Different approaches in understanding accounting

There are different approaches to understand basic principles of accounting.

Balance sheet perspective of accounting starts with stating balance equation (Assets = Liabilities + Equities/”Net Assets”). This always does not means change in balance in one side (i.e. Assets) always affect other side (i.e. Liabilities or Equity). A very simple example to justify the statement is cash purchase of machine. Here, both elements of double entry transaction are covered under assets heading where, decrease in cash results in increase in value of machinery.

The long-term financing approach used in UK and elsewhere is fixed assets + current assets - short term payables = long-term debt plus equity.

Another simplified approach to practice accounting is to apply general rule (Debit for increase in Assets and Expenses and credit for increase in Liabilities, Equity and Revenue/Income).

For simplicity, better understanding and clean presentation I like to adopt breakeven equation approach, which combines (balance sheet) financial position and income statement. We know that (Expenses + Profit = Revenue) and (Assets = Liabilities + Equity). Combining both (given Profit is Zero) at breakeven we get Expenses + Assets = Liabilities + Equity + Revenue.  Understanding the concept simplifies problems encountered in accounting process.

Having discussed different approaches we now see how double entry accounting system affects two sides of the equation and how they simplifies the presentation in different books accounts and financial statements.

The Debit Side : The recording of transaction starts from journal. The debit side/left side of journal amount represents the increase in value of Assets and Expenses or decrease in value of Liabilities, Equity and Revenue. The same rule applies to individual nominal ledger account where normal opening (b/f or b/d) stands on left for assets or expenses. The rule again follows to trial balance. Income statement records expenses in debit side under same rule whereas balance sheet debit side records assets.

The Credit Side : The credit side/right side of journal amount represents the decrease in value of Assets and Expenses or increase in value of Liabilities, Equity and Revenue. The same rule applies to individual nominal ledger account where normal opening (b/f or b/d) stands on right for liabilities, equity, or revenue. The rule again follows to trial balance. Income statement records revenue in credit side under same rule whereas balance sheet credit side records liabilities and equity.

Not for Profit Financial Accounting

Financial accounting perspective:

Ø  Statement of operation/activities (income and expenses): Since a nonprofit's primary purpose is to provide programs that meet certain societal needs, it issues a statement of activities (instead of the income statement that is issued by a for-profit business). The statement of activities reports revenue and expense amounts according to the three classifications of net assets discussed later.  

Ø  Statement of financial position:

o   Net Assets - Since a nonprofit organization does not have owners, the third section of the statement of financial position is known as net assets (instead of owner's equity or stockholders' equity).

A nonprofit's statement of financial position is represented by the following accounting equation:

Assets = Liabilities + Net Assets

The net assets section of a nonprofit's statement of financial position reports totals for each of the following classifications:

Ø   Unrestricted net assets - If a donor does not specify a restriction on his or her contribution, the amount received by the nonprofit is recorded as an asset and as unrestricted contribution revenues. Unrestricted contribution revenues (reported on the statement of activities) also cause the amount of unrestricted net assets to increase.

Ø   Temporarily restricted net assets - If a nonprofit receives a contribution that has a donor-imposed restriction (other than to be held in perpetuity), the amount is usually recorded as an asset and as temporarily restricted contribution revenues. Temporarily restricted contribution revenues (reported on the statement of activities) also cause the amount of temporarily restricted net assets to increase.

Ø  Permanently restricted net assets - If a donor stipulates that her contribution must be held by the nonprofit in perpetuity (forever, not be used up), the amount is recorded as an asset and as permanently restricted contribution revenues. Permanently restricted contribution revenues (reported on the statement of activities) also cause the amount of permanently restricted net assets to increase.

Total net assets

The grand total of the three classifications of net assets is reported as Net Assets or as Total Net Assets.

Not-for-profitAccounting Part 1, Part 2, Part 3 and Part 4

Financial Reporting and Type of business

Reporting period: Quarterly, Semi-annual, Annual and Change in reporting period

Change in financial year end date

Reporting period 

There is a presumption that financial statements will be prepared at least annually. If the annual reporting period changes and financial statements are prepared for a different period, the entity must disclose the reason for the change and state that amounts are not entirely comparable. [IAS 1.36]

Financial report includes statement of profit or loss and other comprehensive income, statement of financial position, cash flow statement and disclosure notes.

Financial reporting is the activity of stating business operating performance, business position and cash position at the end of reporting period.

Financial data used by financial report are historical in nature. These data stand for business reoccurring operational transactions and period end adjustments. Where there is uncertainty in respect to the precise value of assets, liabilities or equity managers/directors use estimate to reach value presented in financial statement.

Recording – transaction processing system – operational data

Analyzing – estimates, control accounts and reconciliation

Summarizing – final value to present in financial statement

Types of business entity  

Unlimited liability		Limited liability
Sole trader	Partnership	Private Limited (Ltd)	Public Limited (PLC)
An individual (owner) sets up business and run under own control. The owner bears all risk and reward resulting from the business	Two or more individuals (owners) set up business and run in shared control. Risk and reward is shared between partners as per partnership agreement.	Limited by share –  liability is limited to issued value of share Limited by guarantee – liability is backed up to a specific amount by members or directors	Offers share to general public and the liability of shareholders is limited contribution agreed for share
Not separate legal entity	Not separate legal entity registered partnership can sue	Separate legal entity which can sue and be sued	Separate legal entity which can sue and be sued
Ownership can change through sales of business.	Changes in partnership share can take place by mutual understanding	Transfer of rights within members	Shares are traded on Stock Exchange

Identify the advantage and disadvantage of operating as

Limited liability partnership:

Private unlimited company: 

Single member companies

Coding of accounts

Coding of nominal ledger account helps to excel performance in using most of accounting database programs and manual working. In this article, we will see some example on how accounts are coded in different industrial sectors or different regime. Coding is a basic logic for operation of computer based accounting applications. Each function of business system has its own module, which is connected with balance of related ledger account.

United States Simple Chart of Account for Sole proprietorship and Partnership	Swedish Standard Account for organisations	Unified Chart of account for Non-For Profit Organisations
Asset Accounts 100 Bank/Cash at Bank - (Cash) 101 Petty Cash 102 Accounts Receivable (also known as Debtors Control) 103 Provision for Doubtful Debts/Allowance for Doubtful Debts 104 GST Receivable 105 Inventory (Stock On Hand) 106 Prepaid Expenses/Prepayment 107 Income Receivable (also known as Income Accrued) 110 Other Assets Liability Accounts 201 Accounts Payable (Creditors) 206 Credit Cards 210 Tax Payable 220 Employment Expenses Payable 270 Accrued Expense ====Equity Accounts (for sole proprietorships and partnerships) 300 Owner's capital 330 Capital contributions 360 Drawings Profit & Loss accounts Revenue Accounts 400 Sales Revenue 420 Interest Income (Non-Operating Revenue) Cost of Goods Sold Accounts 500 Purchases (note: COGS = Beginning Inventory + Purchases - Ending Inventory) Expense Accounts 670 Office Expense 685 Legal Expense 690 Personnel Benefits' Expenses 695 Communication Expense 696 Traveling & Conveyance 697 Labour & Welfare Expenses 698 Advertising Expenses 699 Printing & Stationery Expenses 670 Carriage Outward Source: Wiki	Asset accounts 1000 Immaterial assets 1100 Buildings and land assets 1200 Inventories, Machines, Vehicles & Equipment assets 1300 Financial relations with other near companies 1400 Stored products and work in progress 1500-1699 Receivables 1700 Pre-payments and accrued income 1800 Securities market assets 1900 Cash & Bank Accounts Liabilities accounts 2000 Equity 1 2100 Reserves 2200 Deposits (staff pensions etc.) 2300 Loans 2400 Short debts (payables 2440) 2500 Income Tax Payable 2600 VAT Payable 2700 Staff income Payable 2800-2999 other liabilities Profit & Loss accounts Revenue accounts 3000 Revenue Accounts Expense accounts 4000 Costs directly related to revenues 5000-7999 General expense Accounts 8000 Financial Accounts 9000 Contra-accounts Source: Wiki	Assets Account / Numbers Cash and Cash Equivalents Operating checking 1000 Savings/Money Market 1010 Savings: Restricted grants 1020 Receivables Program svc fees receivable: clients/tenants/etc 1100 Prepaid insurance 1200 Land 1300 Buildings 1310 Software 1350 Accumulated depreciation 1390 Notes Receivable Note receivable #1 1410 Other Assets Rent deposit 1900 Liabilities Account Accounts Payable Accounts payable 2000 Payroll, Payroll Taxes Payroll payable 2100 & Withholding FICA & Hosp. payable 2110 Fed. W/H payable 2120 Accrued Expenses Accrued fees 2200 Accrued interest 2210 Other Current Liabilities Accrued vacation 2300 Deferred revenue 2310 Net Assets Unrestricted net assets 3000 Temporarily restricted net assets 3100 Permanently restricted net assets 3200 Statement of Unrestricted Activities Revenue & Support Contributions Contributions – individuals 4000 Contributions – foundations 4100 Contributions – corporations 4200 Grants – government 4300 Transfers to/from temp. restricted fund 4400 In-kind contributions – goods 4500 Program service fees 4700 Investment income Dividends and interest 5600 Realized gain/loss on sale 5610 Expenses Salaries & wages 6000 Payroll taxes FICA & Medicare 6100 State unemployment 6110 Benefits Health insurance 6120 Accounting/bookkeeping 7000 Auditing 7010 Miscellaneous Bank fees 7020 Books & publications 7030 Depreciation 7040 Dues & subscriptions 7050 Insurance 7090 Interest 7100 IT support 7110 Legal fees 7120 Licenses and fees 7130 Miscellaneous 7140 Staff training 7200 Telephone 7210 Source:  http://www.northlandfdn.org/convening/keeley0109/chartofaccounts.pdf