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Definition of Accounting

November 15, 2012




Irma Miller MBA, CPA
E-mail: info@irmamillercpa.com
Disclaimer:

• The views expressed in this presentation are my own
  and not necessarily those of the Kentucky Society of
  Certified Public Accountants, the American Institute
  Certified Public Accountants and the Internal Revenue
  Service.
• The information is not a substitute for consultation with
  an expert and the creator is not liable for problems
  arising from following the advice on the site.
• The laws and regulations are subject to change over
  time and recent changes after the date of this
  representation may not be reflected on this presentation
What is Accounting ?
               “the language of business”

 •large international corporation
 •single person
 •home based business
 •government agency
 •non-profit

 vehicle for reporting financial information about a
 business entity to many different groups of people
Definition of Accounting
Accountancy is the process of communicating financial
information about a business entity to users such as
shareholders and managers. The communication is
generally in the form of financial statements that show in
money terms the economic resources under the control
of management; the art lies in selecting the information
that is relevant to the user and is reliable. The principles
of accountancy are applied to business entities in three
divisions of practical art, named accounting,
bookkeeping and auditing. (Elliot, Barry & Elliot, Jamie:
Financial Accounting and Reporting, Prentice Hall,
London, 2004 p.3)
Definition of Accounting (continued)
  The American Institute of Certified Public
  Accountants (AICPA) defines accountancy as
  “the art of recording, classifying, and
  summarizing in a significant manner and in
  terms of money, transactions and events
  which are, in part at least, of financial
  character, and interpreting the results thereof.
  (Accounting Terminology Bulletin No.1
  Review and Resume)
There are three types of accounting

• Tax Accounting
• Managerial Accounting
• Financial Accounting
Tax Accounting

• Tax Accounting helps determine how
  much is owed to the government for taxes
• The government sets the rules for
  determining taxes
• Taxes :
  – Tax Authorities : Federal - State - Local
  – Taxes : Business Corporate (Net Profit,
    Property) – Individual (Payroll, Sales,
    Property)
Managerial accounting
• Designed to help people inside the
  business make decisions
• There are no rules
• Report is customized and designed to
  meet needs of users inside the business.
Financial Accounting

• Designed to help people outside of the
  business make decisions (creditors,
  investors, suppliers, customers,
  governments, labor unions)
• Multi purpose reports (one set of financial
  statements meets the need of all users
  outside the business)
• Follows the rules of GAAP (Generally
  Accepted Accounting Principle)
Assets and Equity

• Accounting “accounts for” two things:
           – the business assets and
           – the equity in those assets
• Definition of assets by International Accounting
  Standard Board (IFRS Framework):
     “An asset is a resource controlled by the entity as a result of past
     events and from which future economic benefits are expected to
     flow to the enterprise”
• An asset generally is something that the business owns
  and holds the legal title to.
• Example: building, equipment, furniture
Assets and Equity (cont.)
• Definition of equity by International Accounting
  Standard Board (IFRS Framework) F.49(c):
     “equity capital is the owners’ interest on the
     assets of the enterprise after deducting all its
     liabilities.”


• Equity represents ownership.
Liabilities
• Definition of liabilities by International Accounting
  Standard Board (IFRS Framework) F. 49(b):
     “A liability is a present obligation of the enterprise
     arising from past events, the settlement of which is
     expected to result in an outflow from the enterprise of
     resources embodying economic benefits.”
• Liabilities are debts and obligations of the
  business.
• Liabilities represent creditors’ claim on interest
  of ownership of business assets.
Assets        = Liabilities + Owner’s Equity




ASSETS            =
 •   Cash                      LIABILITIES
 •   Inventory          (creditors’ ownership of interest of
 •   Building                          assets)
 •   Equipment                 +
 •   Furniture
 •   Supplies            OWNER’S EQUITY
 •   Vehicle            (investors’ ownership of interest of
                                       assets)


         The Accounting Equation
Debits and Credits

• Debits and Credits are the two fundamental aspects of
  every financial transaction in the double-entry
  bookkeeping system in which every debit transaction
  must have a corresponding credit transaction(s) and vice
  versa.
• In financial accounting or bookkeeping,
   “Dr” (Debit) means left side of a ledger account
   and
   “Cr” (Credit) is the right side of a ledger account
The Five Accounting Elements
• To determine whether one must debit or credit a specific
  account, we use the modern accounting equation
  approach which consists of five accounting elements.
• Five accounting elements:
   –   Asset
   –   Liability
   –   Equity
   –   Income/Revenue
   –   Expense
• The Modern Extended Accounting Equation :
  Asset + Expense = Liability + Equity + Income/Revenue
The Five Accounting Elements
• (Gross) Income/Revenue: is increases in economic
  benefits during the accounting period in the form of
  inflows or enhancements of assets or decreases of
  liabilities that result in increases in equity, other than
  those relating to contributions from equity participants.
  (The International Accounting Standard Board, IFRS
  Framework F.70)
• Expense: decreases in economic benefits during the
  accounting period in the form of outflows or depletions of
  assets or incurrences of liabilities that result in decreases
  in equity, other than those relating to distributions to
  equity participants. (The International Accounting
  Standard Board, IFRS Framework F.70)
The Five Accounting Elements
                                                Increase   Decrease

• An increase (+) to an      Asset
                             Expense
                                                 Debit
                                                 Debit
                                                            Credit
                                                            Credit

  asset or expense           Liability           Credit     Debit


  account is a debit (Dr).   Equity / Capital
                             Income / Revenue
                                                 Credit
                                                 Credit
                                                            Debit
                                                            Debit


                                                  Debit     Credit
• An increase (+) to a       Asset                  +         -

  liability, equity or       Expense                +         -

  income/revenue account     Liability              -         +

                             Equity / Capital       -         +
  is a credit (Cr).
                             Income / Revenue       -         +
Recording The Transactions
• All accounts must first be classified as one of the five
  accounting elements.
• Each transactions will consist of at least one debit to a
  specific account and one credit to another specific
  account.
• Each transaction must be equal (balance).
• Each transaction recorded in a general ledger or
  t-account.


      Bank (Asset)                             Equity
Dr.                  Cr.               Dr.               Cr.
Recording The Transactions
(1) X made an initial investment of $ 20,000 cash to start the X Law
    Office, PLLC and open a business bank account.


   Journal Entry
                                                      Dr.                    Cr.
   Cash (Bank)                                         $20,000
   Equity/Capital X                                                                $20,000




                      Bank (Cash) – (Asset)      Equity / Capital X
                 Dr.                      Cr.   Dr.                    Cr.

       (1)              $20,000                                  (1)    $20,000
Recording The Transactions
(2)X decided to obtain the loan from Bank Z to finance the entire
   purchase of $ 5,000 in office furniture and equipment.

  Journal Entry

                                                             Dr.                      Cr.

  Office Furniture & Equipment                                     $5,000

  Loan from Bank Z                                                                          $5,000



        Office Furniture & Equipment (Asset)     Loan Bank Z (Liability)
            Dr.                     Cr.        Dr.                     Cr.


                                                             (2)             $5,000
  (2)             $5,000
Recording The Transactions
(3) X Law Office, PLLC paid $ 5,000 for security deposit for leasing an
    office space
        Journal Entry
                                                                            Dr.                   Cr.
        Security Deposit                                                          $5,000
        Bank (Cash)                                                                                 $5,000




                    Bank (Cash) - (Asset)                        Security Deposit (Asset)

              Dr.                           Cr.                  Dr.                        Cr.

                                                           (3)          $5,000
  (1)                 $20,000

                                 (3)              $5,000               $5,000

                      $15,000
X Law Office, PLLC
     Assets            = Liabilities + Owner’s Equity

Assets:                         Liabilities:

Bank/Cash            $ 15,000   Loan Bank Z         $ 5,000

Security Deposit     $ 5,000    Equity:
Office Furniture &
Equipment            $ 5,000    Equity/Capital X    $ 20,000
                     _______                        _______
                                Total Liabilities
Total Asset          $ 25,000   and Equity          $ 25,000
Cost vs. Benefit

The accounting system considers cost versus benefit.
This means when the business designs the accounting
system, the cost of producing the information will not
want to exceed the benefit of having the information.

Legal and regulatory considerations override the cost
and benefit analysis. The business is obligated to comply
with any legal and regulatory considerations that are
applicable to the business.
What are the law office typical
 industry characteristics (based on
our law office clients’ experience) ?
• IOLTA Account
• Retainer
• Reimbursement (Business to Business)
   – Income Reimbursement
   – Expense Reimbursement (mark-up is optional)
• More than a year account receivable / billing
  collection (cut off date at the end of fiscal year
  and necessary adjustment journal entry).

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Definition of Accounting

  • 1. Definition of Accounting November 15, 2012 Irma Miller MBA, CPA E-mail: info@irmamillercpa.com
  • 2. Disclaimer: • The views expressed in this presentation are my own and not necessarily those of the Kentucky Society of Certified Public Accountants, the American Institute Certified Public Accountants and the Internal Revenue Service. • The information is not a substitute for consultation with an expert and the creator is not liable for problems arising from following the advice on the site. • The laws and regulations are subject to change over time and recent changes after the date of this representation may not be reflected on this presentation
  • 3. What is Accounting ? “the language of business” •large international corporation •single person •home based business •government agency •non-profit vehicle for reporting financial information about a business entity to many different groups of people
  • 4. Definition of Accounting Accountancy is the process of communicating financial information about a business entity to users such as shareholders and managers. The communication is generally in the form of financial statements that show in money terms the economic resources under the control of management; the art lies in selecting the information that is relevant to the user and is reliable. The principles of accountancy are applied to business entities in three divisions of practical art, named accounting, bookkeeping and auditing. (Elliot, Barry & Elliot, Jamie: Financial Accounting and Reporting, Prentice Hall, London, 2004 p.3)
  • 5. Definition of Accounting (continued) The American Institute of Certified Public Accountants (AICPA) defines accountancy as “the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof. (Accounting Terminology Bulletin No.1 Review and Resume)
  • 6. There are three types of accounting • Tax Accounting • Managerial Accounting • Financial Accounting
  • 7. Tax Accounting • Tax Accounting helps determine how much is owed to the government for taxes • The government sets the rules for determining taxes • Taxes : – Tax Authorities : Federal - State - Local – Taxes : Business Corporate (Net Profit, Property) – Individual (Payroll, Sales, Property)
  • 8. Managerial accounting • Designed to help people inside the business make decisions • There are no rules • Report is customized and designed to meet needs of users inside the business.
  • 9. Financial Accounting • Designed to help people outside of the business make decisions (creditors, investors, suppliers, customers, governments, labor unions) • Multi purpose reports (one set of financial statements meets the need of all users outside the business) • Follows the rules of GAAP (Generally Accepted Accounting Principle)
  • 10. Assets and Equity • Accounting “accounts for” two things: – the business assets and – the equity in those assets • Definition of assets by International Accounting Standard Board (IFRS Framework): “An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the enterprise” • An asset generally is something that the business owns and holds the legal title to. • Example: building, equipment, furniture
  • 11. Assets and Equity (cont.) • Definition of equity by International Accounting Standard Board (IFRS Framework) F.49(c): “equity capital is the owners’ interest on the assets of the enterprise after deducting all its liabilities.” • Equity represents ownership.
  • 12. Liabilities • Definition of liabilities by International Accounting Standard Board (IFRS Framework) F. 49(b): “A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.” • Liabilities are debts and obligations of the business. • Liabilities represent creditors’ claim on interest of ownership of business assets.
  • 13. Assets = Liabilities + Owner’s Equity ASSETS = • Cash LIABILITIES • Inventory (creditors’ ownership of interest of • Building assets) • Equipment + • Furniture • Supplies OWNER’S EQUITY • Vehicle (investors’ ownership of interest of assets) The Accounting Equation
  • 14. Debits and Credits • Debits and Credits are the two fundamental aspects of every financial transaction in the double-entry bookkeeping system in which every debit transaction must have a corresponding credit transaction(s) and vice versa. • In financial accounting or bookkeeping, “Dr” (Debit) means left side of a ledger account and “Cr” (Credit) is the right side of a ledger account
  • 15. The Five Accounting Elements • To determine whether one must debit or credit a specific account, we use the modern accounting equation approach which consists of five accounting elements. • Five accounting elements: – Asset – Liability – Equity – Income/Revenue – Expense • The Modern Extended Accounting Equation : Asset + Expense = Liability + Equity + Income/Revenue
  • 16. The Five Accounting Elements • (Gross) Income/Revenue: is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. (The International Accounting Standard Board, IFRS Framework F.70) • Expense: decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. (The International Accounting Standard Board, IFRS Framework F.70)
  • 17. The Five Accounting Elements Increase Decrease • An increase (+) to an Asset Expense Debit Debit Credit Credit asset or expense Liability Credit Debit account is a debit (Dr). Equity / Capital Income / Revenue Credit Credit Debit Debit Debit Credit • An increase (+) to a Asset + - liability, equity or Expense + - income/revenue account Liability - + Equity / Capital - + is a credit (Cr). Income / Revenue - +
  • 18. Recording The Transactions • All accounts must first be classified as one of the five accounting elements. • Each transactions will consist of at least one debit to a specific account and one credit to another specific account. • Each transaction must be equal (balance). • Each transaction recorded in a general ledger or t-account. Bank (Asset) Equity Dr. Cr. Dr. Cr.
  • 19. Recording The Transactions (1) X made an initial investment of $ 20,000 cash to start the X Law Office, PLLC and open a business bank account. Journal Entry Dr. Cr. Cash (Bank) $20,000 Equity/Capital X $20,000 Bank (Cash) – (Asset) Equity / Capital X Dr. Cr. Dr. Cr. (1) $20,000 (1) $20,000
  • 20. Recording The Transactions (2)X decided to obtain the loan from Bank Z to finance the entire purchase of $ 5,000 in office furniture and equipment. Journal Entry Dr. Cr. Office Furniture & Equipment $5,000 Loan from Bank Z $5,000 Office Furniture & Equipment (Asset) Loan Bank Z (Liability) Dr. Cr. Dr. Cr. (2) $5,000 (2) $5,000
  • 21. Recording The Transactions (3) X Law Office, PLLC paid $ 5,000 for security deposit for leasing an office space Journal Entry Dr. Cr. Security Deposit $5,000 Bank (Cash) $5,000 Bank (Cash) - (Asset) Security Deposit (Asset) Dr. Cr. Dr. Cr. (3) $5,000 (1) $20,000 (3) $5,000 $5,000 $15,000
  • 22. X Law Office, PLLC Assets = Liabilities + Owner’s Equity Assets: Liabilities: Bank/Cash $ 15,000 Loan Bank Z $ 5,000 Security Deposit $ 5,000 Equity: Office Furniture & Equipment $ 5,000 Equity/Capital X $ 20,000 _______ _______ Total Liabilities Total Asset $ 25,000 and Equity $ 25,000
  • 23. Cost vs. Benefit The accounting system considers cost versus benefit. This means when the business designs the accounting system, the cost of producing the information will not want to exceed the benefit of having the information. Legal and regulatory considerations override the cost and benefit analysis. The business is obligated to comply with any legal and regulatory considerations that are applicable to the business.
  • 24. What are the law office typical industry characteristics (based on our law office clients’ experience) ? • IOLTA Account • Retainer • Reimbursement (Business to Business) – Income Reimbursement – Expense Reimbursement (mark-up is optional) • More than a year account receivable / billing collection (cut off date at the end of fiscal year and necessary adjustment journal entry).

Notas do Editor

  1. The assets will use up (obsolete) by the business operations and activities now and in the future. The business does not have to own 100% of the asset to hold the legal title of the asset. The equity represent the percentage of ownership interest of asset of business. There will a lien against the legal title that will represent the creditors’ interest in the asset.
  2. For example: Building will not own100% by the business. The business owner pay the down payment. The rest is financed through the creditor (lender, bank, financial institution).
  3. Asset = Liability + Equity is the Accounting Equation. Asset + Expense = Liability + Equity + Income/Revenue is the modern extended accounting equation.