How-to Understand the Basics of the Accounting Process

Companies of all sizes often have monthly reports compiled and shared with management to evaluate profit and loss. Major corporations with stock traded on public exchanges like the New York Stock Exchange have financial information added to financial statements that present their financial position over past years and at given points in time. Those same corporations also hire auditors to assure creditors, investors, and shareholders that their assertions regarding financial position are accurate and complete. Similarly, all businesses, regardless of size, must pay taxes — they must store receipts and data about transactions and payroll to report to Uncle Sam at the Internal Revenue Service to prevent fines, fees, and penalties.

Not everyone realizes it, but accounting is everywhere, in both business and individual capacities. Individuals must file tax returns, too, and some are interested in the performance of their investment portfolios. Accountants also provide valuable insights to individuals and businesses through consulting services. Accounting is important. That’s undeniable. However, accounting isn’t always easy to understand — in most situations, it’s near-impossible to understand for laypeople.

Here’s a basic guide to the fundamentals of the accounting process in both individual and business capacities.

Accounting For Businesses

The accounting equation follows as such…

Assets = Liabilities + Owners’ Equity

Just like any basic algebraic equation, these three components can be added and subtracted from each side. For example…

Assets – Liabilities = Owners’ Equity

Transactions are classified as either debits or credits. A debit is considered an increase in overall financial position, whereas a credit is a decrease. For example, debiting an asset account increases its dollar value. Debiting a liability account decreases its value. Debits and credits are difficult to understand without having intimate knowledge of accounting. However, all you need to know is that information is classified as either debits or credits, used to calculate financial position.

The four primary uses of accounting in business capacities serve the following four functions. Let’s learn more about them.

Financial Reporting

Companies registered in the United States that list their stock for public sale on stock exchanges like the New York Stock Exchange are required to adhere to Generally Accepted Accounting Principles (GAAP) outlined by the Securities and Exchange Commission (SEC) and governed by the Public Company Accounting Oversight Board (PCAOB). We’ll spare ourselves of the many intricate details of GAAP, although it’s required for companies to adhere to them or face fines, fees, and penalties. They might even be de-listed from stock exchanges.

There are more than 2,800 companies on the New York Stock Exchange. Every single one of them hires accountants to compile financial statements, documents that often include over a hundred pages of notes supporting financial positions they indicate. Without accountants, there would be few companies with publicly-traded stock.

Auditing

Companies that list their stock on public exchanges must be audited either once a year or once every three years. However, most organizations are audited every year. Organizations undergo auditing to provide confidence to investors, creditors, shareholders, and other interested parties of the financial positions they claim in their financial statements.

Tax Returns

Uncle Sam requires businesses to submit quarterly tax payments, along with tax returns once a year. With millions of dollars — if not billions — in transactions every year — or even every quarter — it’s difficult for organizations to keep up with their financial information for tax returns. Accountants prevent organizations from doling out hefty penalties to the Internal Revenue Service with their help on tax returns.

Consulting

Accountants provide valuable information to organizations related to taxes, internal controls, and regular business functions. Almost every business approaches accounting consultants for advice in some capacity, as consultants often have decades of experience in specific niches of business.

Accounting For Individuals

Accounting for individuals is mostly limited to tax returns. People usually save receipts, bills, and information about transactions like sales of investments or real estate. This information is then submitted to accountants, alongside pay stubs and how much income was earned in a year’s time. Individuals generally don’t have any input in the tax reporting process outside of accountants needing extra information. These services are very valuable to clients, keeping them out of worry and potential financial trouble.

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About the author: Wifred Murray

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