Accrual Accounting and Bookkeeping
This method of accounting records a transaction as it actually occurs. If a customer buys a chair with no money down on February 1st, the sale of the chair is recorded at the same time, but the money is recorded as an outstanding “receivable.” Then, when the customer pays for the chair on March 30th, the transfer of cash is recorded as a separate entry, completing the transaction.
Accrual Accounting is the method required by financial institutions when applying for a loan and is used by most accountants. It's by far the most common approach to accounting for all but the smallest of businesses, and because of its real-time perspective, offers the most value as a management tool. We will use the Accrual Accounting Method for this program.
The basic formula that defines Accrual Accounting is:
Liabilities + Owner's Equity = Assets
- Bookkeeping — The first step in your Bookkeeping System is to transfer the information from your Source Documents into your bookkeeping documents. Source Documents are collected by your bookkeeper who then records and compiles the information for future use. Essentially, your bookkeeping system generates a database that stores all of your financial information in an organized and accessible form. The two main tools used to accomplish this are called Journals and Ledgers.
a. Journals — These organize your financial information chronologically. In other words, they list your financial transactions in the order they occur in real-time.
b. Ledgers — These organize your financial information by category. In other words, they group your financial transactions by type. For example, all cash sales might be listed on one ledger and all sales to a particular customer might be listed on another.
- Accounting — Periodically, your financial information should be organized and formatted for analysis. Your Accountant (or Bookkeeper) will convert your financial information into financial reports that provide useful information concerning the operation of your business.
Financial reports can take many forms, but the three primary reports that a business should produce are: a. Balance Sheets (sometimes called the Statement of Earnings) — show the general financial health of your business at a specific moment in time.
b. Income Statements (sometimes called the Profit and Loss or P&L) — detail the profits (or losses) of your business over a period of time.
c. Statements of Cash Flows — monitor the flow of cash in and out of your business.
d. Common Size Financial Reports — show the relative progress of your business as a percentage of sales or total assets.
A shoebox filled with receipts is not an adequate bookkeeping system.
Bookkeeping is the first step in your Accounting System. Here, the information from your source documents is collected, recorded and organized. Later, you will analyze and output this information in formats that will help you make better business decisions.
It's important to keep track of the numerous and varied transactions your business is involved in, otherwise problems will eventually occur. Overdue payables, uncollected receivables and lost profits are just a few examples of what can happen to a business without a formal bookkeeping system.
To be really useful, bookkeeping should be done as soon as possible after the financial transaction occurs. You don't want to end up basing important decisions on outdated information.
In this section, you'll learn the fundamentals of “keeping your books.” Even though someone else probably does your bookkeeping, it's still important for you to have a basic understanding of what they're doing, so you can recognize errors and make improvements. There's no need for you to become a bookkeeper, but you never want to put yourself in a position where a part of your business becomes a complete mystery to you.
If bookkeeping and accounting methods are new to you, don't get caught up in the mechanics of the process. Instead, focus on understanding the basic principles as well as the meaning of the numbers.
There are two sides to every financial transaction. When you make a sale, you take in money but you also exchange it for a product or service. Alternatively, when you buy supplies, you take in goods, but you also exchange them for money. Double-entry Bookkeeping is simply a method of recording both sides of this equation.
Your bookkeeping documents fall into two basic categories: your Journals and your Ledgers. Basically, your Journals record the details of your financial transactions chronologically and your Ledgers organize those transactions by category. The list of accounts you use to track these transactions is called your Chart of Accounts.
Double-entry Bookkeeping was originally developed as a way of double-checking manual additions. If both the “in” and the “out” columns of a transaction added up to the same number, bookkeepers knew their additions were more than likely correct. Even though most businesses now record their finances using computers, the double-entry method has endured as the international standard.