Starting an accounting system

Business ownersand managersneed accounting recordsin order toproperly manage a business and prepare financial reports. Accounting information may be recorded by hand or by using accounting machinesorcomputers.The kind of business and its size usually determinehow itsaccounting records are best kept. Regardless ofthe accounting records kept, the concepts and principles are the same.

The Accounting Equation

A business owns things, such as cash, equipment, and supplies,which it usesto conduct its activities. Anything of value that is owned is called an asset. Financial rights to the assets of a business are called equities. A business owns the assets with which it conducts business. A business' owner has a financial interest in the business and therefore has rights to its assets. Individuals or other businesses to whom a businessowesmoney also have rights to the business’ assets.

A business' accounting records are kept separate from records of indi­viduals or businesses that have equities in that business. Thus, a business' owner keeps one set of accounting records for the business and another set of records for personal finances. (CONCEPT: Business Entity)

There are two kinds of equities. (1) Equity of persons to whom a business owes money. An amount owed by a business is called a liability. (2) Equity of the owner. The value of the owner's equity is called capital. The value of an owner's equity is the amount remaining after the value of all liabilities is subtracted from the value of all assets.

An equation showing the relationship among assets, liabilities, and capi­tal is called an accounting equation. An accounting equation is most often written as:

Assets = Liabilities + Capital

Implementation of this equation begins with the recording of raw data – that is, the firm’s day-to-day financial transactions. It is accomplished through the double-entry system of bookkeeping.

The Double-Entry Bookkeeping System

Double-entry bookkeeping is a system in which each financial transaction is recorded as two separate accounting entries to maintain the balance shown in the accounting equation. Most often one entry changes the left (asset) side of the equation, and the other entry changes the right (liabilities + owners’ equity) side. However, for the few types of transactions the two entries change only one side of the equation. This occurs, for example, when cash (an asset) is used to purchase equipment (another asset).