Every individual involved in any kind of work practices accounting[close] accounting , which is the process of recording, summarizing, analyzing, and interpreting financial activities to permit organizations and individuals to make informed judgments and decisions.
Organizations need accounting in order to measure success (or failure). One form of organization is the private business[close] business , which is organized with the objective of earning a profit. Three common forms of business are the service business[close] service business , the merchandising business[close] merchandising business , and the manufacturing business[close] manufacturing business . Users of accounting information include owners, managers, investors, lenders, and the government. Ownership of business can be in the form of a sole proprietorship[close] sole proprietorship (owned by one person), a partnership[close] partnership (owned by two or more persons), a corporation[close] corporation (owned by stockholders), or a limited liability company (LLC)[close] limited liability company (LLC) , which combines features of a corporation and those of a partnership or a proprietorship. In financial terms, accounting is used to communicate to those who have a need or legal right to know about the financial activities of a particular business. Thus, accounting has been called the language of business.
The business entity concept[close] business entity concept states that the owner of a business and the business are two separate accounting units. Personal items of the owner should be excluded from all business documents and records. The accounting system that we use today is deeply rooted in history and is based on three elements: assets, liabilities, and owner's equity. An asset[close] asset is an item with money value that is owned by a business. Common examples of assets include cash[close] cash , accounts receivable[close] accounts receivable , equipment[close] equipment , and supplies[close] supplies . Equipment and supplies are tangible[close] tangible , or physical, assets. A liability[close] liability is a debt owed to a creditor[close] creditor . Accounts payable[close] Accounts payable is the major type of liability, and another is notes payable[close] notes payable . Owner's equity[close] Owner's equity is the dollar value of the financial claim of the owner to the assets of the business. The accounting elements are combined into the accounting equation[close] accounting equation : Assets = Liabilities + Owner's Equity, or A = L + OE.
The value of the accounting elements changes constantly as transactions take place. A transaction[close] transaction is any event or condition that changes the value of a firm's assets, liabilities, or owner's equity. The cost principle[close] cost principle is used to value assets.
All business transactions affect one or more of the basic accounting elements. The effect of business transactions can be stated in terms of increases and decreases in the accounting elements. To maintain the accounting equation in balance, all transactions are recorded as having a dual effect[close] dual effect on the accounting elements. One type of transaction involves a shift in assets[close] shift in assets , in which one asset increases and another asset decreases. Other transactions affect two accounting elements, such as an increase in an asset and an increase in a liability.
There are two ways to increase owner's equity: (1) an owner investment of cash or other assets into the business and (2) revenue[close] revenue --income from carrying out the major activity of a firm. The realization principle[close] realization principle states that revenue should be recorded when it is earned. There are two ways to decrease owner's equity: (1) an owner withdrawal[close] withdrawal of cash or other assets from the business and (2) an expense incurred in operating a business. Expenses are the costs of operating a business.
The summarizing function of the accountant is shown by the preparation of financial statements[close] financial statements at the end of an accounting period. An accounting period[close] accounting period is a period of time, usually a year, for which accounting records are kept. The income statement[close] income statement summarizes revenues and expenses, showing net income[close] net income or net loss[close] net loss for an accounting period. When revenues exceed expenses, there is a net income. On the other hand, when expenses exceed revenues, there is a net loss. The statement of owner's equity[close] statement of owner's equity shows changes that have occurred in owner's equity during an accounting period. The balance sheet[close] balance sheet is a list of assets, liabilities, and owner's equity on a specific date, usually the last day of an accounting period.
Business ethics[close] ethics are the standards of conduct that lead to fair, honest, and reliable financial reporting. Ethical considerations affect accounting because effective and accurate financial reporting depends on sound ethical behavior. While we never hear about them, the vast majority of accountants do their jobs professionally and ethically. It is, unfortunately, those who get caught cheating that make the headlines. In the early 2000s, there were accounting scandals, the likes of which our nation has not seen since the 1920s. Congress responded quickly by passing the Sarbanes-Oxley Act of 2002[close] Sarbanes-Oxley Act of 2002 , which made it a criminal offense to falsify financial statements.
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