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Accounting basics in business and employment

In this article you will know about the basics of accounting in business and employment

What Is Accounting?

How Accounting Works

Accounting is one of the key functions for almost any business. It may be handled by a bookkeeper or an accountant at a small firm, or by sizable finance departments with dozens of employees at larger companies. The reports generated by various streams of accounting, such as cost accounting and managerial accounting, are invaluable in helping management make informed business decisions.

KEY TAKEAWAYS

  • Regardless of the size of a business, accounting is a necessary function for decision making, cost planning, and measurement of economic performance measurement.
  • A bookkeeper can handle basic accounting needs, but a Certified Public Accountant (CPA) should be utilized for larger or more advanced accounting tasks.
  • Two important types of accounting for businesses are managerial accounting and cost accounting. Managerial accounting helps management teams make business decisions, while cost accounting helps business owners decide how much a product should cost.
  • Professional accountants follow a set of standards known as the Generally Accepted Accounting Principles (GAAP) when preparing financial statements.
  • What Is the Accounting Equation?

    The accounting equation is considered to be the foundation of the double-entry accounting system. On a company's balance sheet, it shows that a company's total assets are equal to the sum of the company's liabilities and shareholders' equity.

    Based on this double-entry system, the accounting equation ensures that the balance sheet remains “balanced,” and each entry made on the debit side should have a corresponding entry (or coverage) on the credit side.

    KEY TAKEAWAYS

    • The accounting equation is considered to be the foundation of the double-entry accounting system.
    • The accounting equation shows on a company's balance that a company's total assets are equal to the sum of the company's liabilities and shareholders' equity.
    • Assets represent the valuable resources controlled by the company. The liabilities represent their obligations.
    • Both liabilities and shareholders' equity represent how the assets of a company are financed.
    • Financing through debt shows as a liability, while financing through issuing equity shares appears in shareholders' equity.
    • What Is an Asset?

      An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit. Assets are reported on a company's balance sheet and are bought or created to increase a firm's value or benefit the firm's operations. An asset can be thought of as something that, in the future, can generate cash flow, reduce expenses, or improve sales, regardless of whether it's manufacturing equipment or a patent.

      KEY TAKEAWAYS

      • An asset is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit.
      • Assets are reported on a company's balance sheet and are bought or created to increase a firm's value or benefit the firm's operations.
      • An asset can be thought of as something that, in the future, can generate cash flow, reduce expenses or improve sales, regardless of whether it's manufacturing equipment or a patent.
      • What Is a Liability?

        A liability is something a person or company owes, usually a sum of money. Liabilities are settled over time through the transfer of economic benefits including money, goods, or services. Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses.

        In general, a liability is an obligation between one party and another not yet completed or paid for. In the world of accounting, a financial liability is also an obligation but is more defined by previous business transactions, events, sales, exchange of assets or services, or anything that would provide economic benefit at a later date. Current liabilities are usually considered short-term (expected to be concluded in 12 months or less) and non-current liabilities are long-term (12 months or greater).

        Liability may also refer to the legal liability of a business or individual. For example, many businesses take out liability insurance in case a customer or employee sues them for negligence.

        KEY TAKEAWAYS

        • A liability, generally speaking, is something that is owed to somebody else.
        • A liability can also mean a legal or regulatory risk or obligation.
        • In corporate accounting, companies book liabilities in opposition to assets.
        • Current liabilities are a company's short-term financial obligations that are due within one year or within a normal operating cycle such as accounts payable and taxes owed.
        • Long-term (noncurrent) liabilities are obligations listed on the balance sheet not due for more than a year such as bond interest payments.
        • What Is Equity?

          Equity, typically referred to as shareholders' equity (or owners' equity for privately held companies), represents the amount of money that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company's debt was paid off in the case of liquidation. In the case of acquisition, it is the value of company sale minus any liabilities owed by the company not transferred with the sale.

          In addition, shareholder equity can represent the book value of a company. Equity can sometimes be offered as payment-in-kind. It also represents the pro-rata ownership of a company's shares.

          Equity can be found on a company's balance sheet and is one of the most common pieces of data employed by analysts to assess the financial health of a company.

          KEY TAKEAWAYS

          • Equity represents the value that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company's debts were paid off.
          • We can also think of equity as a degree of residual ownership in a firm or asset after subtracting all debts associated with that asset.
          • Equity represents the shareholders’ stake in the company, identified on a company's balance sheet.
          • The calculation of equity is a company's total assets minus its total liabilities, and is used in several key financial ratios such as ROE.
          • What Is Revenue?

            Revenue is the income generated from normal business operations and includes discounts and deductions for returned merchandise. It is the top line or gross income figure from which costs are subtracted to determine net income.

            \begin{aligned} &\text{Sales Revenue} = \text{Sales Price} \times \text{Number of Units Sold} \\ \end{aligned}​Sales Revenue=Sales Price×Number of Units Sold​

            Revenue is also known as sales on the income statement. It is vital for a startup to get positive revenue early.

            KEY TAKEAWAYS

            • Revenue, often referred to as sales, is the income received from normal business operations and other business activities.
            • Operating income is income derived from normal business operations, such as sales of goods or services.
            • Non-operating income is infrequent or nonrecurring income derived from secondary sources (e.g., lawsuit proceeds).
            • What is an Expense?

              An expense is the cost of operations that a company incurs to generate revenue. As the popular saying goes, “it costs money to make money.”

              Common expenses include payments to suppliers, employee wages, factory leases, and equipment depreciation. Businesses are allowed to write off tax-deductible expenses on their income tax returns to lower their taxable income and thus their tax liability. However, the Internal Revenue Service (IRS) has strict rules on which expenses business are allowed to claim as a deduction.

              KEY TAKEAWAYS

              • An expense is the cost of operations that a company incurs to generate revenue.
              • Businesses can write off tax-deductible expenses on their income tax returns, provided that they meet the IRS’ guidelines.
              • Accountants record expenses through one of two accounting methods: cash basis or accrual basis.
              • There are two main categories of business expenses in accounting: operating expenses and non-operating expenses.
              • The IRS treats capital expenses differently than most other business expenses.
              • Current and Noncurrent Assets as Balance Sheet Items

                The portion of ExxonMobil's balance sheet pictured below displays where you may find current and noncurrent assets.1

                • Current assets generally sit at the top of the balance sheet. Here, they are highlighted in green, and include receivables due to Exxon, along with cash and cash equivalents, accounts receivable, and inventories.
                • Noncurrent assets are listed below current assets. These are highlighted in blue, and represent Exxon's long-term investments like oil rigs and production facilities that come under property, plant, and equipment (PP&E).
                • The combined total assets are highlighted in yellow.

This content is accurate and true to the best of the author’s knowledge and is not meant to substitute for formal and individualized advice from a qualified professional.

© 2021 Muhammad Saad

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