Accounting is the process of applying a systematic approach to consolidate a company's financial activities. It includes keeping track of, analysing, reporting and recovering financial transactions. Accounting is required for legal reasons, taxes, and to determine the health of a corporation. Accounting guarantees that every business transaction is recorded and makes it easy to retrieve any expense or revenue information. Financial accounting and managerial accounting are the two types of accounting.
- Financial accounting is concerned with the accurate presentation of transactions in financial statements, such as income statements, that are communicated with persons outside the company.
- Management accounting is a type of accounting in which the management department receives financial data to make critical business decisions and maintain the company's smooth operation. Management accounting is an internal process used to improve a company's overall performance. It contains details such as the budget.
Did You know?
There are three golden rules for accounting: debit - what comes in, credit - what goes out, debit - the receiver, credit - the giver and debit - the expenditure and losses, and credit - the income and gains.
Fundamentals of Accounting Principles
The five basic principles of accounting are as follows:-
- Principle of Revenue Recognition - According to this idea, revenue recognition happens after the deal is concluded. It doesn't matter if you get paid in cash or kind. More importantly, the sale of goods or services should be completed, with payment due immediately. The associated costs are also scheduled for the same period.
- Principle of Matching - This principle dictates that money earned during an accounting period is compared to expenditures made during the same period. Any expenditure associated with a sale or revenue reported in a specific period is considered in that period.
- Principle of Objectivity - According to this principle, all information in the books of accounts should be objective, dependable, and accurate. They should also be free of the reporting person's personal bias. There should be sufficient evidence such as vouchers, receipts, invoices, and other documents to substantiate the accounts.
- Principle of Full Disclosure - According to this idea, a company's books of accounts should completely disclose all important information to its users. There should also be no wilful withholding of information.
- Principle of Historical Cost - This theory states that all assets should be valued at their acquisition cost rather than their current market worth. For highly marketable securities, there is an exception to this rule. They're worth what they're worth on the market. Impaired intangible assets are also reflected in their current market value. As a result, this approach assures that the assets reported have a realistic value or cost.
Also Read: What are the major accounting conventions?
Key Objectives of Accounting
The key objectives of accounting are as follows:-
- Recordkeeping - The primary role of accounting is recordkeeping, one of the cornerstones of accounting. A company must adopt standard methods of storing and keeping data so that it may be retrieved when needed. All transaction-related purposes necessitate thorough and accurate record storage.
- Reporting - After record keeping, financial reporting is a critical accounting goal. Accounting allows firms to keep track of and report on their financial position after a certain period. It entails putting together transaction records and reports required to understand a specific component of a business over some time.
- Analysis - Accounting examines the reports based on the business records. When business health needs to be determined, then the business reports are analysed. Accounting analysis allows accountants to identify ways to increase business efficiency, upgrade systems, and identify areas where wasteful expenditures occur.
Double Entry System
As per GAAP, accounting entries are done by using the double-entry system. Thereby each transaction will have:
- two sides for every financial transaction;
- the entries will be under any of the five categories of accounts;
- Every account "debited" shall have a corresponding "credit" entry in other reports.
That's how the sum of all debits will always be equal to the amount of all credits.
Key Accounting Reports
The three main types of financial statements in accounting are:
- Statement of Profit and Loss - This statement shows the entity's profit or loss over a specific period. A corporate organisation's "Net Profit" or "Net Loss" is calculated by subtracting total income from total costs.
Net Profit or Loss = Income – Expenditure
- Balance Sheet - A balance sheet represents an entity's financial status at a given point in time. It follows the matching principle: both sides of the balance sheet must always match. We have assets on the one hand and liabilities and owner's or stockholder's equity.
Assets = Liabilities Owner’s/Stockholders’ Equity
- Statement of Cash Flows - This statement shows how and where cash has come from. Subsequently, it shows how it has been spent or utilised during a specific period. Cash may have come from its operating activities or financial and investing activities.
Accounting Process and Steps
One of the fundamentals of accounting is the accounting process. It follows a transaction from the time it is recorded until the generation of a report using multiple transactions that occurred over some time, often known as an accounting cycle. Single-entry accounting and double-entry accounting are both options for businesses. Accounting software packages such as Tally Prime are used by businesses to automate the accounting process. For storage, analysis, and retrieval purposes, the advantages include saving time, effort, and money.
Steps of the Accounting Process
There are 8 steps in the accounting process. This is a framework, and it can vary from company to company as each company has an individual model that it works with:-
- Step 1: Transaction identification - First and foremost, you must identify your business transactions. Every one-of-a-kind transaction must be recorded to be accurately reflected. All expenditures, including acquisition, repair, and upgrade, must be accounted for.
- Step 2: Journal creation involves recording each transaction in a journal. You can choose between two types of accounting; cash accounting and accrual accounting. Cash
accounting is recorded the moment the cash is paid or received. Accrual accounting is when transactions are recorded as they occur.
- Step 3: General ledger posting - The general ledger after the journal entry reflects the transaction information must. The general ledger enables categorisation because transactions are kept according to multiple accounts.
- Step 4: Trial balance - The trial balance is calculated in this stage. For each account, the debits should ideally equal the credits. The trial balance reveals the balances in each account that have not yet been updated.
- Step 5: Worksheet analysis - Adjustment of the various transaction entries is made in this step of the accounting process. First, you need to create a worksheet and make sure that the credits and debits are equal. In the case of accrual accounting, there is an additional step here to adjust the entries for revenue and expense matching purposes.
- Step 6: Journal entries adjustment - This is the point in the accounting cycle that you must make modifications. Following the changes, the trial balance is re-prepared to check that the debits and credits are equivalent.
- Step 7: Financial statements - After all of the entries in the journal have been modified; this stage generates the financial statements. The cash flow statement, income statement, and balance sheet are the primary financial statements in most circumstances. These reveal how well the company is doing financially and how much money it is making.
- Step 8: Closing - The closing of the books is the final stage in the accounting cycle. This is applicable for temporary accounts that are being converted to permanent accounts. The profit and loss statement, for example, is moved to the retained earnings accounts, and so on. The reporting period comes to an end with the closing.
Also Read: Accounting Ratios – Meaning, Types, Formulas
How does Accounting Software Help Businesses?
Accounting software may take the doubt out of the process. No matter how small, expanding, or enterprise-level, every firm requires an accounting software program. Tally Prime is the best example of all-encompassing accounting software. All you have to do now is keep track of the bills and invoices, and Tally Prime will handle the rest. It reduces human mistakes and automates the handling of books of accounts, among other things. It also helps with inventory management, tax compliance, business process automation, and business forecasting, among other things.
Some of the critical features of Tally Prime:
- Record and bookkeeping
- Invoicing and billing
- Predefined chart of accounts
- Sales and Purchase Management
- Online business reports
- Inventory Management
- Taxation support
- Accounts receivable and payable management
Accounting is the process of entering, documenting, summarising, evaluating, and reporting data connected to a company's or organisation's financial activities. Accounting fundamentals serve as a set of guidelines for doing such jobs. Financial statements are based on the operations of a company entity over an accounting period, which is usually a year. A corporation uses accounts to assess its financial position. They aid in decision-making, cost planning, and evaluation. Above all, accounting reports are critical to external stakeholders like investors, creditors, and regulatory organisations. For the preparation of these reports, professionals worldwide follow a set of guidelines known as “GAAP– Generally Accepted Accounting Principles." The above article has explained to you in detail the fundamental principles of accounting, accounting process and steps, key accounting reports, and the usefulness of accounting software.
Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.