving your career goal. In accounting field, a good knowledge in accounting, constant accuracy and working experience are of utmost important for a success. Here are 8 steps that you can include in your career path planning to ensure you are in the right track to meet your career goal.
Step 1: You must Excel in Math
Accounting
Accounting is about numbers and the manipulation to numbers; hence, you must certain that you excel in math at high school. People who hate math may not be success in accounting field. That's why you got to love math if you like to become an accountant. Take a special attention in math and ask your teacher or counselor's guidance on which courses to take to best prepare you for earning a degree in accounting when you enter a college later.
8 Steps To Your Career Success in Accounting
Step 2: Request Information From College that Offer Accounting Degree
Beside the traditional brick & mortal colleges, there are many prestige's online colleges and online universities offer degrees in accounting that enable you to earn an accounting degree from home. Send a letter, an email or make an online information request to those colleges that offer accounting degrees for heir catalogs and admission requirement on their accounting degree programs.
Step 3: Research On Certified Public Accountant Requirement
In order to become certified accountant, you must receive Certified Public Accountant certification, CPA from a state. The pre-requirement to CPA certification is you must first receive a bachelor's degree in accounting or in related business fields. Check out the information on the requirement of CPA will make you more prepare on what courses need to be taken in accounting degree program. See the American Institute of Certified Public Accountants (aicpa.org) for further information.
Step 4: Ensure Your Accounting Degree Will Fulfill State Requirement
Normally, you will start your first career in you own state after graduating from your degree program. Hence, you need to make certain that the accounting degree program that you are going to enroll fulfill all state requirements, else you will face problem when you want to start your accounting career later.
Step 5: Decide Accounting Field Of Interest
There are a few starting points for your accounting career, you may major in public, government, and management accounting or internal auditing. No one degree program will cover all these fields; you need to choose which field that best suits your interest which you can choose as your majors of study.
Step 6: Become Proficient with Accounting Software
The time of using Microsoft Excel program in accounting work was over. You need to become proficient with a variety of accounting software if you want to success in this field. You may not be able to learn all the accounting software in the market, but you need to familiar with the common accounting software use by most corporate.
Step 7: Gain Working Experience in Related Fields
Related working experiences are important in determining a success in your accounting career. If you are attending class-based accounting degree program, you could work at part-time jobs or internships in accounting firms during your college years. If you are getting your accounting degree online, then you can start gaining your full working experience in accounting with a full-time job, because an online accounting degree program allows you to plan your learning schedule that fit into your full-time job.
Step 8: Takes CPA Test & Become A Certified Accountant
You can start preparing for CPA (Certified Public Accountant) examination while earning your bachelor's degree in accounting. You will need some accounting experience, in addition to a bachelor's degree, before applying for the test.
Summary
In order to prepare you career path to successfully become an accountant, you need to have a bachelor's degree in accounting, a good working experience in accounting field and pass in CPA examination.
8 Steps To Your Career Success in Accounting
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In today's business world, it is difficult to survive on incompetent supports and thus, most of the intelligent owners are striving hard to ensure the best of services for their business. For this kind of a requirement only, the facility of outsourcing has developed in the business fraternity. Every big, small and medium sized company is actively forming alliances with outsourcing firms, where accounting has been discovered as the most prominent field associated with this application.
Accounting outsourcing is basically a mechanism where business organizations attempt to outsource their quotidian accounting tasks to hired professionals from a reputed vendor dealing in the business of providing outsourcing services. The accounting experts recruited in the outsourcing firms are highly qualified and have updated information about various tools, techniques and softwares launched in the market for better execution of the work. Moreover, the accounting professionals can easily adapt the software techniques and programs that are already being used in the company of the client. Such kind of avid proficiency is beneficial in dissolving the requirement of learning or training and the accounting job processing can be continued in a similar manner.
Accountant
Nowadays, most of the companies are applying for a more safe and convenient option of accounting outsourcing by getting their accounting jobs done through the efficient source of a third party vendor. In turn, the vendor hires competent accounting personnel, efficient in managing and maintaining all financial transactions of the clients. Outsourcing service providers ensure that the client has direct access to his financial records. The regularly updated accounts generated by the experienced accountants benefit the company by offering accurate image of the company for the analysis of the shareholders,creditors, investors and the public in general. On the other hand, the client is also allowed to keep a direct check on the work efficiency of the accountants through the online services. Suggestions and amendments are accordingly made by the client whenever required. In total, the entire concept of accounting outsourcing is advantageous for the business firms in every aspect if the execution is carried out on favorable terms and conditions.
Accounting Outsourcing Will Share Your Burden Of Responsibilities
As far as the small business organizations are concerned, the chances of finding a well qualified accounting team are almost negligible. What usually has been observed with such low profile firms, is the fact, that it is basically their clerical staff which is held responsible for managing their accounting projects. However, such inappropriate work strategy ultimately acts as a catalyst in lowering the quality as well as the efficiency of the company. Therefore, even the small business organizations should focus on the task of accounting with deep consideration and sincerity. Any kind of leniency or disregard to this requirement can result in the downfall of the company. Therefore, for accomplishing an expected growth rate, the owner should immediately opt for an experienced accounting service or an outsourcing firm. Hence, do not waste any more of your precious time in rescheduling your accounting management or recruiting new intelligent team of accountants on a higher payroll. Simply contact a decent accounting outsourcing firm and let all your worries collapse with this added hand of assistance.
However, while searching for a good vendor to take up your task of accounting management, it is recommended to conduct a planned background research on the available vendors, so that you can ensure a beneficial deal. The most demanding requirement of a substantial accounting outsourcing service is the reliability and the authentication of the vendor. Moreover, the entire outsourcing network should be intelligently programed with suitable security tools to avoid the chances of misuse and hacking of confidential data and files shared by the client. For the research, you can contact the previous clients of your preferred outsourcing company as they can offer correct information about their performance and time management. Once you have handed over your accounting work to an appropriate vendor you can then stay assured regarding the maintenance of your company records.
Accounting Outsourcing Will Share Your Burden Of Responsibilities
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Other articles on Domestic Well-Being Accounting (DWBA) have hinted about the new ideas upon which this new domestic accounting model is based. In this article, the rationale, ideas and concepts are summarised, based on the coverage in a new book 'Accounting for a Better Life'.
Accounting
Accounts
A New Domestic Accounting Model based on Domestic Well-Being
At its simplest, an account is just a list of transactions relating to some area of financial activity or interest. The most familiar form of account is the bank statement that customers periodically receive from their bank.
The first important thing to appreciate is that accounts are for accumulating information about value. We are so used to bank and credit card accounts which are all about currency that people sometimes do not realise that accounts are equally useful for accumulating transaction details relating to, for example, our home, our car(s) - one account for each car - our investments, etc.
Accounts will usually have two columns, one for increasing (+) amounts and the other for decreasing (-) amounts.
The next important concept is to appreciate that there are two distinct, overarching types of accounts that we can use in our sets or books of accounts. One is called an asset account and the other is a liability account.
The asset type account as its name infers, typically relates to storing transactions for assets such as bank accounts, houses, cars, etc. The idea behind this is that positive amounts entered into the + column of an asset account signify increasing value; so £500 entered into the + column of an asset account implies an increase in value of £500. However accountants will also have in their business accounts, what I call working accounts for home accounting, as other accounts of the asset type which are not strictly for an asset such as a car or home. Examples include accounts for asset acquisitions and for depreciation.
That other overall type of account is a liability account. It is used for accumulating debts and/or liability. Now we have the reverse concept in that increasing amounts e.g. £300 in the + column of these types of accounts imply more debt or more liability, whilst a decrease of £200 represents less of a debt. You might think more debt means less value but it all depends on the purpose for which a liability account is being used. Again, accountants mostly use liability type accounts for holding true debt amounts but again, have a need for other accounts of the liability type to mediate certain transactions. I refer to these as working accounts in home accounting as they do not relate to any true debts of a person or household; examples of these are for accumulating temporary information about asset acquisitions and growth in the value of a home.
Another area for confusion here relates to the names for column headings used in the different software packages available to support accounting; in business, the convention is that debits (the + column for asset accounts and the - column for liability accounts) are traditionally in the left-hand column of each account, with the credits on the right (the - column of asset accounts and the + column of liability accounts). This convention is not always adhered to in some software packages, together with not always using the headings, debit and credit.
Double Entry and the Accounting Equation
The last bit of theory to mention which lies at the heart of DWBA accounting is so-called, double entry. This concept appears confusing to people because it has two aspects. First, it is an accounting concept which relates to an approach for taking into account (there's an appropriate phrase!) all the financial aspects of some financial entity. In business, an entity might be a department or a division, a sole-trader or even a whole plc. For domestic accounting, such an entity would most often be an individual or a household. The point is that the accounts supporting any of these entities consider or model the totality of the financial aspects of the entity. As such, the accounts will be able to capture and make visible both the static and dynamic aspects of the entity finances. The practical effect is that a set of double entry accounts (the books) requires an account to store the total financial value of the entity as well as usually, some accounts for accumulating periodic changes in terms of increases and decreases to this overall value. The result is what is termed a balanced set of accounts, related to an accounting equation.
The other common use of the word double entry is related to the bookkeeping techniques for implementing this form of accounting which requires two (double) entries in the accounts for each new transaction, in order to maintain the required balance.
What do we mean by balance? Well balance is the key to double entry and it comes from balances in accounts, as maybe related in some way in this equation; the so called accounting equation.
If we consider a household, it might consist of a collection of assets - a home, a car, three investments and a consolidated bunch of unspecified appliances. We could set up 6 accounts to represent all these assets and assuming there were no liabilities of the personal debt sort - an unlikely assumption - we could say that our domestic wealth equals the sum of the balances of those 6 asset accounts. Here is a statement, which is not yet a true equation:
The sum of all Asset a/c balances = our Domestic Wealth
Now if we had some debts, perhaps a mortgage on the house and a loan for the car, we could set up two more accounts (of the liability type) to hold these two debt amounts.
Since we owe two amounts for these debts to some financial organisations, we have to earmark the appropriate amounts to be repaid from the value of our assets, in order to derive the changed new value of our domestic wealth, so we can show this in another statement:
All Asset a/c balances - All Liability a/c balances (of the debt type) = our Domestic Wealth
The crucial point about the double entry system is that we need to setup an additional account in order to store the amount of our changing domestic worth. I call it a Domestic Wealth account.
Now, instead of a statement, we have an equation which is balanced:
All Asset a/c bals - All Liability a/c bals (of the debt type) = Domestic Wealth a/c bal
The next issue is what type of account do we need to hold the domestic wealth - asset or liability?
When you think about it, the amount of the domestic wealth represented by the assets less the debts is owed to the eventual beneficiaries of the household or individual's estate. It should therefore logically, reside in a liability account.
Now we can tidy the equation up by putting all the asset type accounts on one side with all the liability type accounts on the other; the result is with appropriate changes to the signs:
All Asset a/c balances = All liability (debt) balances + the Liability (DW) a/c balance
Let's imagine a situation where an individual starts up with £20,000 in a bank. For that individual to establish a double entry accounting system, we need an asset account for the bank account and since there are no debts, just a domestic wealth account; a double entry is required for the initial transaction, with £20,000 debited to the asset account for the bank and the same amount credited to the liability account for domestic wealth. In the accounting equation, we can see the result as:
Asset a/c bals £20,000 = All liability (debt) bals 0 + Liability (DW) a/c bal £20,000
Let's see how we handle buying a car with a loan of £2,000. By breaking it down into steps, we first consider receiving a loan - so receive (debit) bank with £2,000 and setup a new liability type account for the loan company and credit it with the same £2,000 - with this effect in the equation:
Asset a/c bals £22,000 = All liability (debt) bals £2,000 + Liability (DW) a/c bal £20,000
Still balanced at £22,000 on each side!
Now we buy the car for £7,000 using the £2,000 from the loan and the extra £5,000 from the bank assets. We also need to setup a car account to receive the value of the purchased car. The end result from the equation perspective is still a balanced equation:
Asset a/c bals £22,000 = All liability (debt) bals £2,000 + Liability (DW) a/c bal £20,000
The asset a/cs are now made up of Bank (£22,000 - £7,000) and car a/c £7,000 with no change in overall value on the asset side but a distribution in values across the asset accounts.
Another thought about double entry is that any single entry made to a balanced equation (set of balanced accounts) must unbalance it! The only way to retain balance is, from the maths perspective, if we add something to an account on one side then we must add the same amount to an account on the other side; or if we add something to an account on one side we must reduce by the same amount, in an account somewhere else on the same side. This in effect, if you work it out, is what the accounting rule says in that a debit posting must be balanced with a credit posting.
As we buy food, drink and clothing, pay utility bills and purchase holidays, we will see reductions or credit in our asset account for bank or, if we pay by credit card, equivalent credit entries to increase our debts in the liability type account for each credit card. These are termed expenses and will lead to an equivalent decrease in our domestic wealth. It should be obvious that if we post credits as the first part of each expense transaction, we will need corresponding debit entries to balance them. Increasing debits imply an asset type account so that will be the sort of account that we need for these increases. By the same logic, income such as salary or pension will be first entered as increases or debit entries in our bank account and must be balanced by credit entries in a new account for domestic increases - increases that are credit entries occur in liability type accounts so this is the sort of new account we need to setup for accumulating changes for increases to domestic wealth.
Non Double Entry Accounting
Traditionally, accounting for personal and home use has not made use of the principles of double entry; and the software packages that support home accounting are not usually geared up to properly support it. The reason is partly because when people ventured into home accounting, they tended to start with activities such as reconciliation of checking accounts and simple budgeting. For this, they tended to only require setting up accounts for one or two areas, mainly related to bank accounts. With this, as useful as it is, there is no concept of seeing the total picture, with the static and dynamic views of the financial state of affairs.
Business versus Domestic Accounting
When I first decided to start 'doing' my own home accounts many years ago, I believed that since business accounting had evolved over such a long time to be able to so successfully satisfy business managers' needs to manage business finances (and there was a legal requirement for them to do so) there must be something special in business accounting that I could look for, to be able to help people better manage their personal and home finances. As described elsewhere, I discovered that business accounting methods themselves were of little help because of the wrong focus (profits for capital gain) and that the actual accounts, reports and associated business ratios were also, understandably, entirely inappropriate.
In thinking about alternatives, I realised there were some features that could be extracted from business and with modification, be used effectively to help manage home finances.
Reports
With the double entry system we can obtain a static view or 'snapshot' of the state of the finances of a business and this is called a Balance Sheet. This shows the assets, liabilities and capital value on any particular day.
Most of the entries in the business Balance Sheet come from balances in the accounts which can be easily extracted from a Trial Balance which is simply a list of all the balances for all the accounts in our books.
The structure and contents of the Domestic Balance Sheet (DBS) highlight the major components of the domestic assets and liabilities in order to derive the new value of Domestic Wealth. Rather like the net profits being brought into a business balance sheet, the domestic version shows the Total Domestic Change (TDC) as the contribution to Domestic Wealth over the past period.
Now, the important issue is what does the TDC consist of? We probably know that the business equivalent of profit or loss is exposed in the two accounts - the Trading account and Profit & Loss account. These two accounts highlight the dynamics of the financial situation; the changes over some period.
For business, the focus is on profits and so these accounts concentrates first, on the higher level aspects of the business with opening stock, the purchases made to augment this stock and the closing stock value.
The next account called the Profit & Loss account shows the impact of other increases and decreases which usually reduce the gross profit to some lower value, called the net profit.
The individual accounts required by business have no place in home finances as we are not primarily interested in profit.
The new Focus - Domestic Well-Being
What should the financial focus be for a home finances? Well I gave much thought to this and over some years and developed a new focus with an associated approach and methods, based on what I eventually termed, Domestic Well-Being.
In short, yes, homesteaders do want to increase their worth or value, but not usually for 'profits sake'. People want to increase their wealth to pay for things that tend to occur in a progression throughout a lifetime; like better homes, education perhaps, hobbies, luxuries and provision for those retirement and eventually, declining years when income is drastically reduced.
In general, home finances in the earlier years of a lifetime are such that there is never enough to go round. Everything is a question of priorities and balance. What should be the best distribution of our expenditure to ensure that we can obtain the best possible balance or compromise, with the income at our disposal?
My solution was to come up with a structure that best presented the major areas of domestic finances about which decisions could be made on how best to allocate funds - those alternatives and their prioritisation. So I needed a way that could be used to classify increases and decreases as and when they occurred, as well as for presenting the figures in an appropriate way after they had been accumulated. This presentation had to support the decision making that would be needed to best optimise future spending. It had to be done in a way that could achieve this best balance across the competing priorities so as to maximise Domestic Well-Being. It was therefore DWB that became the new focus for domestic accounting; and it could be identified in terms of a structure for both bookkeeping - capturing the transactions; and accounting - reporting, analysing and the subsequent decision making for future financial activity, implemented perhaps through budgeting.
The Domestic Well-Being Statement
The Domestic Well-Being Statement (DWBS) is the domestic version of the Trading account and the Profit & Loss account and is used to present the derivation of the Total Domestic Change (TDC) over some period. It represents the second of my adopted features from business accounting.
This report simply shows the structure for DWB and is obtained in Microsoft Money with one click to run a pre-stored report. The edited version combines the details for the current and previous years to assist with comparisons.
In summary, the report shows the three top-level Categories of the structure as the Basics, Discretionary and Others groups of transactions, each divided into Increases and Decreases. These categories might be considered as similar to business accounting nominal codes.
Within these groups there are successively lower level groups of sub and sub-sub categories. For example, the Basics included Essentials, Responsibilities and Family, each with further sub-categories below.
The Discretionary group, where obviously there is some amount of discretion or choice as to whether decreases and increases occur in its component sub-categories, includes Nice-to-Have, Investment for the Future (IFF) and Luxuries.
What amazed me when it was first developed was the fantastic visibility it provided on the home finances, especially showing the distribution and makeup of the many expense items.
Financial Ratios
The third feature that I adopted from business accounting is the use made of financial ratios.
You will appreciate that a ratio is simply a comparison of two figures expressed as a quotient, usually in decimal or percentage format. In business over time, certain key quantities and their comparison in the form of ratios have taken prominence as a key to both information dissemination (for shareholders, investors, management boards, auditors etc.) and to various levels of management as a basis for control. Those two components of a ratio, the numerator and denominator, can both be considered as candidates for achieving change.
Over 30 business ratios slim down to few that most people have heard of, such as the different forms of margins and the ratios associated with profitability and liquidity; and of course virtually none of them relate to home finances!
From my experience, I knew that the figures I had exposed for domestic finances must have some potential for assisting in the management and control of home finances. The issue was which figures and in particular, which groupings of pairs of figures as ratios might be informative.
The Stages of Domestic, Financial Life
My other experience was with life; now 68, I realised looking back on my lifetime of interest in home finances, I could distinguish six fairly distinct stages of financial life. By this, I mean that there was a significant enough change in some aspect of personal finances across the stages that might warrant some form of indicator or measurement being useful. For your interest, I call these stages:
Early Adulthood
Early Maturity
Middle Life
Retirement
Declining Years
I have defined five primary factors and a number of secondary factors for domestic finances, changes in which I believe, have a correlation with those stages of financial life and could be useful as a basis for comparison and more detailed analysis.
The Domestic Financial Factors
Briefly, the more important ratios over some period are (where the abbreviations relate to figures in the DWBS):
Basic Cost of Living Factor (BDD/THI) - a measure of the amount spent on basic necessities, out of total household increase.
Well-Being Contribution Factor (DDD/THI) - a measure of the amount spent on discretionary extras, out of total household increase.
Future Affordability Factor (IFF/TDI) - a measure of financial commitment to future well-being, out of total domestic increase.
Feel Good Factor (IFF/DDD) - a measure of how much went on future well-being, out of total discretionary decrease.
Domestic Wealth Factor (TDC/ODW) - for positive TDC the domplus, or for negative TDC the domicit, contributing to growing or diminishing domestic wealth respectively, as a proportion of old domestic wealth. This is the nearest comparison to business profit or loss.
To start with, lacking any reservoir of accumulated figures, the value of these ratios or factors as I call them for home use, will only be of use internally in a household over time, as a means of measuring and looking for changes. With a base of figures, then there would be the possibility of comparison with others and the similarity to business norms.
Value for these five factors give 'shape' to a financial situation and if displayed in the format of a star or radar diagram, could also offer useful indicators that could help to predict problem areas or states of stability or instability about a set of finances.
With an accumulation of values for the domestic factors, either by simulation or by capture after creation by individual home owners, it would become feasible to create and provide further useful charts. With such information, the home owner would be able to determine if the individual figures from the accounts appeared to lie within the expected domestic norms.
Other Graphics
A picture speaks a thousand words. This is no truer than when considering displays of financial information. Such graphical charts are the fourth set of business features of the sort of products that can easily be created with general purpose accounting software packages such as MS Money, especially if double entry accounting is used.
Financial Control
For home finances, control is both feasible and realisable and is only limited by the extent to which homesteaders wish to go. It all comes back to a need for a sense of responsibility.
The analysis should first look at distribution and balance. Are the proportions being spent on the Basics a fair amount compared to the total increases?
The information obtained from your end-year results should reveal some fundamental facts. Have you been able to afford anything over and above the basics? If yes, did the amounts enable a reasonable allocation to discretionary decreases; and what about luxuries?
Your accounts and this new set of accounting methods will give you the data and information to enable you to pick up warnings.
What sort of warnings might you want? In today's climate of a financial debt crisis, probably the most important warning you would look for is one relating to the likelihood of such a pending crisis for you. You would want to know if your decreases are getting too close to your increases, or even exceeding them. You would want to know if your reserves are being depleted, possibly on funding that excess of decreases over increases. You should be looking to see the amount of short-term and long-term liabilities you have; and how their proportions compare to the total value of assets. You would want to know about your liquidity; how well you are able to realise funds in the short term to meet your known commitments. You obviously do not want to sell your house or car just to pay the bills.
On a less dramatic but more important note, you need to know about the proportion of contributions being made to future well-being; and if positive, does the amount being put aside represent a reasonable proportion of your increases?
Conclusion from Adapting Business Accounting Concepts
In order to implement the features I have extracted from business accounting, I needed to be able to use the concepts of double entry.
Simplification
In undertaking home accounting with double entry, the main difficulties related to knowing where I was in relation to individual accounts and the entering of transactions. By this, I mean that when looking at a single account register on the computer screen, it never appeared obvious to me what sort of account I was looking at and into which column of the account, the next posting should be made.
Over time, I realised that the key to understanding the answers to this dilemma lay with the accounting equation. I needed a way to always be able to associate any account with its place in the accounting equation - asset or liability - and to which account it should be associated in order to achieve double entry balance.
Like many amateur accountants I often had problems with reconciling the concept of debts in accounts for mortgages and loans, with a so-called liability related to an amount in a capital or domestic wealth account. To me, domestic wealth was a 'good' liability - more was better - whilst the mortgage and loans were 'bad' liabilities or debts that had to be repaid; and more was not better, but worse! I resolved this by considering all the accounts that were associated with domestic liability as quasi-liabilities - good liabilities; the amounts or the balances of liability held in these accounts, I considered as 'good' liabilities. They were given the letter Q in the appropriate prefixes.
There are a total of four accounts that fell into this quasi group which consisted of the Domestic Wealth account (LQ DW), the Domestic Changes account (LQ DC), the Categorised Increases account (LQ Cat Inc) and the Categorised Decreases account (AQ Cat Dec).
The majority of the changes to domestic wealth over any period come from the decreases associated with expenses such as food, drink, clothes, utilities, holidays etc - virtually all of the Basics and Discretionary decreases. These also end up in the LQ DW account via the LQ DC account but because of the way I handle most of the double entry postings, they arrive via those two quasi accounts for Categorised Increases and Decreases.
Implementation
I initially chose one of the earliest versions of a generalised accounting software packages called MS Money. Being generalised, it provided the capability to create accounts as needed, with any name you chose.
It also had good integrated query and reporting capabilities, together with the concepts of payees, categorisation tags and support for budgets as well as for stocks and shares.
In thinking about the implementation of double entry, MS Money was not designed primarily for double entry. If it was, it would have some journal-like arrangement similar to dedicated double entry accounting software, whereby each transaction is associated in some way with the two accounts involved in the double entry. Then, via a key-click or later batch updating, the two individual postings would be made to the appropriate two accounts.
This does not mean to say however that this software package cannot be used for double entry postings. All it requires is that after adding the necessary extra accounts, that two entries are posted for each transaction entered.
One form of categorisation available in MS Money is its Income and Expense tags. Money comes pre-loaded with tags associated with home finances so that for example, with a simple account (non-double entry system) for reconciliation with bank statements, each transaction could be associated with an appropriate tag, such as wages, food, etc.
Income and Expense are the terms used in MS Money to relate to the accounting terms of debit and credit; Perhaps trying to be helpful to home accountants, MS Money has differing column headings for the increases and decreases across all the various types of accounts that can be created.
In trying to find a way to implement the tagging I needed to associate transactions with the DWB structure, as well as achieve double entry to support the concepts of static and dynamic reporting, I came up with a method that achieved both; without the need to enter transactions with hundreds of double postings.
The 1st halves of the appropriately, categorised double entries accumulate in the accounts where they were entered, mostly bank or credit accounts but that is unimportant. At the end-of-period by running a single report, the sum of the amounts of the 1st half entries can be easily exposed, contributing separately to increases and decreases to domestic change. By then entering just two more postings, one for the total of the 1st half increases and another for the total of the 1st half decreases, balance is re-established.
Summary of the Approach
The main features that I have adopted from business accounting are the ability to create balance sheets for static views, to capture the financial changes over a period for the dynamic aspect, to define ratios/factors as a comparison of useful and significant figures from the balance sheet and the changes, as well as the use of graphical reports to enhance visibility and meaning.
As a thought about setting up your own DWB accounting, my book describes the background and theory, together with the details and prototypes for accounts, categories, reports and graphics on a bonus CD, for implementing the accounts on MS Money.
Regarding implementation on dedicated double entry accounting software packages, I have not yet discovered any that are sufficiently general-purpose to enable the creation of accounts of your own choosing, together with your own details of categorisation.
As a final thought on simplification, life in the accounting world can be made much easier for domestic accountants, if the terminology is simplified as much as possible. It will be important not to remove too much of the distinction between some of the technical words but I have found that I have made life much easier for myself, by simplifying, wherever possible.
An understanding of one idea - double entry - and the following, six key words, will get you through with flying colours: asset, liability, debit, income, credit and expense; and my version of the domestic accounting equation, account prefixes and a couple of 'memory joggers', will tie all these features together.
Also, take a look at the author's website on Domestic Well-Being Accounting, together with sample products and a growing list of tutorials at www.dwba.co.uk; the full rationale and technical introduction with supporting charts and graphics is at:
A New Domestic Accounting Model based on Domestic Well-Being
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