To understand how to use accounting data, first understand that the basic accounting framework is an amazing system of recording, verifying, summarizing and reporting business transactions. It is truly a thing of beauty.
The most fundamental component of that framework is an account. An account is simply a device, a pigeonhole if you will, to logically order whatever it is we want to keep track of. Want to keep track of cash? Create a cash account. Want to keep track of inventory? How much people owe us? How much we owe others? How much are our sales? Our expenses? Create an account for each. Accounts can be created and destroyed at will. Maybe we sold a building. If so, close the building account and get rid of it.
Back in ancient times BC (before computer), creating or closing an account was as simple as putting a sheet of paper in or taking it out of a loose-leaf notebook. Today it can be as simple as creating or deleting a column in an Excel spreadsheet.
Modern accounting rests on a marvelous invention called double entry bookkeeping. Double-entry bookkeeping is a method of recording every transaction an organization makes. Every transaction that a company makes will have an impact on two or more accounts. At least one account will be debited and at least one will be credited. And remember that debits will always equal credits.
Structurally, accounts are very simple. They have three parts: a title (what we’re keeping track of), a left-hand side and a right-hand side. That’s it. We call the left-hand side the debit side and the right-hand side the credit side. When we debit an account, we simply make an entry on the left-hand side of the account. A credit is made on the right-hand side. Debit does not mean increase or decrease. It means left and that’s all. Some accounts are increased when debited and some are decreased. The same holds true for credits. It all depends on the type of account. Sailors say “port and starboard.” Accountants say “debit and credit.”
There are five basic categories of accounts, with some variations thrown in to make it interesting. The five categories are: revenue, expense, asset, liability and owners’ equity and, of course, there are many examples of each.
• Revenues are inflows of cash, increases in other assets or the settlement of liabilities resulting from the sale of goods and services that constitute an organization’s principal operations.
• Expenses are the outflows of cash, the decreases in other assets or the incurrence of liabilities resulting from the performance of activities that constitute an organization’s principal operations.
• Assets are the resources (tangible or intangible) which provide future economic benefit to their owner.
• Liabilities are the obligations of an organization to transfer assets or provide services to another entity.
• Owners’ equity is the owners’ claim to the net assets (assets minus liabilities) of an organization. There are two types of owners’ equity accounts – paid-in capital and retained earnings.