Basic Bookkeeping And Accounting Skills That You Must Have

June 26, 2008

Basic Bookkeeping And Accounting Skills That You Must Have

Book Keeping and Accounting is something foreign to many, maybe because they never cared to learn it thinking it is just a dull game of recording transactions using unnecessarily complicated terms and methods. Far from it, book keeping and accounting is a logical way of recording transactions in a professional manner so that the information could be used in the ascertainment of many other vital business criteria such as the profits or losses made, who owes you and how much; how much you owe others, or are you carrying enough cash in the business for meeting immediate commitments etc., just to name a few.

Accounting is something that is useful in your personal as well as professional lives, and it would be worth your while to shed your prejudices and listen! Accounting is nothing complex as you have mistakenly imagined. It is based on one of the most fundamental concepts that if one receives something, then obviously another has to give; and therefore every transaction has a two-fold aspect called debit and credit in accounting terms. Maybe this reminds you of one of Newton’s Laws that action and reaction are always equal and opposite.

Fundamentally, the study of accounting is built on (i) The Accounting Equation, and (ii) Double Entry Book Keeping.

(i) The Typical Accounting Equation:
Assets = Liabilities + Equity

(ii) Double Entry aspect of Book Keeping:
The perfect balancing of the accounting equation is guaranteed by this system.

I think it pertinent now to define Accounting as a system of summarizing financial transactions and recoding in such a manner as to facilitate using such records for later analysis, preparation of further financial statements, interpretation of accounts and communication as required.

Now let’s go a little further with the Accounting Equation enunciated above, and move on to its practical implications:

Assets are your possessions (including what others owe you) while liabilities are what you owe others. The difference between the two is called Equity, which includes capital introduced by you (if it is a sole proprietorship) or by shareholders (in the case of a limited liability company) plus or minus any retained profits or accumulated losses respectively. May I also just state in passing that capital introduced is not refundable to anybody and as such it is not a liability. Hence it is called Equity.

Say, you buy a Motor Vehicle for $40,000 for which you pay $25,000 out of your retained profits (or personal savings) and for the balance you take a loan of $ 15,000 from an outsider.

Substituting these values in the Accounting Equation, we have:

Assets (Possessions) = Liabilities (what you owe others) + Equity (Capital/Personal Savings)
$ 40,000 = $15,000 + $25,000

You see one debit of $40,000 is equal to two credits added together ($15,000 + $25,000) = totaling to $40,000.

There could be more complex transactions requiring distribution to more ledger accounts as well as transactions involving only two ledger accounts. Every equation comprises of the double entry with one or a series of debits on one side of the equation equaling one or a series of credits on the other side.

In the two examples given below you will see how the two concepts of Accounting Equation and Double Entry are synchronized:

(i) Settlement of a liability by paying cash $50.
The liability represented by a creditor receives while your cash account gives.
creditor (debited with) $50 = cash account (credited with) $50

(ii) Receipt of a debt from a debtor who owed you $75.
Your cash account receives while the debt represented by a debtor gives
Cash (debited with) $75 = debtor (credited with) $75

Earlier we sited one of Newton’s laws to illustrate the concept of double entry in book keeping. At this point we would like to take you back to your algebra lessons way back in grade 8 or so where you were told that if you add something on one side of an equation, that you have to do the same to the other side of the equation too? It’s fair enough, is’t it? That is exactly what we ask you to do in book keeping too making the double entry equal and balancing.

Double entry book keeping is nothing so complex or weird as to defy fair and reasonable common sense. You can easily grasp the concept of double entry by training yourself to think logically as to who or what gives, and who or what receives in each transaction; and by framing the entries accordingly, while ensuring that the two sides of the equation are in agreement (balancing) and are consistent with common sense.

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