Basic Accounting

Definition of Accounting: It is a systematic process of identifying, recording, measuring, classifying, verifying, summarizing, interpreting and communicating financial information. It reveals profit or loss for a given period, and the value and nature of a firm's assets, liabilities and owners' equity. 

Accounting, is the production of financial records about an organization. Accountancy generally produces financial statements that show in money terms the economic resources under the control of management; selecting information that is relevant and representing it faithfully. The principles of accountancy are applied to accounting, bookkeeping, and auditing. 

This App will introduce you to some basic accounting principles, accounting concepts, and accounting terminology. Once you become familiar with some of these terms and concepts

  1. The Accounting Equation
  2. Double Entry Bookkeeping
  3. Reporting Period & Conversion Period
  4. Financial Statements
  5. Balance Sheet
  6. Profit and Loss Account
  7. Cash Flow Statement

The Accounting Equation

The basic accounting equation, also called the balance sheet equation, represents the relationship between the assets, liabilities, and owner's equity of a business. It is the foundation for the double-entry bookkeeping system. For each transaction, the total debits equal the total credits. It can be expressed as: Assets = Liabilities + Owner’s equity [Capital]


Assets are tangible and intangible items of value which the business owns. Examples of assets are:
  • Cash
  • Cars
  • Buildings
  • Machinery
  • Furniture
  • Debtors (money owed from customers)
  • Stock / Inventory


Liabilities are those items which are owed by the business to bodies outside of the business. Examples of liabilities are:
  • Loans to banks
  • Creditors (money owed to suppliers)
  • Bank overdrafts

Owner’s Equity

The simplest way to understand the accounting equation is to understand what makes up ‘owner’s equity’. By rearranging the accounting equation you can see that Owner’s Equity is made up of Assets and Liabilities. Owner’s Equity = Total Assets less Total Liabilities Owner’s Equity can also be expressed as: Owner’s Equity = Capital invested by owner + Profits/Losses to date (also known as ‘Retained Earnings’) Rearranging the equation again, therefore: Total Assets - Total Liabilities = Capital + Retained Earnings

Double Entry Bookkeeping

All accounting transactions are made up of 2 entries in the accounts: a debit and a credit. 
For example, if you purchased a book, your value of books would increase, but your value of cash would decrease by the same value, at the same time. This is double entry bookkeeping. 

Ledger Accounts

A ledger account is an item in either the Profit & Loss account (which we’ll discuss shortly) or the balance sheet. A Ledger account is either a: 
  • Asset
  • Liability
  • Equity
  • Income
  • Expense
The example of purchasing a book, mentioned above, can be shown in the form of ledger accounts as follows: 
Particulars Dr. Amount Cr. Amount
Cash 5000.00
Purchase 5000.00
"Dr." is short for Debit
"Cr." is short for Credit
If all transactions are entered into the books in this way, then the sum of all of the debits would equal the sum of all of the credits.

Trial Balance

A trial balance is a list of all of the ledger accounts of a business and the balance of each. Debits are shown as positive numbers and credits as negative numbers. The trial balance should therefore always equal zero. 
Following on from the previous example, if we were to sell a BOOK for $25 cash then the ledger accounts and trial balance would look like this: 
Particulars Dr. Amount Cr. Amount
Cash 20.00
Purchase (Book) 20.00
Particulars Dr. Amount Cr. Amount
Cash 25.00
Sales (Book) 25.00
Trial Blalance Amount
Cash 5.00
Purchase 20.00
Sales 25.00

Reporting Period & Conversion Period

The reporting period is usually a 12 month period ending 30 June each year. At the end of each financial year the profit and loss account balance is transferred to the Retained Earnings account in the Balance Sheet (under Equity). A new profit and loss account is started for the new financial year

Balance sheet is continuous, the Profit and Loss account is just for the current financial year

The conversion period is the month in which you transfer over to a new accounting system. If you are transferring to a new accounting system at the beginning of a financial year, the final balance in the profit and loss account would be transferred to the new system (retained earnings account) along with all of the current balance sheet account balances.

Conversion partway through year

If you are transferring your accounts partway through a year, all of the individual Profit and Loss account balances must be individually transferred to the new system as opening balances so that all of the current year’s financial data is stored. The individual balances on the balance sheet are transferred as normal.

Other conversion issues

Only the balances of accounts will usually be transferred to the new system. Generally a business would not re-input all of their individual transactions, such as invoices, receipts, payments etc. This means that there are likely to be cut-over issues. For example you may have written a cheque to a supplier but as at the cut-over date the supplier has not cashed the cheque. Even though the bank would have been credited and the supplier’s account would be correct, this cheque would be outstanding, and the new accounting system e.g. MYOB, would not have a record of the outstanding cheque to enable a reconciliation of the bank account. This issue is covered in the course “Getting started with MYOB accounting software”. 
Other similar cut-over issues would include:
  • Monies received but not yet cleared through the bank
  • Supplier invoices not yet paid
  • Customer receipts not yet received

Financial Statements

Financial statements are general purpose, external financial statements prepared according to generally accepted accounting principles. Some terms that apply to the financial statements include: 
  • Balance Sheet reports the amounts of assets, liabilities, and stockholders’ equity at a specified moment, such as midnight of December 31; also known as the statement of financial position. 
  • Income Statement reports revenues, expenses, gains, losses, and net income during the period of time stated in its heading; also known as the statement of operations and as the profit and loss (P&L) statement. 
  • Statement Of Cash Flows reports the changes in cash and cash equivalents during a period of time according to three activities: operating, investing, and financing. 
  • Statement Of Stockholders’ Equity reports the changes in the components of stockholders’ equity, including net income, other comprehensive income, dividends, exercise of stock options. 
  • Interim Financial Statements issued between the annual financial statements, e.g. quarterly 
  • Audited Financial Statements independent CPA firm gives assurance about reasonableness and compliance with accounting principles. 
  • Financial Reporting includes financial statements, annual and quarterly reports to SEC and stockholders, press releases and other financial reports.

Balance Sheet

The balance sheet shows a snapshot of the business’s net worth of financial position reports assets, liabilities, owner’s or stockholders’ equity at a point in time. Accounting Equation Assets = Liabilities + Stockholders’ (Owner’s) Equity. Classified Balance Sheet groups assets into the following classification: current assets,investments, property, plant and equipment, and other assets. Liabilities are classified as either current or long-term. Some terms that apply to balance sheets include: 
  • Assets resources, things owned, and prepaid or deferred expenses; examples include cash, accounts receivable, inventory, prepaid insurance, land, equipment, vehicles, furnishings. 
  • Current Asset will turn to cash within one year of the date of the balance sheet (unless the operating cycle is greater than one year). 
  • Liabilities obligations and deferred revenues; examples include accounts payable, loans payable, wages payable, interest payable, customer deposits, deferred revenues.
  • Current Liability an obligation that will become due within one year of the balance sheet date (unless the operating cycle is greater than one year).
  • Owner’s Equity a sole proprietorship’s assets minus its liabilities. 
  • Stockholders’ Equity a corporation’s assets minus its liabilities; reports paid-in capital, retained earnings, and treasury stock. 

Profit and Loss Account

Whereas the balance sheet shows a snapshot at a point in time of the net worth of the business, the profit and loss account shows the current financial year’s net operating profits, broken down into various sales, cost of sales and expenses ledger accounts. 
  • SALES: Sales accounts show all sales made in the period, regardless of whether or not money has been received yet, and are shown as a credit in the Profit and Loss accounts. Where money has not yet been received, the debit is not to cash (as per the CD example above), but to a Debtors account (money owed from customer account). 
  • COST OF SALES: Cost of Sales are expenses that can be directly attributed to sales items, such as purchases of stocks.
  • EXPENSES: These are all other expenses (other than purchases of assets) which cannot be attributed directly to sales items, such as rent, electricity or advertising.

The income statement (statement of operations, or P&L for profit and loss statement) reports a company’s net income for a specified period of time. Net income is revenues and gains minus expenses and losses. Some terms associated with the income statement include: 
  • Revenues amounts earned, sales, service fees, interest earned. 
  • Expenses costs incurred to earn revenues, costs used up or expiring during the accounting period, and costs for which the future value cannot be measured. 
  • Gain sale of a long-term asset for more than its carrying (book) value; elimination of an obligation for less than its carrying value. 
  • Loss sale of a long-term asset for less than its carrying (book) value; elimination of an obligation for more than its carrying value. 
  • Gross Profit sales minus cost of goods sold. 
  • Cost Of Goods Sold beginning finished goods inventory + net purchases (or cost of goods manufactured) – ending finished goods inventory. Single-Step Income Statement one subtraction to reach net income: operating and nonoperating revenues minus operating (including cost of goods sold) and nonoperating expenses. 
  • Multiple-Step Income Statement at least one subtotal before reaching net income: sales – cost of goods sold = gross profit; gross profit – operating expenses = income from operations. Income from operations +/- nonoperating items = net income. 
  • Selling, General And Administrative SG&A; operating expenses; noninventoriable costs. 
  • Operating Income income from operations; pretax income before nonoperating revenues and expenses. 
  • Non Operating Income income from peripheral activities.

Cash Flow Statement

The statement of cash flows (or cash flow statement) explains the change in cash and cash equivalents during a period of time. The changes are categorized by operating, investing, and financing activities. Significant noncash transactions are also disclosed. Terms related to the statement of cash flows (SCF) include: 
  • Operating Activities activities involving net income 
  • Investing Activities activities involving long-term assets 
  • Financing Activities activities involving long-term liabilities and stockholders’ equity (other than net income). 
  • Other Noncash Transactions activities such