What Is Basic Accounting?

By Indeed Editorial Team

Updated July 23, 2021 | Published February 4, 2020

Updated July 23, 2021

Published February 4, 2020

Basic accounting is one of the business functions that companies have to perform efficiently, therefore whether you intend to do your own accounting/bookkeeping or hire professionals, you have to become familiar with basic accounting.

In this article, we discuss what basic accounting is, what is included in it and examples of basic accounting procedures.

Looking to Hire? Post a Job on Indeed.com.

What is basic accounting?

Basic accounting refers to the process of recording a company's financial transactions. It involves analyzing, summarizing and reporting these transactions to regulators, oversight agencies and tax collection entities. The financial statements used in basic accounting are a brief summary of financial transactions over an accounting period, summarizing a company's cash flows, operations and financial position.

Basic accounting is one of the key functions in almost all types of business. It is typically performed by an accountant or a bookkeeper at a small company, or by large finance departments with dozens of employees at larger companies. The reports that various streams of accounting generate, such as managerial accounting and cost accounting, are crucial in helping a company's management make informed business decisions.

Without accounting, it would be impossible to determine which products were successful, which business decisions were effective and whether the company is generating revenue or making a profit. It would also be impossible to determine how much taxes to pay, whether to buy or lease a property or whether to merge with another company. In other words, accounting is not just about recording financial transactions, it measures a company's success at achieving its goals and helps shareholders understand how efficiently their money is being used. This is why businesses must be proficient in accounting in order to make good decisions.

Related: Learn About Being an Accountant

What is included in basic accounting?

The components of basic accounting include:

System of record-keeping

Companies must have a rational approach to record-keeping before they begin the accounting process. They have to set up accounts in which to store information. Accounts fall into the following classifications:

  • Assets: These refer to resources or items that the company owns. Assets have future economic value that can be measured and can be expressed in monetary terms. Examples of a company's assets include investments, cash, inventory, accounts receivable, land, supplies, equipment, buildings and vehicles.

  • Liabilities: These refer to the legal financial obligations or debts that companies incur during business operations. Liabilities can be limited or unlimited. They are settled over time through the transfer of economic benefits such as money, services or goods. Recorded on the right side of a company's balance sheet, liabilities include accounts payable, loans, mortgages, earned premiums, deferred revenues and accrued expenses.

  • Equity: Equity, also known as shareholder's equity, refers to the amount of money that a company must return to its shareholders after all of its assets are liquidated and all of its debt is paid off. Equity is calculated by subtracting a company's total assets to its total liabilities.

  • Expenses: Expenses refer to the costs of operations that businesses incur to generate revenue. Common expenses include employee wages, payments to suppliers, equipment depreciation and factory leases.

  • Revenue: Revenue refers to the income that a company generates from its normal business operations. It includes deductions and discounts for returned products. Revenue is the gross income figure from which costs are subtracted to determine net income.

Transactions

The accountant is responsible for generatinga number of business transactions, while others are forwarded to the accountant from other departments of a company. As part of these transactions, they are recorded within the accounts mentioned in the first point. Some crucial business transactions include:

  • Sales: These are transactions in which products/services are transferred from buyers to sellers for cash or credit. Sales transactions are recorded in the seller's accounting journal (a document that contains a summary of the transaction) as a credit to the sales account and a debit to cash or accounts receivable. Sales typically involve the creation of an invoice to be sent to the customers, detailing the amount that the customer owes.

  • Purchases: These are transactions that businesses require in order to obtain materials and services necessary to accomplish their goals. Purchases made in cash are recorded as a debit to the inventory account and a credit to cash. If the purchase is made with a credit account, the credit entry would be recorded in the accounts payable account and the debit entry would be recorded in the inventory account. Purchases often involve the issuance of purchase orders and disbursement of supplier invoices.

  • Receipts: These are the transactions that refer to a company getting paid for providing services or goods to customers. The receipt transaction is recorded in the journal for the seller as a credit to accounts receivable and a debit to cash.

  • Employee's compensation: This requires information about the number of hours that employees spent at paid labor, which is then used to generate tax deductions, gross wage information and other deductions, which result in net pay to employees.

Reporting

Once all the company's transactions related to an accounting period have been completed, the accountant consolidates the information stored in the accounts and sort it into three documents that are collectively called financial statements. These statements include:

  • Income statement: This document contains information about the company's revenues and deducts all expenses incurred to determine the net profit or loss for the reporting period. It measures the ability of a company to expand its customer base and operate in an efficient manner.

  • Balance sheet: This document contains information about a company's assets, liabilities and equity as of the end of the reporting period. It shows the financial position of an organization as of a point in time and is carefully reviewed to determine an organization's ability to pay its bills.

  • Statement of cash flows: This document contains information about the uses and sources of cash during the reporting period. It's especially useful when the amount of net income that appears on the income statement is different from the net change in cash during the reporting period.

Related: Learn About Being a Bookkeeper

Generally Accepted Accounting Principles (GAAP)

The Generally Accepted Accounting Principles (GAAP) is a set of guidelines that all accountants must apply to their accounting practices. Just as a newspaper uses a style guide that outlines a set of standards for its writers and editors, the GAAP sets a standard that guides accountants when recording and reporting financial information. Also, when all accountants work in accordance with the GAAP, investors and analysts can easily understand their filings and financial statements.

Related: Learn About Being a Financial Analyst

Example of basic accounting

To illustrate double-entry accounting, imagine your company is going to record sales revenue of $10,000, you would need to make two entries. These include a debit entry of $10,000 to increase the balance sheet account called "Cash" and credit entry of $10,000 to increase the income statement account called "Revenue."

Another example might be the purchase of a new office desk for $250. In this example, you would need to enter a $250 debit to increase your company's income statement "office furniture" expense account and a $250 credit to reduce your balance sheet "Cash" account.

The opposite also holds true: if you borrow money from a bank, your company's assets will increase but your liabilities will also increase by the same amount. The double-entry accounting carefully reviews the accuracy because once you have completed your entries, the sum of the accounts with debit balance should match the sum of the credit balance accounts, making sure that you have captured both parts of the transaction.

The accounting cycle

The accounting cycle is the collective process of recording and sorting out a company's financial transactions. It ensures that a company's financial statements are prepared accurately and are a true reflection of its financial position. It is considered a cycle because the workflow is circular—moving from one accounting period to the next. The full accounting cycle consists of nine steps, which in the past were done manually and recorded in journals. Today, most accountants use accounting software to process many of these steps simultaneously. Here's a look at the steps in the accounting cycle:

  1. Transactions

  2. Journal entries

  3. Posting from the journal to the general ledger

  4. Trial balance

  5. Adjusting entries

  6. Adjusted trial balance

  7. Financial statements

  8. Closing entries

  9. Post-closing trial balance

1. Transactions

The accounting cycle starts with transactions. This means that every time a sale is made, an asset is purchased, a product is returned or debt is paid, the accounting cycle begins. All financial activities that involve the exchange of a company's assets are considered a transaction.

2. Journal entries

A journal is a physical record or digital document kept as a data, spreadsheet or book within the company's accounting software. When a financial transaction is made, a bookkeeper records it as a journal entry. If the income or expense affects one or more business accounts, the journal entry will reflect that as well. Journaling is a crucial part of record-keeping and allows for a brief review and records-transfer later in the accounting process. Along with the general ledger, journals are carefully reviewed as part of the audit process.

3. Posting from the journal to the general ledger

All information recorded in the journal is posted to the general ledger. The general ledger contains the account information that is needed to create the company's financial statements. The transaction data recorded in the general ledger is segregated by type into accounts for expenses, revenues, shareholder's equity, liabilities and assets.

4. Trial balance

When the business transactions are summarized or closed out to the general ledger, the accountant creates a trial balance, which serves as a report of every ledger account's balance. A company generates a trial balance periodically, typically at the end of every reporting period. The trial balance helps a company ensure that entries in its bookkeeping system are mathematically correct. The trial balance is carefully reviewed to make sure there are no errors and adjusted by adding necessary entries.

5. Adjusting entries

When accountants adjust entries, they take into account deferrals and accruals that have affected the final balances of accounts on the general ledger. These adjustments are made to make sure that the reported results are consistent with the financial position of the company before financial statements are made.

6. Adjusted trial balance

Once the adjustments on the entries are made and finalized, the accountant prepares the adjusted trial balance. Like the trial balance, the adjusted trial balance ensures the debits and credits match after adjustments on the entries are made. The adjusted trial balance is the most accurate record of a company's financial transactions.

7. Financial statements

Using the adjusted trial balance, the accountant prepares the cash statement, income statement and balance sheet. These will be used to show the company's financial condition, results and cash flow.

8. Closing entries

At this stage, the accountant moves data from temporary accounts to permanent accounts on the balance sheet. Temporary accounts include expenses, revenues and dividends. These accounts must be closed (reduced to zero) at the end of the accounting period to prepare them for the next period of transactions. For instance, $500 in revenue this year doesn't count as $500 of revenue for next year, even if your company retained the funds for use next year.

9. Post-closing trial balance

The post-closing trial balance is the final step of the accounting cycle. At this stage, the accountant checks the debits and credits match after closing entries are made. They also make sure that the trial balance only contains permanent accounts, since temporary accounts are already reduced to zero.

Jobs in accounting

If you want to pursue a career in accounting, there are various options you can consider in your job search. Here's a list of 10 roles in the accounting field:

1. Bookkeeper

2. Auditor

3. Tax accountant

4. Forensic accountant

5. Payroll administrator

6. Accounts payable specialist

7. Accounts receivable clerk

8. Assistant controller

9. Accounting manager

10. Financial reporting manager

Explore more articles