Accounting Basics: In-Depth Explanation with Examples

Accounting is the process of tracking and recording a business’s financial transactions. Accounting basics include understanding assets, liabilities, equity, revenues, and expenses, as well as relevant financial statements and accounting principles. One of the main financial statements (along with the statement of comprehensive income, balance sheet, statement of cash flows, and statement of stockholders’ equity). The income statement is also referred to as the profit and loss statement, P&L, statement of income, and the statement of operations. The income statement reports the revenues, gains, expenses, losses, net income and other totals for the period of time shown in the heading of the statement. If a company’s stock is publicly traded, earnings per share must appear on the face of the income statement.

Fundamentals of Accounting and Reporting

Thoroughly understanding your business means understanding your finances and many terms you’ll use when talking about your business relate to finance. This rule is applicable to transactions involving people or businesses, for instance, a bank transaction. Indirect transactions, such as staff owed wages paid through another company. Liabilities deal with what the company owes, such as accounts payable, loans payable, mortgages and payroll. Understanding these cost elements and how they affect the overall financial health of a business is crucial for any business owner.

Financial year

The idea behind grasping accounting principles is to become better equipped at budgeting wisely, forecasting future financial needs, and maintaining the overall health of your business. I wrote this basic accounting guide to ease you into the world of financial management. By the end, you’ll feel ready to tackle your own business’s accounting — or at least navigate the fundamentals with confidence. In its most basic sense, accounting describes the process of tracking an individual or company’s monetary transactions.

This is the act of tracking and reporting income and expenses related to your company’s taxes. You don’t want to be in a situation where you have to pay more income tax than is normally required by the Internal Revenue Service (IRS). Generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) are actually based on the fundamental accounting principles and concepts discussed in this chapter.

Forensic accounting does require a certain degree of digging and detective work. Return on investment, or ROI, is a metric used to measure the profitability of an investment, usually expressed as a percentage. To calculate ROI, divide the net profit from the investment by its initial cost and then multiply the result by 100 to get a percentage. There accounting basics are four main types of expenses, although some expenses fall into more than one category.

Management Accounting

For example, the year-to-date net income at May 31, 2025 for a calendar year company is the net income from January 1, 2025 until May 31, 2025. For a company with a fiscal year beginning on July 1, 2024 the year-to-date net income at May 31, 2025 is the net income for the 11-month period from July 1, 2024 through May 31, 2025. Often this is interest and dividends earned on a company’s investment in stocks and bonds of other companies. (Some corporations have preferred stock in addition to their common stock.) Shares of common stock provide evidence of ownership in a corporation.

Chart of Accounts

• The principle of permanence of methods confirms that all financial reporting methods remain the same over time.
• This rule is applicable to the assets of a business, such as cash, land, building, equipment, furniture, etc.
• An example of an asset could be a company vehicle used for delivery services.
• Debits and credits are the two sides of an accounting entry, and they must always be equal and opposite.

Therefore, you should always consult with accounting and tax professionals for assistance with your specific circumstances. On December 2, Direct Delivery purchases a used delivery van for $14,000 by writing a check for $14,000. The two accounts involved are Cash and Vehicles (or Delivery Equipment). When the check is written, the accounting software will automatically make the entry into these two accounts. Marilyn points back to the basic accounting equation and tells Joe that if he memorizes this simple equation, it will be easier to understand the debits and credits.

Some of the basic accounting terms that you will learn include revenues, expenses, assets, liabilities, income statement, balance sheet, and statement of cash flows. You will become familiar with accounting debits and credits as we show you how to record transactions. You will also see why two basic accounting principles, the revenue recognition principle and the matching principle, assure that a company’s income statement reports a company’s profitability. This is the practice of recording and reporting financial transactions and cash flows. This type of accounting is particularly needed to generate financial reports for the sake of external individuals and government agencies. These financial statements report the performance and financial health of a business.

Each section has many examples of real business transactions and even sample ledgers and financial statements to help you understand the concepts. If the rented space was used to manufacture goods, the rent would be part of the cost of the products produced. Usually financial statements refer to the balance sheet, income statement, statement of comprehensive income, statement of cash flows, and statement of stockholders’ equity.

For doing this type of accounting, I recommend having a solid understanding of how to file taxes and of your tax code. You’ll need to comply with both federal regulations and the states in which you operate your business. Tax accounting involves maintaining and keeping track of your business’ taxes.

Also, if you have the funds, hiring an in-house accountant is my recommended option. This way the responsibility for maintaining your business’s accounting is off your shoulders. Whomever you choose, be sure to read plenty of reviews and testimonials about your potential accountant. Inquire about their experience in your industry, rates, and services, and make sure you’re comfortable with how and how often you’ll communicate with your accountant before you sign anything. If the nature of your business is seasonal, tailor different factors, like the frequency of your evaluation, to this cycle. For instance, you might require more reviews of your accounting process during high season and fewer during slower months.

Objectivity in the recording of transactions is possible when the transactions of the firm are supported by verifiable vouchers or documents. The purpose of the objectivity concept is that it does not let the firm’s management and accountants’ opinions impact the financial statements and provide a false image. The concept can be helpful for an organization in creation of its goodwill. Besides, it warns the companies about the penalties if there is any sort of misinterpretation in the financial statements. Together, the income statement and cash flow statement provide a comprehensive view of a company’s financial health.

• From managing day-to-day transactions to preparing for future growth, accounting is the backbone that supports business operations.
• Accruals are revenues and expenses recognized by a business before being recorded in its accounts.
• GAAP is a set of standardized guidelines and rules for financial accounting and reporting.
• After learning these accounting basics, you may be eager to dive headfirst into accounting for your small business.
• Revenues accounts are credited when the company earns a fee (or sells merchandise) regardless of whether cash is received at the time.
• If you’re just getting started, consider adding your accounting strategy to your business plan.

For any business, big or small, understanding and managing costs is essential for sustainability and growth. Effective cost management involves detailed knowledge of all expenses involved in the business operations and utilizing cost accounting methods to make strategic financial decisions. In the world of accounting, debits and credits are the very foundation upon which financial transactions are built. They are the key components of double-entry accounting, a method that ensures every financial transaction affects at least two accounts in a way that maintains the balance of the accounting equation. The accrual method recognizes revenue and expenses on the day the transaction takes place, regardless of whether or not it’s been received or paid.

Navigating Tax Obligations and Accounting

A business with healthy (positive) equity is attractive to potential investors, lenders, and buyers. Investors and analysts also look at your business’s EBITDA, which stands for earnings before interest, taxes, depreciation, and amortization. I like to remember equity as the difference between my business’s assets (what I own) and liabilities (what I owe). Not to be confused with your personal debit and credit cards, debits and credits are foundational accounting terms to know. Certified public accounting and management accounting are two of the profession’s most common specializations. Auditing and forensic accounting represent other important accounting specializations.