Understanding the Accounting Process

Accounting

A Quick Introduction to Accounting

Accounting involves a lot of complexities, but understanding some basic principles can be very helpful. This article is designed to help you get a start in understanding the accounting process.

The accounting process involves all the steps that take place between a single transaction and the completion of financial statements at the end of an accounting cycle. Included in this article are lots of useful links to pictures and websites that will help you to better understand the accounting process.

Most accounting today is done on computers using software programs and networking capabilities.
Most accounting today is done on computers using software programs and networking capabilities. | Source
Journal Entry
Journal Entry

The Accounting Process

The first step in the accounting process is recording journal entries and naturally this requires a transaction. It is important to understand that not every transaction will involve cash. In today's business world, nearly every service or good that is transacted is done so on some form of credit. This means that you might walk out of a store with a forty dollar piece of equipment and at that exact moment you have not yet paid a single dollar. Instead you used a credit card and you will pay for that purchase at some later point. In accounting, it is important to record transactions when they happen, regardless of when the transaction will be paid for with cash. This is known as accrual accounting.

Once the transaction occurs, a journal entry must be recorded. A journal entry should be put into a table with each entry taking up two rows. Each row will list an account affected by the transaction. In accounting, every transaction will affect two different accounts (and in cases more). If you buy supplies for your business on credit, the journal entry should record a debit to your supplies account, meaning that now you have more assets (in supplies) and a credit to your accounts payable account because you now owe money to businesses that sold you the supplies. In every journal entry one of the accounts will always be debited and one will always be credited. The image to the upper-left illustrates what a journal entry should look like.

At the end of a month, quarter, or year, you will need to prepare financial statements. By that time you should have a nice long list of journal entries. The next step is to create T-accounts or ledger accounts by taking each account and listing all the debits and credits to that account. Simplified T-accounts will look like this.

After the T-accounts are created, the information must be transferred to a trial balance. The trial balance is a simple table listing each account and the current balance of that account. Asset accounts (cash, accounts receivable, equipment, building, land, etc) almost always have a debit balance while liability and equity accounts (accounts payable, notes payable, owner's equity, etc) have credit balances. When completed, a trial balance will look like this. In a trial balance, the debit and credit side will always balance out with equal totals.

Often, a trial balance will need to be adjusted, which means things like depreciation, prepaid expenses, and accrued expenses are accounted for in the proper accounting period.


Using the trial balance, financial statements are prepared. The first statement is the income statement. It will list the service revenue (money that is brought in from services provided or products sold) followed by all the expenses incurred during that financial period. Using the total from the income statement which is found by subtracting expenses from revenue, the owner's equity statement is prepared. Finally, the balance sheet is completed by listing all the assets, liabilities, and owner's equity. Assets will always equal the liabilities and equity, which is why this statement is called a balance sheet. These statements should be completed in the order mentioned above because information needed for the equity statement and balance sheet come from the previous statement. All of this may sound very complicated, but viewing samples of each of these should help you to understand what types of accounts are recorded in each statement. Click on the links below to view.

Income statement, owner's equity statement, balance sheet.

The accounting process is completed when all accounts are closed and "reset" for the new financial cycle. This involves working with a work sheet that condenses all the financial statements onto one table. All accounts must then be emptied out into the capital account, which is the only account which rolls-over from year to year.There is no doubt that accounting can be very difficult and complex. Hopefully this article has helped you to grow in your knowledge of the subject. Most likely, you will still have a few questions, but using the links and other external information you can continue to expand your knowledge. As with anything, know that accounting, especially at a business level, has both legal and ethical ramifications. Be sure to consult a certified public accountant if you have any concerns.

A mechanical calculator - used during the mid to late 1800s and early to mid 1900s.
A mechanical calculator - used during the mid to late 1800s and early to mid 1900s.

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Comments 18 comments

John 6 years ago

This article is really helped us to grow in our knowledge of the subject.


Don Simkovich profile image

Don Simkovich 6 years ago from Pasadena, CA

Thanks, Jason, for writing this. I think for small business owners accounting seems like a daunting, mysterious task but it doesn't have to be. Glad you took the time to write this up.


Jason Matthews profile image

Jason Matthews 6 years ago from North Carolina Author

Thanks John, I am glad it was helpful in some way!


Jason Matthews profile image

Jason Matthews 6 years ago from North Carolina Author

Don, thanks for the feedback. Accounting is not super easy, but it is something anyone can learn if they want to. Understanding accounting can really help a person in the business world, even if they are not directly doing accounting work.


minso profile image

minso 6 years ago

Good hub explaining the accounting basics clearly. Thank you.


Jason Matthews profile image

Jason Matthews 6 years ago from North Carolina Author

Thanks minso, I am glad it made sense!


joehickox profile image

joehickox 6 years ago from texas

This hub makes sence. Thanks.


Colette 6 years ago

Good, clearly written and well illustrated guide to the basics of accounting. It's a complicated field but you are right Jason, understanding a little will definitely help, whatever your role within a business.


Jason Matthews profile image

Jason Matthews 6 years ago from North Carolina Author

Thanks joehickox and Colette. I appreciate your feedback!


Cpawebtechnology 5 years ago

a well comprised hub on basics , you may want to think of adding a few more hubs as a chain and explain a bit more and detail


fulcherben profile image

fulcherben 5 years ago from Milledgeville, Georgia

I try to explain it to people by relating it to buying a house and a basic algebra equation "A=L+E If A=L+X A is five and L is four what is X?" explanation.


Nayaz 4 years ago

A nice and well written hub. If I am allowed, may I share the following link so that readers of this hub may have a continuation of what they read:

http://principlesofaccounts.weebly.com


BizVT34 profile image

BizVT34 4 years ago from USA

Good explanations with excellent link info. Thanks.


miame 4 years ago

excellent!!!


jude obinna 4 years ago

nice one


John 4 years ago

I myself am an accountant and have my own business, this article helped me a lot it gave me a more in depth look and I will definitely use this to help my employees, Thanks!

http://www.lbca.co.uk/


Shiya 3 years ago

Thankyou for explaining the accounting process. Im a beginner and want to grasp accounting concepts so I can move on to more advanced topics later on. I am looking for free basic accounting resources, if anyone knows do let me know. The one that i found useful so far is www.accountingprodigy.com

Any help in this regard will be appreciated. Thankyou


erorantes profile image

erorantes 2 years ago from Miami Florida

Thank you for explaining the accounting process. Contability ia not an easy task. It is a lot of work. I like numbers. You have to love numbers to be an excellent accountant. I like your article. I can see that you like counting. I like your hub. Many people are going to benefit fron your writing. You did a great job. Undertanding and explaing to others is an honorable action to do.

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