Basics of Accounting
(The Language of Finance)
Business & Accounting
Accounting is the universal language of Business and
Fiance.
More CEO’s from fortune 500 companies have come up
through the ranks of accounting than from any other area
in business. Currently: 54%
Small businesses usually fail because of poor
accounting understanding.
Marriages usually fail because of poor financial
management (80% of divorces are $$$$ related.)
If you want to get ahead in business & marriage
determine that you are going to understand accounting
basics.
Terms
Assets: Tangible and Non-tangible resources
of a business that have future value. Usually
sub-classified as follows:

Quick Assets (Liquid Assets)
Cash – Petty Cash – Receivables - Securities

Current Assets (Turn into cash/use annually)
All the above + Inventories, Supplies

Fixed Assets (Depreciated over several yrs.)
Buildings, Equipment, Natural Resources


Land (Fixed, but never depreciated)
Intangible Assets: Patents, Trademarks, Copyrights
What are your Assets?
Bank Account & Money in your pocket
Car
Clothes
Books
Stocks/Bonds/CD’s
Prepaid rent
Computers & Electronic Equip.
Knowledge????
Abilities????
Accounting Term: Liabilities
Other people’s claims against your assets!


What you owe!! Debts!
Classified as:
Current Liabilities (one year debt)

Credit Card Debt, Accounts Payable
Long Term Liabilities

Car, Mortgage, Note Payable
Unearned revenues
Bonds (usually super long term)
What are your liabilities?
School Loan
Car Loan
Credit Card Balance
J.C. Penny Account
BYU-Idaho Amount Due
Capital or Owners Equity
The portion of your assets that you can legally claim.
(Net Assets) What you really own legally.
Assets – (minus) Liabilities = Capital
Example (purchased a building for $500,000 with a 10%
down payment ($50,000)



Cost of a building (sales price = Asset amount) $500,000
Less: What you still owe on the building (Liability) $450,000
Equals: Your equity in the building (Capital) or your net worth in
the building. $50,000
Formula universally used in all financial and personal
financial institutions:


Assets = Liability + Owners Equity (Balance Sheet
Equation)
(Resources you have) =(What you owe on them) + (the principle
you have paid on them.)
Owners Equity Account Titles
Single Proprietorship:

Capital
Corporation:



Common Stock (what owners paid in)
Preferred Stock (what owners paid in)
Retained Earnings (profits that the business
keeps in the business)
What is your net worth???
What you have minus what you owe.
What format do we use in business and in
personal finance to show our net worth?

A Balance Sheet Financial Statement
List of Assets (classified by type in accounts)
Compared or balanced with:

List of Liabilities and Owners Equity (classified by type
and in accounts)
Text Book Example Page 74
Example (Simplified)
John Doe’s Business or Personal Records
Balance Sheet
September 10, 2003
Assets:

Current:
Cash at Home
Cash Deposits in Bank

Fixed:
Wardrobe
Equipment
Car

$100
500
2000
1000
5000
Total Assets:
Liabilities:

Current:
Credit Card Payable

Long Term:
Note Payable (on Car)

Total Liabilities
Capital, John Doe:
Total Liabilities & Owners Equity:
$8,600
$500
$2000
$2,500
6,100
$8,600
Other Terms
Temporary Accounts are used in addition to
balance sheet accounts to record changes in
owners equity each reporting period.



Expenses – Decrease in owners equity during the
period by using up an asset or a portion of an asset.
(or creating additional liabilities)
Revenue – Increase in owners equity during the
period by performing a service or selling an asset.
Drawing or Dividends – Decrease in owners equity
due to personal withdrawals by the owner(s).
Income Statement Report
Used to determine the net income or net
loss of an individual or business for a
defined period of time.



Used for marking progress by comparing
months and years
Used by financial institutions for determining
the progress and status of a company or
individuals financial health.
Used by the IRS for determining taxes
Income Statement – What does it
contain?
Matches Expenses with Revenues for a specific
period of time. (Only the temporary type of
accounts are on the income statement.) No
Assets/Liabilities
Income Statement accounts are closed out at
the end of the reporting period and started over
again the next period….so comparisons can be
made.
Personal Income Statement sometimes called a
Cash Flow Statement example on page 78.
Income Statement – Example
Name of Individual or business
Income Statement
For period of time (Month of Sept. 2003)
Revenue:
Income from Job
$500
Income from Pell Grant
2000
Total Revenue:
Expenses:
Clothes Expense
$300
Rent Expense
200
Food Expense
50
Tuition Expense
1200
Misc. Expense
250
Total Expenses:
Net Income for September:
$2500
$2000
$ 500
How do individuals or businesses keep track for all
their assets, liabilities, capital, expenses,
revenues. Etc.?
The “Accounting Process” or otherwise
known as the Accounting Cycle. (also
called the “Audit Trail” of business.
Based on universally accepted accounting
principles. (Generally accepted
accounting principles)
Double Entry Bookkeeping
Accrual Accounting vs. Cash Accounting
Bookkeeping part of accounting.
Accounting Cycle – Start with
financial transactions
Verbs & Nouns for each step
#1 Analyze Source Documents


Check, receipts, invoices, deposit slips, etc.
Decide what accounts they represent
#2 Enter (journalize) data in the journal.



Chronological record of transactions
Book of original entry – checks and balances
Two or more accounts entered at cost
Accounting Cycle
#3 Post from the journal to the individual ledger
accounts. (to keep a running balance of each
account)

Ledger divided up into these different accounts:
Assets (100 accounts)
Liabilities (200 accounts)
Capital/Owners Equity (300 accounts)
Revenues (400 accounts)
Cost of Goods Sold (Expense) – (500 accounts)
General Expenses (600 accounts)
Accounting Cycle #4
Adjust the necessary accounts to bring
them up to date.




Requires internal transactions
Requires journal entries & posting as well
Example: Maybe some of your Supplies
valued at $500 when you bought them have
been used…you need to bring their value up
to date and expense what has been used.
Example: Depreciation of Equipment
Accounting Cycle #5
#5 At the end of the period or at any time
(with computers) balance all of the
accounts in a trail balance. (Checks and
balance step to see if all of your journal
entries and posting was correct.)


The trail balance is a list of all of your
accounts with balances.
The total of the debit balances must equal the
total of the credit balances.
Accounting Cycle #6 & 7 & 8
#6 Prepare the Financial Statements



Income Statement
Statement of Changes in Owners Equity
Balance Sheet
#7 Close out all the temporary accounts
to zero, so that you can start a new
period/cycle.


Requires journal entries and posting
8. Prepare a Post-closing trail balance
The Balance Sheet and Debits and Credits
Balance Sheet Equation

A = L + OE
Use of another checks & balance method



Debits and Credits are terms used to increase or
decrease various accounts and show balances.
All Accounts have either a debit or credit balance.
Assets/Expenses/Withdrawals have debit balances
Increased by debiting and decreased by crediting

Liabilities, Capital, and Revenues have credit
balances.
Increased by crediting, and decreased by debiting
The best way to learn:
Complete a simplified practice set that
covers the entire accounting cycle.
Work in partnership with another student
and the teacher. Use a pencil!
Final product: Do your own set of
personalized financial statements.
Problem due on Friday 1/16/04. Quiz over
the accounting language and Accounting
Cycle on Friday.
Separate Entity Principle
(Keep your business records separate
from you personal records)
Lets start a home building business.
First Transaction
Pull $10,000 savings out of your personal
account and put it into your business account.
 Assets
= Liabilities + Owners Equity
Cash
=
0
Capital
10,000
10,000

2nd Transaction
Acquire a Loan of $50,000 to buy
materials to build a spec home for resale.
Assets
= Liabilities + OE
Cash
Loan Payable Capital
$60,000
$50,000
$10,000
($10,000 + $50,000)
3rd Transaction
Purchased a lot to build a home. Cost:
$8,000.
Assets = Liabilities + OE
Cash
Loan Payable + Capital
$52,000
$50,000
$10,000
Land
$8,000
4thTransaction
Paid a concrete subcontractor to put in a
foundation. (Cost $6,000)
Assets
=
Liabilities
+
O.E.
Cash
Loan Payable
Capital
$46,000
$50,000
$10,000
Home in progress
$6,000
Land
$8,000
5th Transaction
Purchased building materials to build your home. Cost
$16,000
Assets = Liabilities +
Owners Equity
Cash
Loan Pay.
Capital
$30,000
$50,000
$10,000
Building Materials
$16,000
Home in progress
$6,000
Land
$8,000
6th Transaction – Paid wages for
helper who helped to put $2000 of
materials into home.
Cash
L/P
Capital
$29,000
$50,000
$10,000------Materials
Wages Expense
$14,000
($1,000)
Home in progress
$8,000
Land
$8,000
7th Transaction – Received $6000
earnest money agreement from buyer.
Cash
Loan/Pay
$35,000
$50,000
Materials
$14,000
Home in Progress
$8,000
Land
$8,000
Total Assets
Liabilities
$65,000
=
$50,000 +
OE
$10,000
Wages Exp
($1,000)
Revenues
$6,000
Capital
$15,000
Owners Equity
Two ways to increase this account:

1) New investments in the business
Cash Investments
Equipment Investments

2) Revenues earned in the business
Two ways to decrease this account:


1) Expenses (Using assets up to generate a
profit or incurring new liabilities)
2) Taking money out of the business for
personal use.
Debits and Credits
Terms used to increase or decrease an
account and keep everything in balance.
Assets
=
Liabilities + O.E.
Increases
Increases
Increases
(Debits)
(Credits)
(Credits)
Decreases
Decreases Decreases
(Credits)
(Debits)
(Debits)
Steps in the Accounting Cycle
1. Analyze the transaction source documents
and decide what accounts are involved. What
account needs to be increased and what
account needs to be decreased…..what
account(s) needs to be debited and what
account(s) need to be credited.
Examples of Source Documents:

Deposit Slips, Invoices, Sales Slips, Contracts,
memos, packing slips, electronic memos, etc.
Source documents are usually kept on file (three
years) as backup for tax and company audits.
Step #2 - Enter source document
data in a chronological journal.
(Data Entry on the Computer)
The Journal is called the book of original entry,
and is on the computer in most companies.



It gives the date of the transaction.
It gives a record of the accounts debited and credited
in the transaction. (the accounts increased or
decreased)
It gives the post reference number of the ledger
accounts involved. (after the transaction has been
posted to the ledger accounts)
Step #3 – Post (transfer)
transaction data from the journal to
the individual ledger accounts.
The “Ledger Accounts” are individual records of
all the assets, liabilities, and owners equity
accounts.
Each Ledger Account is updated daily and
keeps a ongoing record of activity in the account
and balance of the account.
All data that goes into the ledger accounts must
first be put into the journal and then posted from
the journal to the ledger account on the day the
information is journalized.
Step #4 – Adjustments
Adjustments are the internal transactions of a
company that a good accountant will make to set
in order each account. They must be journalized
first and then posted to the ledger.
Adjustments are usually made at the end of an
accounting period.
Examples: Depreciation, Use of pre-paid rent
or insurance, interest earned or expensed, use
of supplies and materials, unearned revenues
earned during the period.
Step #5 – Trial Balance
Before preparing your statements, make
sure that all of your accounts have the
correct balance.
List of all accounts with debit and credit
balances……DEBITS MUST EQUAL
CREDITS.
If not in balance you must go back in your
audit trail and find your errors.
#6 Prepare your Financial
Statement – Income Statement,
Statement of OE, & Balance Sheet
This is the main product of the accounting
system that outsiders/investors/creditors
etc. will look at to see the financial health
of your business.
These statements and how to read them
and create profitability ratios from their
numbers should become second nature to
a business owner, or anyone interested in
finance. This knowledge is essential.
#7 – Close all the temporary
accounts and start over.
Close the temporary accounts:



All Expense Accounts
All Revenue Accounts
All Drawing or Dividend accounts.
Transfer the net increases or decreases of these
temporary accounts into the permanent owners
equity account of capital or retained earnings.
This makes it possible for the company to start a
new set of reports to compare with the old etc.
#8 Prepare a Post-Closing Trial
Balance.
A list of the accounts you start the new
accounting period with.
A check to see if Debits = Credits with
these continuing accounts.
If total DEBITS DO NOT EQUAL total
CREDITS a mistake has been made and
needs correction.