A Simple Guide To Accounting Basics At Any Age
Whether you’re still a student or already working, there’s no “best” time to learn accounting basics. Start learning as early as you can with our comprehensive guide below! RELATED: What Is Bookkeeping–Explained In this article:
- What Is Accounting
- Basic Accounting Terms
- Five Basic Accounting Principles
- Five Basic Accounting Concepts
- Accounting Basics: The Three Golden Rules of Accounting
- Accounting Basics: The Accounting Equation
Accounting Basics for Beginners
What Is Accounting?Accounting is a broad subject that branches out into different industries like bookkeeping. To get you started, you need to know the basics of accounting since this serves as the foundation of your accounting knowledge. I’ve divided the accounting basics I’ll tackle into five parts:
Basic Accounting TermsThere are universal terms in accounting — meaning you‘ll encounter them at any given situation while on the job. It’s important to get a good grasp on how we define these terms within the context of accounting so you’ll know what to do when you come across them.
1. GAAPThis abbreviation stands for “Generally Accepted Accounting Principles.” These are the standard guidelines for accounting and financial reports.
2. Fiscal YearFiscal year is the accounting period. This varies from one company to another — some follow the calendar year while others base it on when their accountants prepare the financial statements.
3. Accounts Payable and Accounts ReceivableAccounts payable refers to the money due to other people. These are the ones owed to suppliers, customers, bondholders, etc. When you create a report called the Balance Sheet, you place the accounts payable under liabilities. Accounts receivable is the opposite: it’s what people owe you for their consumption of the goods and services you offer. In the Balance Sheet, you place the accounts receivable under assets.
4. AssetsAssets are the tangible and intangible properties of a company. Tangible assets include cash, property, and equipment. Intangible assets include patents, trademarks, and copyrights.
5. ExpensesExpenses are the costs involved in doing business. This includes your company’s purchases and the money spent to generate revenue. There are four categories of expenses, namely:
- Accrued — Expenses that were already recorded but not yet paid. These go under accounts payable.
- Fixed — These are the expenses you regularly pay for, such as salaries, utilities, and rent.
- Operating — These expenses are necessary for the business to run and produce revenue. It includes all the fixed expenses mentioned above.
- Variable — These are the expenses that constantly change depending on the company’s production and performance. Raw materials used to produce goods fall under this category.
6. LiabilitiesLiabilities refer to anything the company owes, whether short-term or long-term. Debts, loans, and taxes are some of the typical liabilities a business has.
7. AccrualsBookkeepers are responsible for recording the business’ financial transactions. This includes taking note of accruals or the debts and credits the business has not paid yet. Accruals can come in the form of the following:
- Sales you’ve delivered but haven’t collected the payment for
- Expenses you’ve incurred but haven’t paid for yet
8. Burn RateThe burn rate tells you how quickly the business spends its money. It’s important to know this when you’re managing the cash flow. You can calculate the business’ burn rate first by picking a time period, and then follow this formula:
Cash on hand at the beginning – cash on hand at the end ——————————————————————————————– Number of months in the chosen time period
9. Cost of Goods Sold (COGS)Also known as the cost of sales (COS), this refers to the production cost of your products and services. Reducing the COGS can help increase your profit without raising sales. This is the first expense recorded in the Profit and Loss (P&L) Statement. You also need to know the COGS to calculate the business’s gross margin.
10. EquityEquity is the amount of money the owners or stakeholders (also known as shareholders) invest in their business. Another term used is “owner’s equity,” and it covers non-monetary value as well. Equity is the difference between the assets (what the business owns) and liabilities (what the business owes).
11. ProfitIn the context of accounting, profit is also known as the “bottom line.” It’s the difference between the business’ income, expenses, and COGS.
12. RevenueThe total amount of money you earn upon selling your goods and services is the revenue. This is the total amount you gather before taking out any expenses you’ve incurred.
Five Basic Accounting PrinciplesNow that you’ve learned basic terms, it’s time to go over the principles. There are five basic accounting principles essential in governing this field. As GAAP puts it, these accounting principles are the very foundation of accounting. It’s important to learn these accounting basics as they take effect in every step of the process. They help accountants accurately represent the business’ financial position.
1. Full Disclosure PrincipleThis principle states that the financial statement should convey not conceal. It must reveal all the reliable, relevant information it represents to become useful to concerned parties. Financial statements should present information with substance and comply with the real economic situation while adhering to legal requirements. Some accountants include notes in their financial statements to ensure they meet the Full Disclosure Principle.
2. Historical Cost PrincipleThis principle states that assets are normally recorded by the price paid to obtain it at the time of its acquisition. This cost is the basis for the accounts during the acquisition period and accounting periods moving forward. If there was nothing paid in exchange for an asset, you often won’t find the acquisition under assets. RELATED: 7 Reasons Why Bookkeeping Is A Great Job For A Stay-At-Home Parent
3. Matching PrincipleUnder this principle, accountants should match the expenses incurred during an accounting period with the known revenues within that period. For instance, if the business earned revenue for all the goods they sold during a certain period, they should also charge the COGS to that period. The act of matching doesn’t mean you identify the expenses with revenues. This principle works on the concept of accruals because it focuses on the accrual of revenue and expenses.
4. Objectivity PrincipleAccording to this principle, accounting data should be:
- Bias-free on the accountant’s part
5. Revenue Recognition PrincipleThis principle says that accountants should recognize revenue in an enterprise income statement.
Five Basic Accounting ConceptsIn discussing accounting basics, we certainly can’t leave out accounting concepts. These will help you better understand how accounting works:
1. ConservatismWith this concept, you recognize revenue only when you have reason to be certain you’ll earn it. On the other hand, you recognize expenses as soon as there’s a reasonable possibility you’ll incur them. As a result, applying this concept will yield conservative financial statements.
2. ConsistencyOnce the business chooses the accounting method they‘ll use, they should keep on using the same method moving forward. This will benefit them in the long run because they can compare their past and present financial statements reliably.
3. Economic EntityOwners should separate their business transactions from their personal transactions. Doing so ensures the company’s financial statements contain purely business transactions.
4. Going ConcernIn this concept, you prepare financial statements under the assumption that the company will remain in business in future periods. As you are assuming such, it’s acceptable to defer recognizing revenue and expense to a future period, when the business is still in operation. Otherwise, you accelerate all-expense recognition into the current period.
5. MaterialityTransactions require recording when not doing so may cause alterations in the decisions made by the reader of the company’s financial statements. This concept often results in the recording of relatively small-sized transactions for the financial statements to represent the following comprehensively:
- Financial results
- Financial position
- The business’ cash flows
Accounting Basics: The Three Golden Rules of AccountingThe last two accounting basics I’ll talk about have something to do with the double-entry system. In this system, each transaction affects two accounts wherein one’s debited and the other’s credited. Recording these transactions in a sequence in the journal requires certain guidelines called the Three Golden Rules of Accounting. These allow anyone to become a bookkeeper, as they only need to understand the different account types and apply these three rules:
1. Debit the Receiver, Credit the GiverThis rule applies to personal accounts. These are accounts concerned with real persons and artificial judicial persons like government bodies and companies. When someone gives something to the business, it’s considered as an inflow, so the accountant must credit that person (the giver) in the books of accounts. The opposite is also true, so the accountant must debit the receiver.
2. Debit What Comes In, Credit What Goes OutThis rule applies to real accounts. These cover all accounts related to the assets of the firm, and it includes both tangible and intangible real accounts:
- Tangible — cash, investment, furniture, building
- Intangible — intellectual property and goodwill
3. Debit All Expenses and Losses, Credit All Incomes and GainsThis rule applies to nominal accounts, which are fictitious accounts associated with gains, revenues, expenses, and losses. These include things like:
- Traveling expenses
- Interest paid
- Commission received
- Rent and rates account
Accounting Basics: The Accounting EquationPart of the accounting basics we’ll discuss is the accounting equation, as it is the foundation of the double-entry system. The Balance Sheet is the basis for the accounting equation. The equation ensures it’s balanced: each entry encoded on the debit side should have a corresponding coverage on the credit side. Three factors make up the accounting equation, and they also measure the company’s financial position:
- Owner’s / Shareholders’ Equity
- Look for the company’s total assets during the period
- Add up all the declared liabilities
- Find the total shareholders’ equity and add that number to the total liabilities
- The sum of the liabilities and equity will equal the total assets.