We have an innate need for organization. We need to organize our lives. We need to get out stuff together. We need to organize our rooms, and our kitchens.
School tries to arm us with such a capacity from an early age too. Write heading in a specific color. Write paragraphs in a different one. Leave a certain margin. Allocate a notebook for each subject, and never use a notebook for all of them (I have to admit that I used to do this).
On an individual level, we are different, and just as some of us are obsessed with order and long for strict organization, others despise such dependence on systems and see them as mere constructs that further complicate matters rather than simply them.
The reality is that by “just living,” we—our activities—are generating data on a minute-to-minute basis. That data needs to be processed, organized, and stored. We then can use that our archives/historical records to make inferences, or to help researchers better understand and solve the challenges of their fields by making the access to the information resources they need most easy and time-efficient.
Here comes the field of organizing recorded information. The International According to the Federation of Library Associations and Institutions (IFLA)1, end-users of the information benefit from the organization process by being able to accomplish the following five tasks more efficiently:
Find: look for entities that match tight and specific criteria
Identify: verify that the entities sought is the same as the one found
Select: ensuring of retaining only resources that match the user’s need
Obtain: make the resource sought accessible
Explore: make possible the discovery of new resources and entities
We should differentiate between the terms “recorded information” and “information resource.”
The first refers to any form of factual knowledge about something or someone.2 The second is an identifiable and describable unit of information; an instance of recorded information.3
Information resources often have some common attributes, such as title, creator, date, ISBN, etc..
Archivists and collection specialists use these attributes to help them organize these resources collectively, and according to a specific criteria.
These attributes are called metadata, which is just a fancy name for “data that provides information about other data.” 4
There are generally four steps we should follow if we want to organize recorded information:
Identify every information resource available at our disposal
Closely examine the contents of each resource
Collectively organize these resources into separate collections
Work out a list of every information resource prepared according to some standard guideline for citation
This is part of a financial literacy blog series, check out the first part.
What an Account is, and How it Helps the Recording Process
For companies and financial institutions with large daily volumes of business transactions, the recording process is a very crucial part of keeping track of the company’s financial data. Problems arise all the time, an example of these problems is mistakes that occur while recording(remember the woman from Dallas who woke up one day, opened her personal bank account on her smartphone to find $37million deposited by mistake?)
Here is the video for you in case you don’t know about it:
And that’s why, these companies need to record their transactions in simple, practical, and inexpensive way. Thus, to keep track of their transaction data, companies follow certain procedures and keep certain records.
The Account:
An account is an individual accounting record of increases and decreases in a specific asset, liability, or equity item.
And so each company has an account separate for each item. So items that belong under assets like Cash, Accounts Receivables, Equipment, etc.. have their own account. Also, item that belong under liabilities, like Accounts Payable, Notes Payable, Wages Payable have their own accounts, and so on.
An account’s most basic form has three parts:
a title
a debit side (on the left)
a credit side (on the right)
a T-account used for simplify things for learners
=> This is also known as a T-account (because of its form where illustrated obviously).
Definition of Debits & Credits:
Debit and Credit are commonly abbreviated as Dr. and Cr. respectively.
However, be careful Debit and Credit should not be interpreted as either Increase nor Decrease. You only should understand them as to what side of the Account they affect.
Debit: describes entries made into the left side of the account. Credit: describes entries made into the right side of the account.
=> Hence, come the terms Debiting and Crediting an account. => After comparing the totals of each side, the account will either show a Debit Balance or a Credit Balance.
Double-entry bookkeeping system requires that for each transaction, the debit amount must be equal to the credit amount.
Benefits/Pros of the The Double-entry system(claimed to be invented by many including, but not limited to the Koreans during the time of the Goryeo Dynasty but first used in Europe by Italian Florentine merchant Amatino Manucci): Increases Accuracy Reduces Errors and Facilitate their detection Generally more efficient
And if you are wondering why the above effects are opposite, it will be beyond easy to understand why once you remember the basic accounting equation we’ve covered in part I of this series. Assets=Liabilities+Equity.
=>Hence whatever effects Debits have on assets, then they must have exactly the opposite of that on Liabilities.
=> Most of the time, Assets should have debit balances, and liabilities should have credit balances.
Effects of Debit/Credit entries on Equity Accounts (Share Capital—ordinary, Retained Earnings, Dividends, Revenues & Expenses): Effects on Share Capital—Ordinary: => Debits Decrease it => Credits Increase it Retained Earnings: => Debits Decrease it => Credits Increase it Dividends: => Debits Increase it => Credits Decrease it Revenues: => Debits Decrease it => Credits Increase it Expenses: => Debits Increase it => Credits Decrease it
Now, of course, you may saying to yourself ‘Do I have to remember each Account’s specifics when it comes to Debits and Credits?’
Of course not! In fact, you only have to remember one account’s effects and understand well The Basic Accounting Equation, and you are good to go; You will be able to figure out how each of the accounts is affected by Debiting or Crediting & its normal balance by simply looking at The Basic Accounting Equation.
The Basic Steps in The Recording Process:
There are 3 steps in the recording process:
Each Transaction Gets Analyzed
Transaction Gets Entered into THE JOURNAL
That Transaction Entry into THE JOURNAL Gets further Transferred into THE LEDGER
What is a Ledger in Bookkeeping:
If you could think of the General Journal as a way to keep track of business transactions, then, the General Ledger is keeping track of all the accounts.
=>Journal: keeps tracks of events happening (business events=business transactions) =>Ledger: keeps track of ‘state’ of accounts(increases, decreases, balance, etc..)
And, hence a Ledger is the set of all accounts maintained a company. The most common being the General Ledger.
a three-column account in the Ledger
The standard form of recording the state of an account within the Ledger is also known as the three-column form of account (it has three columns allocated for money: debits, credit, and balance)
What is a Journal in the Recording Process:
The Journal (aka the book of original entry) is a series of business transactions recorded in a chronological order, using the Double-Entry System. The whole process is also known as Journalizing.
Pros/Benefits of Jounalizing/Keeping a Journal: It clearly portrays the effect of each business transaction Its chronological nature helps the business identify certain trends, find errors easily, and keeping a historical record hustle-free
There are two kind of journal entries: Simple Entries: involves two accounts only; one for debit, and the other for credit. Compound Entries: usually a business transaction that involves more than two accounts
A good example of a compound entry is when your business buys new equipment to improve overall operations(lower cost, faster delivery, etc..) and when you don’t pay the full sum in cash. Let’s assume you got billed £79,000 British Pounds for the new line of equipment. And, you pay £30,000 in cash, and the remaining £49,000 on credit. =>Then, this business transaction will be ‘journalized’ as a compound entry.
Usually, the Journal has columns for account title, explanations, references, dates, and two columns one for Debit and the other for Credit.
The General Journal in Recording/Bookkeeping
Within the account title and explanation section, the name of the account to be debited is written first and then beneath it, and a little bit indented, the name of the account to be credited.
Then, each corresponding Debit and Credit amount are recorded in their respective columns.
The Ref column is initially left empty, till the entries are transferred to the Ledger; At that time, it will be assigned a Reference number.
What is Posting in Bookkeeping?
Posting is simply the process of transferring the journal entries into the corresponding affected accounts in the Ledger.
The Trial Balance & Its Purposes:
This is a list that is usually prepared at the end of an accounting period. It lists all of the accounts and their balances at any given moment t. This is obviously directly fetched from the ledger. In fact, The Trial Balance lists all the accounts in that same order in which they appear within The Ledger.
Some FAQs:
Do Companies Report All of Equity Accounts in The Same Financial Report? => No. => Companies report Revenues and Expenses (as well as net them out to determine the resulting Net Income or Net Loss) in The Income Statement. => They report Share Capital—Ordinary & Retained Earnings in The Statement of Financial Position. => Then, they report Dividends (as well as Retained Earnings again in details) in The Retained Earnings Statement.
Do Companies only use one type of Journal? => No. They use a variety of Journals during the recording process. However, almost every company keeps the simplest and most basic form of a Journal aka The General Journal.
What is a Chart of Accounts? => This is simply a list of all of the Ledger’s accounts with their names and corresponding unique identifying number. And generally (this differs from one company to another) there is an allocated range or interval for recognizing specific types of accounts. Example: Asset accounts numbers between 101-199.
This is a series of posts about Accounting. They are simply a rearranged version of my notes and summaries while reading the textbook Financial Accounting: IFRS, 3rd edition by Jerry Weydgandt, Paul Kimmel and Donald Kieso. Taking the auto-education route myself, I know how important notes are to make sure I understand the material within a book ( or several of them). I know too, that sometimes you may need extraordinary level of commitment and motivation to keep going, especially when you get stuck as you will often do throughout your journey towards learning or mastering something. And so, these posts are for my fellow autodidacts out there, who believe in themselves and who know from within that they don’t need anyone to ‘teach them’; they can learn it themselves. Keep Learning!
You have to know accounting. It’s the language of practical business life. It was a very useful thing to deliver to civilization. I’ve heard it came to civilization through Venice which of course was once the great commercial power in the Mediterranean. However, double entry bookkeeping was a hell of an invention.
Charlie Munger
Although Accounting is one popular major across colleges, many businesses spend money to make their employees more ‘financially literate’. That often means, understanding ‘the numbers’. Which in turn, mean getting familiar with Accounting and its lingo.
Accounting Simply Defined
Here is the formal definition pulled out straight from the Financial Accounting Textbook 3rd edition (IFRS Edition):
Accounting basically is the process of identifying, recording and communicating the economic events (usually monetary transactions, more on that later on within the monetary unit assumption ) of an organization (often, a business, but also can be a non-profit or a government agency/subsidiary) to ‘interested users’.
Who Uses Accounting?
External users: Debtors, Creditors, Investors/Shareholders, Government Agencies, etc..
Internal Users: Managers, Decision Makers, etc..
Accounting Standards
When they prepare financial statements, accountants follow a well defined set of terms and guidelines. And depending on which country or jurisdiction the business is based in, these guidelines can differ.
We call these guidelines Accounting Standards, and they are set by either one of two organizations(also called accounting standard-setting bodies) The IASB(International Accounting Standards Board, its headquarters is in London) or The FASB(Financial Accounting Standards Board).
IFRS is one of these accounting standards. It is set and updated by the IASB and used by businesses in 130 countries. Businesses in the US however use GAAP(generally accepted accounting standards) which is another type of accounting standards set and updated by the FASB.
While in this post, I use IFRS, all the principles are applicable to GAAP as well.
The Measurement Principle
In IFRS, we either use the historical cost principle or the fair value principle when recording assets. When using the historical cost principle, we must record asset at their original cost. For instance, if the company bought a 10 acre piece of land ten years ago at $2,500 per acre, then according to the historical cost principal, we must record the asset value as $25,000, even though the current market value of the land may have risen over time(to say $3,150 per acre). On the other hand, if we choose to follow the fair value principle, we must report assets and liabilities at fair value. Fair value means the current market price to sell an asset or settle a debt. There is a trade-off when choosing between using either the historical cost principle or the fair value principle: a trade-off between relevance and faithful presentation.
Generally, and because IFRS allows the usage of both principle, companies choose to use the fair value principle only when it is perceived as necessary—assets that are often traded on a daily basis or real time or whose prices can be easily determined e.g. investment securities, bonds, etc…
The Monetary Unit Assumption
According to the Monetary Unit Assumption, companies should only record business transactions that can be measured using monetary unit. Hence, business events that cannot be measured in monetary units—and though they can be important to managers and decision makers or to the operation of the business as a whole—such as the attitude of employees (think labor unions and strikes) or the deteriorating health of the CEO should not be included in financial records of a company.
The Economic Entity Assumption
As business owners, we should keep our personal living costs, our personal economic records separate from that of our business. By doing that, we abide by the Economic Entity Principle. ==> The best way to do that? Register a Proprietorship, a Partnership, a Limited Liability Company, or better yet a Corporation!
The Accounting Equation
Assets = Liabilities + Equity
As a business, our assets are everything we have as a resource. That includes the cash in our business accounts, the equipment in our factories, the furniture in our headquarters, the patents we registered as ours, the technology we’ve invented such as source code properties (assets such as patents, and technologies are often called intangible assets). ==> So, our Assets are all our Resources.
Assets
Now, Liabilities are our Debtors claims against our assets. So, if we have a total assets value of $150,000 and our debtors’ claims on those assets are $50,000, then we owe those $50,000 to our debtors (creditors/suppliers, etc..) and that is our Liabilities.
Liabilities can include: Notes Payable to a Bank, Accounts Payable to Suppliers, or Salaries Payable to employees, Sales/Real Estate Taxes payable to the government.
Now, subtract the Liabilities from the Assets, and you get the Equity: our Shareholders’ claims on Assets. And by the way, in the case of bankruptcy, debtors are paid first, and the rest, if any remains, goes to the shareholders—often referred to as residual equity.
Residual Equity
Equity itself generally consists of:
Share Capital—Ordinary: The Sum of the face value of all issued Shares—a piece of the company sold to public investors (usually for cash)
Retained Earnings= Revenues – Expenses – Dividends ==> Expenses decrease equity, while Revenues and new Shares sold to outside investors increase equity ==> Dividends: these are distributed to shareholders, as a result of a net income and an agreement within the board of directors that this is the best use of the increase in assets (they can choose not to distribute dividends instead and reinvest the net income into the business). Dividends, when they are distributed, decrease equity. ==>
The effects of business transactions on the accounting equation:
Let’s define transactions! Transactions are the business events that are worth recording by accountants. They can be classified into:
External Transaction: these involve business transaction between our company and an external entity or enterprise
Internal Transaction: these are the economic events that happen within our company
All in all, the company records the transaction only if the event affects the accounting equation.
The 5 Financial Statements
There are 5 financial statements that one must learn to read and interpret:
The Income Statement
The Retained Earnings Statement
The Balance Sheet (AKA The Statement of Financial Position)
