Accounting for Beginners

In this lesson we’ll look closer at the balance sheet. The balance sheet is an important document that offers the businesses value at a point in time. The balance sheet uses the accounting formula which is assets = liabilities + equity. This formula is key to everything done in financial accounting. Well look at each element in detail and explain these concepts using a couple small business examples. The examples include a yard service and a coffee kiosk business.

We introduced assets in a previous lesson as an account that is found on the balance sheet. That account contains the information on the resources available in that business. In this lesson we’ll consider if all balance sheets have the same assets and if not why. We’ll look at how differences in how management will influence what kind and how much of an asset is reported on the balance sheet.

In this lesson we will look at various transactions that can lead to liabilities. Liabilities are obligations, meaning that the business owes someone something. An easy example is a loan. If the business manager takes a loan out for the business, that loan is an obligation and therefore a liability. We’ll look at other liabilities and see how managers use liabilities to run their business.

Loans are not the only way that a business can get funds to buy their assets. Another way is to get investors interested in the business. When a business attracts an investor, the money received goes into the business as equity. Then the business can use that to buy resources needed to run the show. We’ll discuss interesting concepts like corporations, common stock, and retained earnings. We’ll see why managers might want to find investors rather than take out loans.

One of the biggest questions in business relates to net income. Managers, owners, bankers, investors, etc. want to know the profitability. Intuitively even people that do not have a business background understand profits are important. In our lesson we don’t just cover how to calculate the profit, but we understand each element and how the income statement offers the user a glimpse into operations.

Accounting uses the accrual basis to measure revenue and expenses. This can be confusing to non-accountants because the accrual basis ignores the movement of cash and instead follows when a revenue is earned or an expense is incurred. However, by the time you complete this lesson you will understand the accrual basis and why it is so important to the accounting process.

Most people that learn basic accounting are confused by the use of debits and credits. In accounting the debit and credit columns are used to increase the value of accounts impacted in transactions. The short answer is that a debit is just the left column and the credit is the right column. But the key to understanding this is when to use the debit column or credit column.

In business when business activity happens, we call that a transaction. We need to show that transaction’s impact on the business. To do this we use accounts to categorize the transaction. In this lesson we learn how to increase and decrease accounts based on the account’s placement on the balance sheet or income statement.

As business activities occur, they must be input into the accounting system. This is accomplished by using journal entries. Journal entries use debits and credits to increase or decrease accounts that are impacted in a transaction. This lesson will look at a couple examples from the coffee shop. We’ll see how the coffee shop can use journal entries for common business transactions.

The journal entry is an excellent source of information for specific transactions. But the journal entry does not show the current balance in each account. To do that you will need to look into the General Ledger. Accountants call the transfer of information from the journal entry into the general ledger “posting”. In this lesson we will learn how to post information for various transactions that are commonly found in business.

The next step in the basic accounting cycle is to take the ending balances from each of the accounts in the general ledger and transfer these amounts to a report called the “Trial Balance”. The trial balance is a useful step in the preparation process of the financial statements. This lesson will walk through how the transfer occurs and the importance of a trial balance.

In our final lesson we close the loop on the accounting cycle. Using the totals from the trial balance we can build both the Balance Sheet and Income Statement.

Companion eBook