Principles of Financial Accounting
Accounting may be defined as the process of analyzing, classifying, recording, summarizing, and interpreting business transactions. One of the key aspects of the process is keeping “running totals” of “things.” Examples of items a business might keep track of include the amount of cash the business currently has, what a company has paid for utilities for the month, the amount of money it owes, its income for the entire year, and the total cost of all the equipment it has purchased. You want to always have these running totals up to date so they are readily available to you when you need the information. It is similar to checking what your cash balance in the bank is when deciding if you have enough money to make a purchase with your debit card.
We will now refer to these “running totals” as balances and these “things” as accounts. Any item that a business is interested in keeping track of in terms of a running dollar balance so it can determine “how much right now?” or “how much so far?” is set up as an account. There are five types, or categories, of accounts.
There are many items that businesses keep records of. Each of these accounts fall into one of five categories.
1. Assets: Anything of value that a business owns
2. Liabilities: Debts that a business owes; claims on assets by outsiders
3. Stockholders’ equity: Worth of the owners of a business; claims on assets by the owners
4. Revenue: Income that results when a business operates and generates sales
5. Expenses: Costs associated with earning revenue
Different accounts fall into different categories. Cash is an account that falls in the asset category. The Cash account keeps track of the amount of money a business has. Checks, money orders, and debit and credit cards are considered to be cash.
Other than Cash, we will begin by covering accounts that fall into the revenue and expense categories.
Revenue is income that results from a business engaging in the activities that it is set up to do. For example, a computer technician earns revenue when they repairs a computer for a customer. If the same computer technician sells a van that they no longer needs for his business, it is not considered revenue.
Fees Earned is an account name commonly used to record income generated from providing a service. In a service business, customers buy expertise, advice, action, or an experience but do not purchase a physical product. Consultants, dry cleaners, airlines, attorneys, and repair shops are service-oriented businesses. The Fees Earned account falls into the revenue category.
Expenses are bills and other costs a business must pay in order for it to operate and earn revenue. As the adage goes, “It takes money to make money.”
Expense accounts differ from business to business, depending on individual company needs. The following are some common expenses that many businesses have:
A chart of accounts is a list of all accounts used by a business. Accounts are presented by category in the following order: (1) Assets, (2) Liabilities, (3) Stock-holders’ equity, (4) Revenue, and (5) Expenses.
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