The Essentials of Accounting BasicsBookkeepers, accountants, and business managers must have a firm grasp of accounting fundamentals. Accounting is an essential business function that involves recording transactions, summarizing data, and then reporting and analyzing the results on a periodic basis.

The Difference between Bookkeeping and AccountingEvery business and not-for-profit entity needs a reliable bookkeeping system based on established accounting principles. Keep in mind that accounting is a much broader term than [MORE…]

Bookkeeping and Its Basic PurposeBookkeeping, when done properly, gives you an excellent gauge of how well your business is doing. Bookkeeping also provides financial information throughout the year so you can test the success of your [MORE…]

Basic Bookkeeping Terms and PhrasesGet a firm understanding of key bookkeeping and accounting terms and phrases before you begin work as a bookkeeper. Bookkeepers use specific terms and phrases everyday as they track and record financial [MORE…]

Organizing Bookkeeping Records for Your BusinessStaying organized is critical to efficient and accurate bookkeeping. Organize your bookkeeping records by deciding what to keep, and how to find information quickly when you need it. Everything you do [MORE…]

Responsibilities of an Accounting DepartmentMost people don’t realize the importance of the accounting department in keeping a business operating without hitches and delays. That’s probably because accountants oversee many of the back-office functions [MORE…]

How Accounting Focuses on TransactionsBusiness accounting focuses on transactions. A good bookkeeping system unfailingly captures and records every transaction that takes place. Understanding accounting, to a large extent, means understanding [MORE…]

Balance Sheet Basics and the Accounting EquationOne type of accounting report is a balance sheet, which is based on the accounting equation: Assets = Liabilities+Owners’ Equity. The balance sheet — also called a [MORE…]

The Eight Steps of the Accounting CycleAs a bookkeeper, you complete your work by completing the tasks of the accounting cycle. It’s called a cycle because the accounting workflow is circular: entering transactions, manipulating the transactions [MORE…]

Choosing an Accounting Method for Your BusinessDifferent businesses make different accounting decisions. Some businesses choose conservative accounting methods while others choose liberal accounting methods. Accounting is more than just reading the [MORE…]

The Basics of Double-Entry BookkeepingAll businesses, whether they use the cash-basis accounting method or the accrual accounting method, use double-entry bookkeeping to keep their books. A practice that helps minimize errors and increase [MORE…]

Key Basic Accounts for Balance Sheets and Income StatementsA bookkeeper tracks all the financial transactions of a business and is responsible for identifying the account in which each transaction should be recorded. Accounting provides the structure you must [MORE…]

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Understanding a Bookkeeper’s Chart of AccountsThe Chart of Accounts is the roadmap that a business creates to organize its financial transactions. Essentially, this chart lists all the accounts a business has, organized in a specific order; each account [MORE…]

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The Difference between Bookkeeping and Accounting1 of 12 in Series: The Essentials of Accounting Basics

Every business and not-for-profit entity needs a reliable bookkeeping system based on established accounting principles. Keep in mind that accounting is a much broader term than bookkeeping. Bookkeeping refers mainly to the record-keeping aspects of accounting; it's essentially the process of recording all the information regarding the transactions and financial activities of a business.

Defining bookkeepingBookkeeping is an indispensable subset of accounting. Bookkeeping refers to the process of accumulating, organizing, storing, and accessing the financial information base of an entity, which is needed for two basic purposes:

• Facilitating the day-to-day operations of the entity

• Preparing financial statements, tax returns, and internal reports to managers

Bookkeeping (also called recordkeeping) can be thought of as the financial information infrastructure of an entity. The financial information base should be complete, accurate, and timely. Every recordkeeping system needs quality controls built into it, which are called internal controls.

Defining accountingThe term accounting is much broader, going into the realm of designing the bookkeeping system, establishing controls to make sure the system is working well, and analyzing and verifying the recorded information. Accountants give orders; bookkeepers follow them.

Accounting encompasses the problems in measuring the financial effects of economic activity. Furthermore, accounting includes the function of financial reporting of values and performance measures to those that need the information. Business managers, investors, and many others depend on financial reports for information about the performance and condition of the entity.

Accountants design the internal controls for the bookkeeping system, which serve to minimize errors in recording the large number of activities that an entity engages in over the period. The internal controls that accountants design are also relied on to detect and deter theft, embezzlement, fraud, and dishonest behavior of all kinds.

Accountants prepare reports based on the information accumulated by the bookkeeping process: financial statements, tax returns, and various confidential reports to managers. Measuring profit is a critical task that accountants perform — a task that depends on the accuracy of the information recorded by the bookkeeper. The accountant decides how to measure sales revenue and expenses to determine the profit or loss for the period.

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Bookkeeping and Its Basic PurposeBy Lita Epstein from Bookkeeping For Dummies2 of 12 in Series: The Essentials of Accounting Basics

Bookkeeping, when done properly, gives you an excellent gauge of how well your business is doing. Bookkeeping also provides financial information throughout the year so you can test the success of your business strategies and make course corrections to ensure that you reach your year-end profit goals.

Bookkeeping can become your best system for managing your financial assets and testing your business strategies, so don’t shortchange it. Take the time to develop your bookkeeping system with your accountant before you even open your business’s doors and make your first sale.

Choosing your accounting methodThe two basic accounting methods you have to choose from are cash-basis accounting (also called just cash accounting) and accrual accounting. The key difference between these two accounting methods is the point at which you record sales and purchases in your books:

• If you use cash accounting, you record transactions only when cash changes hands. For example, you don’t record a purchase from a vendor until you actually lay out the cash to the vendor.

• If you use accrual accounting, you record a transaction when it’s completed, even if cash doesn’t change hands. For example, you record a purchase from a vendor when you receive the products, and you also record the future debt in an account called Accounts Payable.

Understanding assets, liabilities, and equityEvery business has three key financial parts that must be kept in balance:

• Assets include everything the company owns, such as cash, inventory, buildings, equipment, and vehicles.

• Liabilities include everything the company owes to others, such as vendor bills, credit card balances, and bank loans.

• Equity includes the claims owners have on the assets based on their portion of ownership in the company.

The formula for keeping your books in balance involves these three elements:

Assets = Liabilities + Equity

Introducing debits and creditsTo keep the books for your business, you need to revise your thinking about two common financial terms: debits and credits. Most non-bookkeepers and non-accountants think of debits as subtractions from their bank accounts. The opposite is true with credits — people usually see these as additions to their accounts, in most cases in the form of refunds or corrections in favor of the account holders.

Debits and credits are totally different animals in the world of bookkeeping. Because keeping the books involves a method called double-entry bookkeeping, you have to make a least two entries — a debit and a credit — into your bookkeeping system for every transaction. Whether that debit or credit adds or subtracts from an account depends solely upon the type of account.

You can’t just enter transactions in the books willy-nilly. You need to know where exactly those transactions fit into the larger bookkeeping system. That’s where your Chart of Accounts comes in; it’s essentially a list of all the accounts your business has and what types of transactions go into each one.

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Basic Bookkeeping Terms and PhrasesBy Lita Epstein from Bookkeeping For Dummies3 of 12 in Series: The Essentials of Accounting Basics

Get a firm understanding of key bookkeeping and accounting terms and phrases before you begin work as a bookkeeper. Bookkeepers use specific terms and phrases everyday as they track and record financial transactions — from balance sheets and income statements to accounts payable and receivable. The following sections list bookkeeping terms that you'll use on a daily basis.

Balance sheet terminologyHere are a few terms you’ll want to know when working with balance sheets:

• Balance sheet: The financial statement that presents a snapshot of the company’s financial position as of a particular date in time. It’s called a balance sheet because the things owned by the company (assets) must equal the claims against those assets (liabilities and equity).

• Assets: All the things a company owns in order to successfully run its business, such as cash, buildings, land, tools, equipment, vehicles, and furniture.

• Liabilities: All the debts the company owes, such as bonds, loans, and unpaid bills.

• Equity: All the money invested in the company by its owners. In a small business owned by one person or a group of people, the owner’s equity is shown in a Capital account. In a larger business that’s incorporated, owner’s equity is shown in shares of stock.

Another key Equity account is Retained Earnings, which tracks all company profits that have been reinvested in the company rather than paid out to the company’s owners. Small businesses track money paid out to owners in a Drawing account, whereas incorporated businesses dole out money to owners by paying dividends.

Income statement terminologyHere are a few terms related to the income statement that you’ll want to know:

• Income statement: The financial statement that presents a summary of the company’s financial activity over a certain period of time, such as a month, quarter, or year. The statement starts with Revenue earned, subtracts the Costs of Goods Sold and the Expenses, and ends with the bottom line — Net Profit or Loss.

• Revenue: All money collected in the process of selling the company’s goods and services. Some companies also collect revenue through other means, such as selling assets the business no longer needs or earning interest by offering short-term loans to employees or other businesses.

• Costs of goods sold: All money spent to purchase or make the products or services a company plans to sell to its customers.

• Expenses: All money spent to operate the company that’s not directly related to the sale of individual goods or services.

Other common bookkeeping termsSome other common terms used in bookkeeping include the following:

• Accounting period: The time period for which financial information is being tracked. Most businesses track their financial results on a monthly basis, so each accounting period equals one month. Some businesses choose to do financial reports on a quarterly or annual basis. Businesses that track their financial activities monthly usually also create quarterly and annual reports.

• Accounts payable: The account used to track all outstanding bills from vendors, contractors, consultants, and any other companies or individuals from whom the company buys goods or services.

• Accounts receivable: The account used to track all customer sales that are made by store credit. Store credit refers not to credit card sales but rather to sales in which the customer is given credit directly by the store and the store needs to collect payment from the customer at a later date.

• Depreciation: An accounting method used to track the aging and use of assets. For example, if you own a car, you know that each year you use the car its value is reduced (unless you own one of those classic cars that goes up in value). Every major asset a business owns ages and eventually needs replacement, including buildings, factories, equipment, and other key assets.

• General Ledger: Where all the company’s accounts are summarized. The General Ledger is the granddaddy of the bookkeeping system.

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• Interest: The money a company needs to pay if it borrows money from a bank or other company. For example, when you buy a car using a car loan, you must pay not only the amount you borrowed but also interest, based on a percent of the amount you borrowed.

• Inventory: The account that tracks all products that will be sold to customers.

• Journals: Where bookkeepers keep records (in chronological order) of daily company transactions. Each of the most active accounts — including cash, Accounts Payable, and Accounts Receivable — has its own journal.

• Payroll: The way a company pays its employees. Managing payroll is a key function of the bookkeeper and involves reporting many aspects of payroll to the government, including taxes to be paid on behalf of the employee, unemployment taxes, and workman’s compensation.

• Trial balance: How you test to be sure the books are in balance before pulling together information for the financial reports and closing the books for the accounting period.

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Organizing Bookkeeping Records for Your BusinessBy Lita Epstein from Bookkeeping Workbook For Dummies4 of 12 in Series: The Essentials of Accounting Basics

Staying organized is critical to efficient and accurate bookkeeping. Organize your bookkeeping records by deciding what to keep, and how to find information quickly when you need it. Everything you do in your business generates paperwork that can easily become overwhelming if you don't keep it under control.

If you computerize your accounting you may not need to keep as much paper, but you still want a paper trail in case something happens to your computer records or you need the backup information for a transaction that is questioned at a later date.

Obviously, file cabinets are where you’ll store most of your records for the current year and the prior year. Older files you may store in boxes in a warehouse or store-room if you don’t have room in your file cabinets. How you set up the files can be critical to your ability to find something when you need it.

Bookkeeping storage methodsMany bookkeepers use four different methods to store accounting information:

• File folders: these are used for filing invoice, payment, and contract information about vendors; information about individual employees, such as payroll related forms and data; and information about individual customer accounts.

• Three-ring binders: Your Chart of Accounts, General Ledger, and Journals are usually kept in three-ring binders. Even if you do use a computerized accounting system, it’s a good idea to keep a copy of this for the month most recently closed and the current month in hard copy in case your computer system goes down and you need to quickly check information.

• Expandable files: These types of files are good for managing outstanding bills and vendor activity. You can get alphabetical expandable files for managing pending vendor invoices and purchase orders. You can use 30-day and 12-month expandable files for managing outstanding bills.

As bills come in you can place them in the 12-month file for the month they are due. Then move the current month’s bills to the 30-day file by the day they are due. You may be able to avoid using these files if you are using a computerized bookkeeping system and set up the bill pay reminder system in your accounting program.

• Media for storing backup computer data: If you are keeping the books on computer, be certain you make at least one backup copy of all your data daily and store it in a safe place — a place where the data won’t be destroyed if there is a fire. A good alternative could be a small fire safe if your business does not have a built-in safe.

When to keep or discard paperworkYou’ll find it doesn’t take long to build up lots of paper and not have room to store it all. Luckily not everything has to be kept forever. Generally anything related to tax returns has to be kept for at least three years, but once you’re past three years the IRS can’t audit you unless it suspects fraud. So you can get rid of most of your paperwork once it is four years old.

Some exceptions include employees. Those records you must keep until the employee has left the employment of the company for at least three years. The statute of limitations for most actions that can be filed by an ex-employee is three years after they left.

In the fourth year, you will be able to get rid of most of your paperwork, but you may want to keep certain sensitive data longer. Any information about assets that are still held by the company should be kept. You also should keep any information about pending legal issues. Check with your attorney and your accountant before destroying old paperwork and be certain you are not tossing something that could be needed.

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Responsibilities of an Accounting Department5 of 12 in Series: The Essentials of Accounting Basics

Most people don’t realize the importance of the accounting department in keeping a business operating without hitches and delays. That’s probably because accountants oversee many of the back-office functions in a business — as opposed to sales, for example, which is front-line activity, out in the open and in the line of fire.

Folks may not think much about these back-office activities, but they would sure notice if those activities didn’t get done. On payday, a business had better not tell its employees, “Sorry, but the accounting department is running a little late this month; you’ll get your checks later.”

Typically, the accounting department is responsible for the following:

• Payroll: The total wages and salaries earned by every employee every pay period, which are called gross wages or gross earnings, have to be calculated. Based on detailed private information in personnel files and earnings-to-date information, the correct amounts of income tax, social security tax, and other deductions from gross wages have to be determined.

Stubs, which report various information to employees each pay period, have to be attached to payroll checks. The total amounts of withheld income tax and social security taxes, plus the employment taxes imposed on the employer, have to be paid to federal and state government agencies on time. Retirement, vacation, sick pay, and other benefits earned by the employees have to be updated every pay period.

In short, payroll is a complex and critical function that the accounting department performs. Many businesses outsource payroll functions to companies that specialize in this area.

• Cash collections: All cash received from sales and from all other sources has to be carefully identified and recorded, not only in the cash account but also in the appropriate account for the source of the cash received. The accounting department makes sure that the cash is deposited in the appropriate checking accounts of the business and that an adequate amount of coin and currency is kept on hand for making change for customers.

Accountants balance the checkbook of the business and control who has access to incoming cash receipts. (In larger organizations, the treasurer may be responsible for some of these cash flow and cash-handling functions.)

• Cash payments (disbursements): In addition to payroll checks, a business writes many other checks during the course of a year — to pay for a wide variety of purchases, to pay property taxes, to pay on loans, and to distribute some of its profit to the owners of the business.

The accounting department prepares all these checks for the signatures of the business officers who are authorized to sign checks. The accounting department keeps all the supporting business documents and files to know when the checks should be paid, makes sure that the amount to be paid is correct, and forwards the checks for signature.

• Procurement and inventory: Accounting departments usually are responsible for keeping track of all purchase orders that have been placed for inventory (products to be sold by the business) and all other assets and services that the business buys — from postage to forklifts.

A typical business makes many purchases during the course of a year, many of them on credit, which means that the items bought are received today but paid for later. So this area of responsibility includes keeping files on all liabilities that arise from purchases on credit so that cash payments can be processed on time.

The accounting department also keeps detailed records on all products held for sale by the business and, when the products are sold, records the cost of the goods sold.

• Property accounting: A typical business owns many substantial long-term assets called property, plant, and equipment — including office furniture and equipment, retail display cabinets, computers, machinery and tools, vehicles (autos and trucks), buildings, and land.

Except for small-cost items, such as screwdrivers and pencil sharpeners, a business maintains detailed records of its property, both for controlling the use of the assets and for determining personal property and real estate taxes. The accounting department keeps these records.

The accounting department may be assigned other functions as well, but this list gives you a pretty clear idea of the back-office functions that the accounting department performs. Quite literally, a business could not operate if the accounting department did not do these functions efficiently and on time. To do these back-office functions well, the accounting department must design a good bookkeeping system and make sure that it is accurate, complete, and timely.

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How Accounting Focuses on Transactions6 of 12 in Series: The Essentials of Accounting Basics

Business accounting focuses on transactions. A good bookkeeping system unfailingly captures and records every transaction that takes place. Understanding accounting, to a large extent, means understanding how accountants record the financial effects of transactions. They also record events that have an economic impact on a business.

Counting on transactionsThe immediate and future financial effects of some transactions can be difficult to determine. A business carries on economic exchanges with six basic types of persons or entities:

• Its customers, who buy the products and services that the business sells.

• Its employees, who provide services to the business and are paid wages and salaries and provided with benefits, such as a retirement plan, medical insurance, workers’ compensation, and unemployment insurance.

• Its suppliers and vendors, who sell a wide range of things to the business, such as legal advice, products for resale, electricity and gas, telephone service, computers, vehicles, tools and equipment, furniture, and even audits.

• Its debt sources of capital who loan money to the business, charge interest on the amount loaned, and are due to be repaid at definite dates in the future.

• Its equity sources of capital, the individuals and financial institutions that invest money in the business and expect the business to earn profit on the capital they invest.

• The government, or the federal, state, and local agencies that collect income taxes, sales taxes, payroll taxes, and property taxes from the business.

Here's a look at the interactions between a business and the other parties in its economic exchanges.

Transactions between a business and the parties it deals with.

Accounting for eventsEven a relatively small business generates a surprisingly large number of transactions, and all transactions have to be recorded. Certain other events that have a financial impact on the business have to be recorded, as well. These are called events because they’re not based on give-and-take bargaining — unlike the something-given-for-something-received nature of economic exchanges.

Events such as the following have an economic impact on a business and are recorded:

• A business may lose a lawsuit and be ordered to pay damages. The liability to pay the damages is recorded.

• A business may suffer a flood loss that is uninsured. The waterlogged assets may have to be written down, meaning that the recorded values of the assets are reduced to zero if they no longer have any value to the business. For example, products that were being held for sale to customers (until they floated down the river) must be removed from the inventory asset account.

• A business may decide to abandon a major product line and downsize its workforce, requiring that severance compensation be paid to the laid-off employees.

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At the end of the year, the accountant makes a special survey to make sure that all events and developments during the year that should be recorded have been recorded, so that the financial statements and tax returns for the year are complete and correct.

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Balance Sheet Basics and the Accounting Equation7 of 12 in Series: The Essentials of Accounting Basics

One type of accounting report is a balance sheet, which is based on the accounting equation: Assets = Liabilities +Owners’ Equity. The balance sheet — also called a statement of financial condition — is a “Where do we stand at the end of the period?” type of report. The header of a balance sheet lists the date that it was prepared.

Balance sheet fundamentalsA balance sheet shows two sides of the business, which you could think of as the financial yin and yang of the business:

• Assets: On one side of the balance sheet the assets of the business are listed, which are the economic resources owned and being used in the business. The asset values reported in the balance sheet are the amounts recorded when the assets were originally acquired.

An asset is written down below its historical cost when the asset has suffered a loss in value. Some assets are written up to their current fair values. Some assets have been on the books only a few weeks or a few months, so their reported historical values are current. The values for other assets are their costs when they were acquired many years ago.

• Sources of assets: On the other side of the balance sheet is a breakdown of where the assets came from, or their sources. Assets come from two basically different sources: creditors and owners.

Businesses borrow money in the form of interest-bearing loans that have to be paid back at a later date, and they buy things on credit that are paid for later. So, part of total assets can be traced to creditors, which are the liabilities of a business.

Every business needs to have owners invest capital (usually money) in the business. Also, businesses retain part or all of the annual profits they make, and profit increases the total assets of the business. The total of invested capital and retained profit is called owners’ equity.

An accounting equation exampleSuppose a business reports $2.5 million in total assets. The total of its liabilities, plus the capital invested by its owners, plus its retained profit, adds up to $2.5 million. Otherwise, its books would be out of balance, which means there are bookkeeping errors.

Continuing with this example, suppose that the total amount of the liabilities of the business is $1.0 million. This means that the total amount of owners’ equity in the business is $1.5 million, which equals total assets less total liabilities. The total owners’ equity may be traceable to capital invested by the owners in the business as well as profit retained in the business. The total of these two sources of owners’ equity is $1.5 million.

The financial condition of the business in this example is summarized in the following accounting equation (in millions):

$2.5 assets = $1.0 liabilities + $1.5 owners’ equity

Looking at the accounting equation, you can see why the statement of financial condition is called the balance sheet; the equal sign means the two sides balance.

Double-entry bookkeeping is based on the accounting equation — the fact that the total of assets on the one side is counterbalanced by the total of liabilities, invested capital, and retained profit on the other side. Double-entry bookkeeping means that both sides of transactions are recorded. For example, if one asset goes up, another asset goes down — or, alternatively, either a liability or owners’ equity goes up. This is the economic nature of transactions. Double-entry means two-sided, not that the transactions are recorded twice.

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The Eight Steps of the Accounting CycleBy Lita Epstein from Bookkeeping For Dummies8 of 12 in Series: The Essentials of Accounting Basics

As a bookkeeper, you complete your work by completing the tasks of the accounting cycle. It’s called a cycle because the accounting workflow is circular: entering transactions, manipulating the transactions through the accounting cycle, closing the books at the end of the accounting period, and then starting the entire cycle again for the next accounting period.

The accounting cycle has eight basic steps, which you can see in the following illustration. These steps are described in the list below.

1. Transactions

Financial transactions start the process. Transactions can include the sale or return of a product, the purchase of supplies for business activities, or any other financial activity that involves the exchange of the company’s assets, the establishment or payoff of a debt, or the deposit from or payout of money to the company’s owners.

2. Journal entries

The transaction is listed in the appropriate journal, maintaining the journal’s chronological order of transactions. The journal is also known as the “book of original entry” and is the first place a transaction is listed.

3. Posting

The transactions are posted to the account that it impacts. These accounts are part of the General Ledger, where you can find a summary of all the business’s accounts.

4. Trial balance

At the end of the accounting period (which may be a month, quarter, or year depending on a business’s practices), you calculate a trial balance.

5. Worksheet

Unfortunately, many times your first calculation of the trial balance shows that the books aren’t in balance. If that’s the case, you look for errors and make corrections called adjustments, which are tracked on a worksheet.

Adjustments are also made to account for the depreciation of assets and to adjust for one-time payments (such as insurance) that should be allocated on a monthly basis to more accurately match monthly expenses with monthly revenues. After you make and record adjustments, you take another trial balance to be sure the accounts are in balance.

6. Adjusting journal entries

You post any corrections needed to the affected accounts once your trial balance shows the accounts will be balanced once the adjustments needed are made to the accounts. You don’t need to make adjusting entries until the trial balance process is completed and all needed corrections and adjustments have been identified.

7. Financial statements

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You prepare the balance sheet and income statement using the corrected account balances.

8. Closing the books

You close the books for the revenue and expense accounts and begin the entire cycle again with zero balances in those accounts.

As a businessperson, you want to be able to gauge your profit or loss on month by month, quarter by quarter, and year by year bases. To do that, Revenue and Expense accounts must start with a zero balance at the beginning of each accounting period. In contrast, you carry over Asset, Liability, and Equity account balances from cycle to cycle.

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Choosing an Accounting Method for Your BusinessBy John A. Tracy from Accounting Workbook For Dummies9 of 12 in Series: The Essentials of Accounting Basics

Different businesses make different accounting decisions. Some businesses choose conservative accounting methods while others choose liberal accounting methods. Accounting is more than just reading the facts or interpreting the financial outcomes of business transactions. Accounting also requires accountants to choose between alternative accounting methods.

Similar to the conservative states and liberal states addressed in politics, accounting has:

• Conservative accounting methods: These accounting methods delay the recording of revenue and accelerate the recording of expenses. Profit is reported slowly.

• Liberal accounting methods: These accounting methods accelerate the recording of revenue and delay the recording of expenses. Profit is reported quickly.

In general terms, conservative accounting methods are pessimistic, and liberal methods are optimistic. The choice of accounting methods also affects the values reported for assets, liabilities, and owners’ equities in the balance sheet.

Accounting methods must stay within the boundaries of Generally Accepted Accounting Principles (GAAP). A business can’t conjure up accounting methods out of thin air. GAAP isn’t a straitjacket; it leaves plenty of wiggle room, but the one fundamental constraint is that a business must stick with its accounting method when it makes a choice.

Consistency is the rule; the same accounting methods must be used year after year. The Internal Revenue Service (IRS) allows businesses to change their accounting methods once in a while, but the justification has to be persuasive.

A new business with no accounting history has to make accounting decisions such as the following, for the first time:

• If the business sells products, it has to select which cost of goods sold expense method to use.

• If the business owns fixed assets, it has to select which depreciation method to use.

• If the business makes sales on credit, it has to decide which bad debts expense method to use.

The choices of accounting methods for these three expenses — cost of goods sold, depreciation, and bad debts — can make a sizable difference in the amount of profit or loss recorded for the year. Choosing conservative accounting methods for these three expenses can cause profit for the year to be lower by a relatively large percent compared with using liberal accounting methods for the expenses.

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The Basics of Double-Entry BookkeepingBy Lita Epstein from Bookkeeping For Dummies10 of 12 in Series: The Essentials of Accounting Basics

All businesses, whether they use the cash-basis accounting method or the accrual accounting method, use double-entry bookkeeping to keep their books. A practice that helps minimize errors and increase the chance that your books balance, double-entry bookkeeping gets its name because you enter all transactions twice.

When it comes to double-entry bookkeeping, the key formula for the balance sheet (Assets = Liabilities + Equity) plays a major role.

In order to adjust the balance of accounts in the bookkeeping world, you use a combination of debits and credits. You may think of a debit as a subtraction because you’ve found that debits usually mean a decrease in your bank balance. And, you’ve probably found unexpected credits in your bank or credit card account that mean more money has been added in your favor. Now forget what you’ve learned about debits or credits. In bookkeeping, their meanings aren’t so simple.

The only definite thing when it comes to debits and credits in the bookkeeping world is that a debit is on the left side of a transaction and a credit is on the right side of a transaction.

Transaction #1: Purchasing an item with cashHere’s an example of the practice in action. Suppose you purchase a new desk that costs $1,500 for your office. This transaction actually has two parts: You spend an asset — cash — to buy another asset — furniture. So, you must adjust two accounts in your company’s books: the Cash account and the Furniture account. Here’s what the transaction looks like in a bookkeeping entry:

Purchasing a New Office Desk

Account Debit Credit

Furniture $1,500

Cash $1,500

In this transaction, you record the accounts impacted by the transaction. The debit increases the value of the Furniture account, and the credit decreases the value of the Cash account. For this transaction, both accounts impacted are asset accounts, so, looking at how the balance sheet is affected, you can see that the only changes are to the asset side of the balance sheet equation:

Assets = Liabilities + EquityFurniture increase = No change to this side of the equationCash decrease

In this case, the books stay in balance because the exact dollar amount that increases the value of your Furniture account decreases the value of your Cash account. At the bottom of any journal entry, you should include a brief description that explains the purpose for the entry.

Transaction #2: Purchasing items on creditTo show you how you record a transaction if it impacts both sides of the balance sheet equation, here’s an example that shows how to record the purchase of inventory. Suppose that you purchase $5,000 worth of widgets on credit.

These new widgets add value to your Inventory Asset account and they also add to your Accounts Payable account. (Remember, the Accounts Payable account is a Liability account where you track bills that need to be paid at some point in the future.) Here’s how the bookkeeping transaction for your widget purchase looks:

Purchasing Widgets for Sale to Customers

Account Debit Credit

Inventory $5,000

Accounts Payable $5,000

Here’s how this transaction affects the balance sheet equation:

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Assets = Liabilities + EquityInventory increases = Accounts Payable increases + No change

In this case, the books stay in balance because both sides of the equation increase by $5,000.

You can see from the two example transactions how double-entry bookkeeping helps to keep your books in balance — as long as you make sure each entry into the books is balanced. Balancing your entries may look simple here, but sometimes bookkeeping entries can get very complex when more than two accounts are impacted by the transaction.

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Key Basic Accounts for Balance Sheets and Income StatementsBy Lita Epstein from Bookkeeping Workbook For Dummies11 of 12 in Series: The Essentials of Accounting Basics

A bookkeeper tracks all the financial transactions of a business and is responsible for identifying the account in which each transaction should be recorded. Accounting provides the structure you must use to organize these transactions, as well as the procedures you must use to record, classify, and report information about your business.

In most cases, the accounting system will be set up with the help of an accountant to be sure the information generated by that system will be useable and meets the requirements of solid accounting principles.

A bookkeeping system is designed based on the data needed for the two key financial reports — the balance sheet and the income statement. The balance sheet gives you a snapshot of a business as of a particular date. The income statement gives you a summary of all transactions during a particular period of time, usually a month, a quarter, or a year.

The key balance sheet accounts include:

• Assets: Everything the business owns in order to operate successfully is considered an asset. This includes cash, buildings, land, tools, equipment, vehicles, and furniture. Each type of asset has a separate account. Another asset is the Accounts Receivable account (money due from customers who bought on credit).

• Inventory: Products on hand that the business plans to sell.

• Liabilities: All the money the company owes to others are considered liabilities. This includes unpaid bills (called Accounts Payable account), loans, and bonds. Each type of liability will have a separate account.

• Equity: All the money invested in the company by the owners or stock holders is considered equity. Each type of equity, and possibly each owner in a small business, will have a separate account.

The key income statement accounts include:

• Revenue: All the money a business receives in selling its products or services is called revenue or sales and tracked in these accounts.

• Cost of goods sold: All money the company must spend to buy or manufacture the goods or services it sells to customers is tracked in these accounts. An account called Purchases is used to track goods purchased.

• Expenses: All money that is spent to run the company that is not related specifically to a product or service being sold is tracked in expense accounts. For example, Office Supplies, Advertising, Salaries, and Wages are all types of expense accounts.

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Understanding a Bookkeeper’s Chart of AccountsBy Lita Epstein from Bookkeeping For Dummies12 of 12 in Series: The Essentials of Accounting Basics

The Chart of Accounts is the roadmap that a business creates to organize its financial transactions. Essentially, this chart lists all the accounts a business has, organized in a specific order; each account has a description that includes the type of account and the types of transactions that should be entered into that account.

Every business creates its own Chart of Accounts based on how the business is operated, so you’re unlikely to find two businesses with the exact same Charts of Accounts. However, some basic organizational and structural characteristics are common to all Charts of Accounts.

The organization and structure are designed around two key financial reports: the balance sheet, which shows what your business owns and what it owes, and the income statement, which shows how much money your business took in from sales and how much money it spent to generate those sales.

The Chart of Accounts starts first with the balance sheet accounts, which include:

• Current Assets: Includes all accounts that track things the company owns and expects to use in the next 12 months, such as cash, accounts receivable (money collected from customers), and inventory.

• Long-term Assets: Includes all accounts that tracks things the company owns that have a lifespan of more than 12 months, such as buildings, furniture, and equipment.

• Current Liabilities: Includes all accounts that track debts the company must pay over the next 12 months, such as accounts payable (bills from vendors, contractors, and consultants), interest payable, and credit cards payable.

• Long-term Liabilities: Includes all accounts that tracks debts the company must pay over a period of time longer than the next 12 months, such as mortgages payable and bonds payable.

• Equity: Includes all accounts that tracks the owners of the company and their claims against the company’s assets, which includes any money invested in the company, any money taken out of the company, and any earnings that have been reinvested in the company.

The rest of the Chart of Accounts is filled with income statement accounts, which include:

• Revenue: Includes all accounts that track sales of goods and services as well as revenue generated for the company by other means.

• Cost of Goods Sold: Includes all accounts that track the direct costs involved in selling the company’s goods or services.

• Expenses: Includes all accounts that track expenses related to running the businesses that aren’t directly tied to the sale of individual products or services.

When developing the Chart of Accounts, you start by listing all the Asset accounts, the Liability accounts, the Equity accounts, the Revenue accounts, and finally, the Expense accounts. All these accounts come from two places: the balance sheet and the income statement.

You should develop an account list that makes the most sense for how you’re operating your business and the financial information you want to track. The Chart of Accounts is a money management tool that helps you track your business transactions, so set it up in a way that provides you with the financial information you need to make smart business decisions.

You’ll probably tweak the accounts in your chart annually and, if necessary, you may add accounts if you find something for which you want more detailed tracking. You can add accounts during the year, but it’s best not to delete accounts until the end of a 12-month reporting period.

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