Accounting
Basic Accounting Principles
Accounting is the language of business. It is based upon several very simple principles
concerning financial transactions. Financial transactions are recorded into accounts. These
accounts are one of the following types:
Assets: something the business owns that has value
Liabilities: monies that the business owes
Capital: the investment in the business
Income: the monies received from selling a product, providing a service, investing, etc.
Expense: monies spent in order to produce an income
All financial transactions are recorded into these accounts. The accounts increase or
decrease according to the effect that the financial transaction has on that account, and in
accordance with accounting principles:
 Assets = Liabilities + Capital (or Owner's Equity)
Therefore, if someone invests cash into a business, the business records the financial
transaction as a debit to cash (an increase to cash) and as a credit to capital (an increase
to capital). This has kept both sides of the equation equal.
What is an Asset?
It is an item that shows the value of an item. The asset is recorded at what it costs you.
Assets are generally classified in one of these three categories:
 Current Assets
 Fixed Assets
 Other Assets
1. What is a Current Asset?
A Current Asset is an asset that can be converted into cash within a twelve month
period. Examples are:
1. Cash in your checking account.
2. Accounts Receivable owed by your customers who have purchased the
merchandise on credit.
3. Inventory
4. Prepaid expenses. An example of a prepaid expense would be insurance.
1. You pay for the insurance at one time but it is not expensed in one
month.
2. It is recorded as an expense each month since it is for the entire year.
2. What is a Fixed Asset?
Fixed assets cannot be converted into cash easily. Typically, you don't want to
convert them into cash unless you no longer need them, replace them with better
equipment, need a larger or more space (new or larger building), etc.
1. Building
2. Computer
3. Improvements to the building
4. An automobile or truck that is used for the business
5. Furniture and fixtures
6. Office equipment
3. What is an Other Asset?
Other assets consist of other items that are not a current asset or a fixed asset. An
example is:
1. Long-term investments (not intended to be converted to cash in the shortterm)
What is a Liability?
It is an item on the balance sheet that shows the amounts that you owe your creditors. It is
recorded at cost.
Liabilities are generally classified into two categories:
 Current Liabilities
 Long-Term Debt
1. What is a Current Liability?
A Current Liability is a liability that you owe within a twelve month period. Examples
of Current Liabilities are:
1. Accounts Payable, which is the amount you owe your creditors for purchases
of merchandise or services on account that will be paid within the next twelve
months.
2. Accrued salaries payable, which is the amount of salaries you owe your
employees that you have not paid them yet.
3. Payroll taxes payable, which are the amount you owe the Internal Revenue
Service and your State Agency for payroll taxes that you have not paid to
date.
4. Rent payable that is the amount you owe your landlord for back rent. Current
portion of long-term debt, which is the current portion that you owe the bank
on a note that, will be paid within the next twelve months.
2. What is a Long-Term Debt?
Long-Term Debt is the amount you owe the bank on a loan that was given to you by
the bank that is net of your current portion of the debt.
3. What is Capital?
Capitol is your "Net Worth" of your business. Total assets minus total liabilities
equals capital or net worth. The types of capital accounts are based upon the type of
ownership of the business:
1. Sole Proprietorship or single owner
2. Partnership
3. Corporation
Examples of accounts for a corporation are:
 Stockholders' Equity
 Retained Earnings (Retained Earnings includes the corporation's net income or loss for
the year and accumulated net income or losses since the inception of the corporation)
For example:
Net income for 2002 -$100,000
Net income for 1999-2001 $600,000
Total Retained Earnings $500,000