The main purpose of accounting is recording, summarizing and providing financial data about businesses. For the data to be used by other users, a few means for achieving the main purpose is necessary. An account is one such means commonly used. It is one of the basic accounting terms that students should know. Accounts is essential and have a practical necessity as well.
With the help of accounts, information can be recorded and tracked. The information can be about assets, liabilities, revenues, expenses and even equity. A general ledger is an entire list of accounts that a business uses for the purpose of accounting. Then ledger can differ based on purpose, size and other aspects of the concerned business.
Accounts help in categorizing financial data, keeping all the necessary information. This information shows what happened during a specific accounting period. In financial statements, information can be classified into liability, asset, equity, expense and revenue. There is a separate account of each of the item types.
There are some terms that form the basis of accounting and all accountants are expected to know them. Some of these terms are T-account, credit, debut and double entry system. It goes without saying that accounting students are also familiar with these terms. Any individual associated with a business, like a small business owner or an investment banker, should know them as well. Having an idea of basic accounting terms will allow you to get a better grasp of different business situations.
T-Account
In accounting, records about transactions and events are stored in accounts. An individual account is nothing but a single record of whether a specific asset, liability or equity item has increased or decreased. Accounts can be considered as a place for storing numbers with regards to a specific item or type of transactions. Fixed Assets, Cash, Accounts Payable, Accounts Receivable, Accrued Payroll, Rent Expenses, Sales, etc. are examples of accounts. You can learn them in detail by click here.
There are three parts of an account:
- The title
- Debit on the left side
- Credit on the right side
These parts of account are aligned in a way that they have a visual resemblance of the ‘T’ alphabet. T accounts can be drawn directly on paper and can be used for maintaining records. Nowadays, however, rather than drawing T accounts, accounting software is usually preferred by accountants. Nevertheless, students should know how to make T accounts and store financial records in it.
Debit and credit
Debit and credit are two of the most basic terms in account. Abbreviated as Cr and Dr, credit and debit are shown on the left and right side respectively. They are an indication of which side of the T account the numbers need to be recorded.
The difference between the amount of credit and debit is known as the account balance. For certain types of accounts, there is an increase in balance with debit, while it decreases for other types. There is an opposing result with credit. For the following accounts, credit to the account means:
- Asset – Decrease
- Contra Assets – Increase
- Liability – Increase
- Equity – Increase
- Contribution Capital – Increase
- Revenue – Increase
- Expenses – Decrease
- Distributions – Decrease
Double Entry Accounting
In a double entry accounting system, any amount that is entered into the records should be shown on a minimum of two separate accounts. For instance, when cash is paid by a customer for purchasing your product, the cash received should be shown on Cash Account as debit. At the same time, there should be a credit in Sales Account. If the double entry system is followed properly, the total debit amount will be equal to the total credit amount.
There are benefits that double entry accounting offers offer a general single sided system. One such benefit is that it helps in identification of errors while recording. For example, if an amount is mistakenly entered only once, there won’t be a balance between debit and credit amount. This will give the accountant an indication of an error in an entry or more. Knowing the principle of double entry accounting helps in analyzing probable causes of errors in records.
Bookkeeping and Accounting
Bookkeeping is primarily concerned with correctly recording transactions resulting in transfer of money or its value. The transactions are recorded in books. On the other hand, accounting can be said to be more comprehensive. It is more extensible and is concerned with classification, summarization, presentation and analysis of accounting information.
Accountancy and Accounting
The body of knowledge that governs the recording, classification and analysis of financial transaction is called accounting. It states the principles, concepts, conventions, rules and assumptions for accounting. On the other hand, the actual act of accounting in real practice is known as accountancy.
Different branches of accounting
There has been an increasing demand on accounting by various parties associated with a business, like the owner, management, tax authority, creditor, etc. Different branches of accounting have come up as a response to these demands. Three of the most common branches of accounting include:
- Financial accounting:
The main goal of financial accounting is to determine the result of operations of a business during a specific period. At the end of that period, financial position of the business is also stated. The result of a business operations is indicated with profit and loss, and the financial position is indicated through balance sheet.
- Cost accounting:
The main goal of cost accounting is to determine the cost of services rendered or goods sold by business. It also indicates wastes and losses that can potentially be avoided. Thus, it helps businesses control the cost.
- Management accounting:
The main goal of management accounting is supplying relevant information to the management team of a company. The information should be provided at the right time to allow the management to take the right decision with effective control
Even though there are multiple branches of accounting, when you think of accounting, you primarily think of financial accounting. As stated above the main goal of financial accounting can only be achieve if financial transactions are recorded systematically. The recording of transaction needs to be done based on a set of accounting principles. The information that is recorded needs to be to ascertain the financial position and results of a business.
Benefits of Accounting
In any business, accounting plays an important role. It is useful in developing financial information that can be used for the benefit of the business. The information provides answers to many questions, including:
- What is the current financial condition of a business?
- Has there been a loss or a profit from a certain business activity?
- How has the performance of different departments within the business been?
- Which product or business activity has resulted in profit?
- Which of the existing products needs to be discontinued? Which production commodities needs to be increased?
- Is it more viable to manufacture a component or to buy it directly from the market?
- Is the production cost excessive or within reasonable amounts?
- What impact have the current policies had on the business’ profitability?
- How would new policy decisions affect the earning potential of the business in future?
- Keeping the performance of the past in mind, how should a business plan to achieve desirable results in future?
These are just a few questions that can be answered through proper analysis of accounting information. Different users of the information are faced with different questions. Using the relevant information, they can get their answers.
Apart from all these, accounting can also be useful in following aspects:
- With more action taking place within a business, the number of transactions taking place also increases. It is not possible for any business to remember all of it. Accounting eliminates the necessity to remember different business transactions.
- The transactions are recorded based on the standard accounting practices. This allows businesses to compare accounting results from an accounting period with other accounting periods.
- Both sales and income tax authorities are likely to find the information on accounting books to be reliable. Of course, the accounting books should be maintained as per the accepted standards and principles.
- Stored records backed by authentic and proper vouchers serve as food evidences in the court of law.
- In case the owner needs to sale the business, accounting records are useful. The balance sheet can be used for showing the various assets of the business. It can be used for determining the right value of the business.
Accounting Limitations
Even though the advantages of accounting are manifold, it doesn’t mean that it doesn’t have any limitations. Some of the limitations include:
- Alternative treatments are permitted:
Accounting is actually based on certain concepts and follows principles that are generally accepted. However, there are multiple principles that exists for treating any item. So, within the framework of accepted principles, alternative treatments are permitted. For example, one can value a business’ closing stock through different methods like LIFO, FIFO, Standard Price, and Average Price. If different methods are used, the results will obviously not be comparable.
- Timely information is not provided:
This is more of a shortcoming of manual accounting. This limitation does not come into play when advanced software applications are used. These software programs allow to store and maintain concurrent accounts online. The balance sheet is almost instantaneously available. However, that is not possible manually
The information provided by financial accounting is available in the form of statements. These include Profit and Loss statements, balance sheets etc. The information is provided for a specific period, which is usually a year. Hence, the information provided is only of the past. Only an analysis of the information can be done for the benefit of the business.
The business needs information in a timely manner at regular intervals. Timely information allows the management to take the necessary action and plan accordingly. Conventionally, accounting doesn’t provide information for a time period shorter than a year. However, nowadays, use of accounting software has made things computerized. It is possible to get monthly accounting information in terms of profit and loss and balance sheet.
- Susceptible to subjective judgement:
In accounting, there is a respect for convention of objectivity. However, for recording certain transactions, it is required to make estimates. That is where individual judgements are involved. This makes it extremely difficult to get accuracy for future estimates. Thus, the objectivity is compromised. For instance, the yearly amount of depreciation that has to be charged for a fixed asset requires an estimation. This estimation is based on approximation and isn’t authoritative.
- Non-monetary information is ignored:
Transactions that are not monetary in nature are not considered by financial accounting. Information like competition of the business, technical advancements, efficiency and loyalty of employees, change in money’s value, etc. are neglected by accounting. However, these are important elements that the management can use. Accounting is not tailormade for utilizing such information. Hence, any user of accounting information doesn’t have some vital information that are non-monetary in nature.
- A detailed analysis is not provided:
The information provided by financial accounting is nothing but an aggregate of transactions taking place over an accounting period. It does enable analysis of the overall results of business through the information about the revenue, profit, cost, etc. However, it doesn’t provide information for each product.
For example, if a business has gained certain profit over a year from the sale of different products, accounting doesn’t specify the profit that each product has earned. The financial information is only an overall indication. Of course, advanced accounting software can be used for overcoming this limitation.
- Present value of a business is not disclosed:
With financial accounting, balance sheet is used for showing the position of a business. The business’ position is stated on a specific date. In balance sheets, assets are considered to be continuing entities. This means that it is assumed that the business would have a long life. The business is presumed to exist for an indefinite time period. Hence, the real value of a business cannot be known through balance sheets.
Author Bio:
Michelle Johnson is a reputed tutor with tremendous experience at some of the most reputed academic institutions. She has an inherent passion for tutoring and educating students. All her students really appreciate her vast knowledge and innovative methods of teaching. She also provides a lot of useful academic information online.