Basic Accounting Procedure is the process of recording, classifying, summarizing, and interpreting financial transactions to produce financial statements that provide insight into the financial health of an organization. The Basic Accounting Procedure refers to the systematic steps followed to manage the accounting records, ensuring that every transaction is accurately captured and reported. By following this Basic Accounting Procedure, businesses can produce accurate and reliable financial statements that provide insight into their financial performance and position. Below is an overview of the basic accounting procedure:
Table of Contents
Identification of Transactions
The first step in the accounting process is to identify all the financial transactions that have occurred. These could include:
- Sales and purchases of goods or services.
- Receipts and payments of cash.
- Investments and loans.
- Accruals and deferrals.
Transactions should be relevant, measurable, and verifiable and must be based on actual business activities.
Recording of Transactions (Journalizing)
Once a transaction has been identified, it needs to be recorded in the Journal. The journal is a chronological record of all financial transactions, and each entry includes the following:
- Date of the transaction.
- Particulars of the accounts affected.
- Debit and credit amounts.
- A brief description or narration of the transaction.
Each journal entry will have two parts:
- Debit: The account that receives value.
- Credit: The account that gives value.
For example, if a company sells goods worth $500 in cash, the entry would be:
- Debit: Cash account $500
- Credit: Sales account $500
Posting to the Ledger
After recording transactions in the journal, the next step is to transfer them to the Ledger. The ledger is a collection of accounts where transactions are classified and summarized. Each account has its own ledger, such as:
- Cash Ledger
- Accounts Payable Ledger
- Accounts Receivable Ledger
- Sales Ledger
Posting is done by transferring the debit and credit amounts from the journal to the appropriate ledger accounts. This Basic Accounting Procedure helps in organizing data by account type and provides a summary of each account’s activity.
Preparation of Trial Balance
Once all transactions have been posted to the ledger, the next step is to prepare a Trial Balance. The trial balance is a summary of all ledger balances to ensure that the total debits equal total credits. The equation must always hold:
Total Debits = Total Credits
If the trial balance does not balance, it indicates that an error was made in journalizing or posting. The trial balance is a tool for identifying such errors.
For example, a trial balance might look like this:
| Account Name | Debit Amount | Credit Amount |
|---|---|---|
| Cash | $1,000 | |
| Accounts Payable | $500 | |
| Sales Revenue | $500 | |
| Capital | $500 |
Adjusting Entries
At the end of an accounting period, certain adjustments need to be made to reflect the true financial position of the business. These adjustments are called adjusting entries and are necessary to account for:
- Accruals: Revenues earned or expenses incurred that have not yet been recorded.
- Deferrals: Cash payments or receipts recorded before the revenue or expense has been earned or incurred.
- Depreciation: The reduction in value of tangible fixed assets over time.
- Amortization: The gradual writing off of intangible assets.
Examples of adjusting entries include:
- Accrued expenses (e.g., wages owed but not yet paid).
- Deferred revenue (e.g., payments received in advance for services to be provided later).
Adjusting entries are made to ensure that the financial statements accurately reflect the financial position of the business as of the end of the accounting period.
Preparation of Financial Statements
After making the necessary adjustments, the next step is the preparation of Financial Statements. The most common financial statements are:
Income Statement (Profit and Loss Statement)
- The income statement provides information about the company’s revenues and expenses during a specific period, showing whether the company made a profit or incurred a loss.
- Formula: Net Income = Revenues – Expenses
Balance Sheet
- The balance sheet shows the company’s financial position at a specific point in time by listing its assets, liabilities, and equity.
- Formula: Assets = Liabilities + Equity
Cash Flow Statement
- The cash flow statement reports the cash inflows and outflows from operating, investing, and financing activities.
- It shows how the business generates and uses cash, highlighting the liquidity and solvency of the company.
Statement of Changes in Equity
- This statement shows the changes in the company’s equity during a specific period, including retained earnings, dividends, and other adjustments.
Closing Entries
At the end of the accounting period, closing entries are made to transfer the balances of temporary accounts (such as revenues, expenses, and dividends) to the Retained Earnings account. This resets the balances of temporary accounts to zero for the next accounting period. The closing process includes:
- Closing revenue accounts: Debit revenue accounts and credit retained earnings.
- Closing expense accounts: Credit expense accounts and debit retained earnings.
- Closing dividend accounts: Debit retained earnings and credit dividend accounts.
After the closing entries are made, the temporary accounts will have a zero balance, and the Retained Earnings account will reflect the profits or losses for the period.
Post-Closing Trial Balance
After all the closing entries have been made, a final post-closing trial balance is prepared. This trial balance ensures that all temporary accounts have been closed properly and that the permanent accounts (assets, liabilities, and equity) have the correct balances carried forward to the next accounting period.
Key Principles in the Basic Accounting Procedure
Key Principles in the Basic Accounting Procedure:
- Double-Entry Principle: Every transaction has two effects, and the total debits must equal the total credits.
- Accrual Basis of Accounting: Revenue is recognized when earned, and expenses are recognized when incurred, not when cash is received or paid.
- Consistency: The same accounting methods should be applied consistently from one period to the next.
- Materiality: Transactions that have a significant impact on financial statements should be recorded and reported.
- Conservatism: When in doubt, report lower profits or higher liabilities to avoid overstating the company’s financial position.
Conclusion
The basic accounting procedure is a systematic approach to recording, classifying, summarizing, and interpreting financial transactions. By following this Basic Accounting Procedure, businesses can produce accurate and reliable financial statements that provide insight into their financial performance and position. These statements are essential for decision-making, financial planning, and compliance with regulatory requirements. While the process involves several steps, the application of sound accounting principles ensures that financial information is reported consistently and transparently, allowing stakeholders to make informed decisions.
The Basic Accounting Procedure refers to the systematic steps followed to manage the accounting records, ensuring that every transaction is accurately captured and reported. By following this Basic Accounting Procedure, businesses can produce accurate and reliable financial statements that provide insight into their financial performance and position.