Nature of Accounting

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Accounting is the process of recording, summarizing, analyzing, and interpreting financial (money-related) activities to permit individuals and organizations to make informed judgments and decisions. By law all businesses must keep accounting records. Decisions are based on accounting information for profit and non-profit companies alike. There are different forms of business organizations:

·         Private business

o   object is to earn a profit

·         Sole Proprietorship

o   owned by one person

·         Partnership

o   co-owned by two or more persons

·         Corporation

o   Owned by investors called stockholders (The business—not the owners—are responsible for the company’s obligations.)

There are different types of business organizations:

Service business

 Doctors, lawyers, barber shop, etc.

Merchandising business

 —purchases goods for resale

Manufacturing business

 —produces a product to sell

THE ELEMENTS OF ACCOUNTING

ASSETS

Assets are items with money value that are owned by a business. Some examples are: cash, accounts receivable (selling goods or services on credit), equipment (office, store, delivery, etc.), and supplies (office, store, delivery, etc.).

 

LIABILITIES

Liabilities are debts owed by the business. Paying cash is often not possible or convenient, so businesses purchase goods and services on credit. The name of the account used is Accounts Payable. Another type of liability is Notes Payable. This is a formal written promise to pay specific amount of money at a definite future date.

OWNER’S EQUITY

The difference between Assets and Liabilities is Owner’s Equity. The can also be called capital, proprietorship, or net worth.

THE ACCOUNTING EQUATION

Assets = Liabilities + Owner’s Equity This equation must always balance!

BUSINESS TRANSACTIONS AND THE ACCOUNTING EQUATION

A transaction is any activity that changes the value of a firm’s assets, liabilities, or owner’s equity. Each transaction has a dual effect on the basic accounting elements. A transaction may affect more than two accounts in a transaction. This is called a combined entry.

Withdrawal (Drawing)

Is the removal of business assets for personal use by the owner? This transaction decreases the asset taken and the value of the business. Each transaction increases or decreases (or both) the basic elements in the accounting equation. The effect of recording a business transaction must always leave the two sides of the accounting equation in balance. To understand how a transaction affects the accounting equation, go through each of the examples in the textbook. Be sure to pay attention to the “Notes” and “Cautions” that are given.

FINANCIAL STATEMENTS

Summaries of financial activities are called financial statements which are prepared on regular basis at the end of an accounting period. The accounting period typically is one year; however, it can be any length of time for which records are maintained. Usually the minimum is one month and the maximum length of time is one year for financial statements.There are several financial statements. You are going to prepare the

Income Statement, Statement of Owner’s Equity, and Balance Sheet. These must be completed in that order. Notice the page in your book that shows the three statements and how the information goes from one source to another. It is very important to always check your numbers since an incorrect number will affect more than one statement.

Income Statement

 This is a summary of a business’s revenue and expenses for specific period of time. It

ONLY shows revenue and expenses. These should be listed in order from largest to smallest. (This should be done in this chapter because accounts are not given account numbers.)

Net Income is realized when revenue exceeds expenses.

Net loss is realized when expenses exceed revenue.

Statement of Owner’s Equity.

This is a summary of the changes that have occurred in the owner’s equity during a specific period of time. This statement will show either an increase or decrease in the capital account.

Balance Sheet.

This statement is a listing of the firm’s assets, liabilities, and owner’s equity at a specific point in time. Total Assets must equal the addition of Liabilities and Owner’s Equity.

NOTE:

Be sure that you are looking carefully at the examples given in the book whencompleting your assignments. You must write legibly and use a ruler to draw the lines. Notice that there are double rules to show that items have balanced. Be sure to read andstudy the Summary and Key Terms at the end of each chapter