Introduction to accounting

The abacus user is expected to have some task in mind that is solvable using Python code or scripts. But if you are totally new to the accounting area subject? Here is an introductory guide accounting, broken into several steps.

Limited liability concept

1. A firm is an entity that is legally separate from shareholders. The shareholders risk
   loosing their investment into the firm if things go bad, but are not liable for any losses beyond that amount that may arise from firm operations.

2. The shareholders, creditors, trading partners and other parties want to know if the firm is profitable and if it can meet obligations to repay its debt. To satisfy these interesets the firm discloses financial information.

Balance sheet and income statement view of the firm

1. A firm keeps records of the resources that the firm owns (assets) and sources of funds —
   shareholder equity (or capital) and liabilities (debt). This is a firm financial position, or balance sheet view of the firm.

2. A firm also keeps records of income and expenses that indicate does the firm make a profit or make a loss. This is income statement view of the firm.

3. Balance sheet and income statement are derived from the same data linked together in an accounting equation as explained below.

Assets, capital and liabilities

1. Capital and liabilities indicate who has claims on the firm. A claim shows where the money came from and where the money should be distributed if the firm is liquidated. Claims also have order of precedence in a firm liquidation.

2. Capital, or equity, are funds provided by firm owners. The shareholders expect the firm will make a profit by allocating these funds at the best of their interest and distribute all or part of this profit back to shareholders as dividend. The profit not distributed remains with the firm as 'retained earnings'.

3. Liabilities are financial obligations of the firm. These are the records of what the firm owes to other parties. When a firm takes a loan for a bank it is reflected as a liability. Also when some payment is due but not yet fulfilled this amount is also reflected as a firm's liability (for example, interest payment on a loan that is die. but was not mede yet). Liabilities are classified based on duration as current liabilities (due within a year) and long term liabilities (due at time beyond one year).

4. Assets is everything that is owned by the firm itself and what can be converted into cash. Assets are classified into fixed, or non-current, assets (like property, plant, and equipment) and current assets (like cash and inventory).

Assets = Capital + Liabilities

1. An accounting identity Assets = Equity + Liabilities is a statement that says the sources of funds are equal to the uses of funds. This is a published form of balance sheet statement at the end of an accounting period (a quarter or a year).

2. Profit of the firm is revenue (or sales, or income) less expenses associated with this revenue:
   Profit = Income - Expenses. The report containing this data is income statement.

3. In accounting equation profit is recorded on the right side where capital and liabilities side. Why so? Profit is an increment of capital invested into the firm, so it appears next to equity. When no dividends are paid, all of the current profit will add up to retained earnings, which is a component of equity. When the firm incurs a loss, this loss will diminish the firm capital.

4. In Assets = Equity + Liabilities representation the current period profit was already distributed to dividend and retained earnings and does not appear on a balance sheet as separate entity.

Extended accounting identity

Assets + Expenses = Equity + Liabilities + Income

1. Within a reporting period, the accounting equation can be written as Assets = Equity + Profit + Liabilities, where Profit is the current period profit before dividend. Substituting Profit = Income - Expenses into the equation and rearranging we get the extended form of the accounting identity above.

2. The extended accounting equation always holds true. Whenever a new accounting transaction is recorded you are just changing some variables in this equation. In a double entry, you change two variables, in a compound entry you change several variables.

3. If you try to record just one change, for example, just receipt of cash from a customer as
   increase in Assets, the equation will break. For cash receipt from customer, you should record an increase in Income and an equal increase in Assets.

Recording transactions

1. You may take a mind experiment and thinking of various business transactions and provide
   examples of four types of double entries:

2. two variables of the right side are changed;

3. two variables of the left side are changed;
4. both left side and right side are increased;

5. both right side and left side are decreased.

6. You do not specifically need debits and credits to manipulate the extended accounting equation. The debits and credits are just a convenient notation system that helps denote which accounts are increased and which decreased.

Is real accounting system different from above?

1. A "real" accounting system would have more components, like keeping track of original paperwork or electronic documents that validate the information that enters the system.

2. On account system side there may be "contra" accounts added that keep track of changes in original accounts, for example "depreciation" contra account for "property, plant, equipment" or "refunds" contra account for "sales".

3. On recognition, valuation and reporting sides important aspects are:

4. accrual basis and recording of receivables and payables;

5. fair value, depreciation and amortization concepts, valuation changes;
6. deferred or accrued income and expenses and adjustment entries.