Accounting

 Chapter 1

Grasping Bookkeeping and Accounting Basics

M ost folks aren't enthusiastic bookkeepers. You probably balance your checkbook against your bank statement every month and somehow manage to pull together all the records you need for your annual federal income tax return. But if you're like most people, you stuff your bills in a drawer and just drag them out once a month when you pay them.

Individuals can get along quite well without much bookkeeping but the exact opposite is true for a business. A business needs a good bookkeeping and account- ing system to operate day to day, and a business needs accurate and timely data to operate effectively.

In addition to facilitating day-to-day operations, a company's bookkeeping and accounting system serves as the source of information for preparing its periodic financial statements, tax returns, and reports to managers. The accuracy of these reports is critical to the business's survival. That's because managers use finan- cial reports to make decisions, and if the reports aren't accurate, managers can't make intelligent decisions.

Obviously, then, a business manager must be sure that the company's bookkeep- ing and accounting system is dependable and up to snuff. This chapter shows you to ensure that the information coming out of the accounting system is complete, accurate, and timely.

Knowing What Bookkeeping and Accounting Are All About

In a nutshell, accountants "keep the books" of a business (or not-for-profit or government entity) by following systematic methods to record all the financial activities and prepare summaries. This summary information is used to create financial statements.

Financial statements are sent to stakeholders. Stakeholders are people who have a stake in the company's success or failure. Here are some examples of stakeholders

>>>> Stockholders: If you own stock in General Electric, for example, you receive regular financial reports. Stockholders are owners of the business. They need to know the financial condition of the business they own.

>>> Creditors: Entities that loan money to your business are creditors. They need to review financial statements to determine whether your business still has the ability to repay principal and make interest payments on the loan.

>>> Regulators: Most businesses have to answer to some type of regulator. If you produce food, for example, you send financial reports to the Food and Drug Administration (FDA). Reviewing financial statements is one responsibility of a regulator.

The following sections help you embark on your journey to develop a better understanding of bookkeeping and accounting. Here you discover the differences between the two and get a bird's-eye view of how they interact.

Distinguishing between bookkeeping and accounting

REMEMBER

Distinguishing between bookkeeping and accounting is important, because they're not completely interchangeable. Bookkeeping refers mainly to the recordkeeping aspects of accounting the process (some would say the drudgery) of recording all the detailed information regarding the transactions and other activities of a business (or other organization, venture, or project).

The term accounting_is much broader; it enters the realm of designing the book- keeping system, establishing controls to make sure the system is working well, and analyzing and verifying the recorded information. Accountants give orders; bookkeepers follow them.

Bookkeepers spend more time with the recordkeeping process and dealing with problems that inevitably arise in recording so much information. Accountants, on the other hand, have a different focus. You can think of accounting as what goes on before and after bookkeeping. Accountants design the bookkeeping and accounting system (before) and use the information that the bookkeepers enter to create financial statements, tax returns, and various internal-use reports for managers (after).

Grasping Bookkeeping and Accounting Basics

Taking a panoramic view of bookkeeping and accounting

Figure 1-1 presents a panoramic view of bookkeeping and accounting for busi- nesses and other entities that carry on business activities. This brief overview can't do justice to all the details of bookkeeping and accounting, of course. But it serves to clarify important differences between bookkeeping and accounting.

Bookkeeping has two main jobs: recording the financial effects and other rele- vant details of the wide variety of transactions and other activities of the entity; and generating a constant stream of documents and electronic outputs to keep the business operating every day.

Accounting, on the other hand, focuses on the periodic preparation of three main types of output - reports to managers, tax returns (income tax, sales tax, payroll tax, and so on), and financial statements and reports. These outputs are com- pleted according to certain schedules. For example, financial statements are usu- ally prepared every month and at the end of the year (12 months).

Accounting All-In-One For Dummies, 2nd Edition is concerned predominately with Financial accounter Books to the financial and manager-purpose financial statements (sed to 5). General preparation of fat the financial statements are prepared according to standards established for financial reporting to stakeholders, as explained earlier in this chapter.

These financial statements are useful to managers as well, but managers need more information than is reported in the external financial statements of a business. Much of this management information is confidential and not for circulation outside the business. Management accounting refers to the preparation of internal account ing reports for business managers. Management accounting is used for planning business activity (Book 6) and to make informed business decisions (Book 7).

This chapter offers a brief survey of bookkeeping and accounting, which you may find helpful before moving on to the more hands-on financial and management topics.

Wrapping Your Brain around the Accounting Cycle

Figure 1-2 presents an overview of the accounting cycle. These are the basic steps in virtually every bookkeeping and accounting system. The steps are done in the order presented, although the methods of performing the steps vary from busi- ness to business. For example, the details of a sale may be entered by scanning bar codes in a grocery store, or they may require an in-depth legal interpretation for a complex order from a customer for an expensive piece of equipment. The follow- ing is a more detailed description of each step:

1. Prepare source documents for all transactions, operations, and other events of the business; source documents are the starting point in the bookkeeping process.

When buying products, a business gets an invoice from the supplier. When borrowing money from the bank, a business signs a note payable, a copy of which the business keeps. When preparing payroll checks, a business depends on salary rosters and time cards. All of these key business forms serve as sources of information entered into the bookkeeping system - in other words, information the bookkeeper uses in recording the financial effects of the activities of the business.

2. Determine the financial effects of the transactions, operations, and other events of the business.

The activities of the business have financial effects that must be recorded the business is better off, worse off, or affected in some way as the result of its transactions. Examples of typical business transactions include paying employees, making sales to customers, borrowing money from the bank, and buying products that will be sold to customers. The bookkeeping process begins by determining the relevant information about each transaction. The chief accountant of the business establishes the rules and methods for measuring the financial effects of transactions. Of course, the bookkeeper should comply with these rules and methods.

3. Make original entries of financial effects in journals, with appropriate references to source documents.

Using the source documents, the bookkeeper makes the first, or original, entry

for every transaction into a journal; this information is later posted in accounts (see the next step). A journal is a chronological record of transactions in the order in which they occur like a very detailed personal diary.

Here's a simple example that illustrates recording a transaction in a journal. Expecting a big demand from its customers, a retail bookstore purchases, on credit, 100 copies of The Beekeeper Book from the publisher, Animal World. The books are received, a few are placed on the shelves, and the rest are stored. The bookstore now owns the books and owes Animal World $2,000, which is