Accounting 101 anyone?

Accounting 101 - In many occasions when I am meeting with my Client's Accounting folks, I relaize that one of the most difficult jobs is to understand and translate the accounting requirements to Oracle Accounting Processes. Here is a quick tutorial which I thought will be helpful to anybody who wants a quick understanding of the accounting concepts.

Definition - accounting is a process of recording, classifying, summarizing, analyzing and interpreting the complete financial activities of a business and communicating the results thereof to the key stakeholders . Any financial transaction should represent three basic components namely Account, Currency and Fiscal Calendar. All financial activities s need to be accounted based on Generally Accepted Accounting Principles (GAAP).

Accounting Methodologies - There are two types of accounting methodologies namely Cash Basis and Accrual Basis Accounting.

Cash Basis Accounting - Accounting entries are captured only when cash is received or paid. No entry is done when a payment or receipt is merely due.

Accrual Basis Accounting - Accounting entries are captured on the basis of amounts having become due for payment or receipt. The term Accrual in this context is recognized as Revenue when it is earned and Cost when it is incurred.

1. Accounting Rules and Concepts:
Following rules can be used t o store and process the financial activities in a typical enterprise:-
Ø Business Entity Concept (Owner’s Equity + Liability = Assets).
Ø Going Concern Concept.
Ø Money Measurement Concept.
Ø Dual Aspect Concept.
Ø Cost Concept.
Ø Accounting Period Concept.
Ø Materiality.

2. Classification of Business Transactions:
The business transactions have been broadly classified into three categories namely: -

2.1 Personal Account
It includes the accounts of persons with whom the business has dealings like customers, vendors
and bank accounts. In this scenario , the two entries of double entry book keeping will be as
follows:-
a. Debit the Receiver.
b. Credit the Payer.

2.2 Real Account
It includes the accounts of Tangible assets such as Cash A/c, Machinery A/c, Inventory, Land & Building A/c, Furniture A/c and Intangible asse ts such as Patents A/c, Goodwill A/c etc. In this scenario, the two entries of double entry book keeping will be as follows:-
a. Debit What Comes IN
b. Credit What Goes OUT.

2.3 Nominal Account
It includes accounts of all expenses, losses, incomes & gains such as salaries, rent, insurance, electricity, interest & divided received, commission received, discounts etc.
a. Debit Expenses & Losses.
b. Credit Gains & Incomes.

3. Concept of Chart of Accounts:
The Chart of Accounts is the basis of any accounting system. The Chart of Accounts is the means by which like transactions are grouped in order to collate data and generate reports. In the new Chart of Accounts, transactions will fall into five major categories:
· Income
· Expenditure
· Assets
· Liabilities
· Equity (fund balances)
In a private sector or commercial organization, equity represents shareholders funds.

4. Accrual Basis Accounting - Recording Transactions
The purpose of recording transactions is to generate information and reports used in the decision making process. By grouping like transactions over a specific time period —and matching income to expenditure over that time period—managers can monitor the financial position and performance of an organization or business unit. For instance, actual can be monitored against budget—a business unit’s financial plan—and corrective action taken if necessary.

5. Time period
A critical point in monitoring is ensuring that transactions are recorded in the correct time period. In accrual accounting, items are recorded or ‘brought to account’ as soon as they are earned or incurred.
(NOTE: In cash accounting, items are only recorded or ‘brought to account’ when actual monies are received or paid.)
Similarly, transactions are included in the financial statement for the period in which they occurred—not when monies were received.

6. Non-cash transactions
In addition, accrual basis accounting entails recording non-cash transactions such as depreciation, provisions, bad debts, etc. Non-cash transactions have a monetary value and contribute to the business unit’s financial position.

For example, a photocopier has a ‘life span’ greater than a year. It is an asset in accrual accounting terms. The initial cost of the copier is recorded as an asset in the Statement of Financial Position to recognize the ongoing benefit the copier provides to the business unit. The cost of using the photocopier is allocated across the years to the business unit or department that uses it. This cost allocation is called depreciation and is recorded as an expense in the department’s Statement of Performance. When the photocopier is replaced, the profit or loss from the sale is recorded against the department’s Statement of Performance and the accumulated depreciation is deducted from the asset account in the Statement of Financial Position. Effectively, the depreciation covers the cost of the asset and the value of the asset reduces to zero over time.

In summary, recording transactions against the correct time period and recording non –cash transactions is designed to allow the true cost of operating activities for a specific time period to be recorded and monitored. The cost of using assets and providing for accumulated leave or outstanding debts is identified and recorded.

7. Financial reports
In accrual accounting, there are three financial reports. Each report provides a set of information that assists managers in their decision -making.

7.1 Statement of Receipts and Payments
A Statement of Receipts and Payments reports the cash transactions that have occurred during the time period. It shows the actual monies received and the payments made during the time period. The Statement shows the full cost of any capital item purchased —e.g., any equipment purchases of $5000 or more. The statement presents the cash position of the business unit and allows managers to monitor that cash position.

7.2 Statement of Performance
The Statement of Performance reports the operating performance during the time period. It records the income and expenses for the period. In addition, it records non-cash transactions such as depreciation and movements in provisions. The Statement presents the financial outcome of operating activities for the period and allows managers to monitor that operating performance.

7.3 Statement of Financial Position
The Statement of Financial Position—previously called a Balance Sheet—reports the financial position of the business unit. It records the current values of the business unit’s asset and liabilities. The Statement will include accumulated depreciation on asset purchases and the provisions accumulated to meet annual and long service leave, Accounts Receivable (debtors who have not yet paid invoices raised for services delivered) and Accounts Payable (creditors who have not yet paid for their services).

8. The Accounting Doctrine
The accounting doctrine refers to accrual accounting. The accounting doctrine is designed to ensure the reliability of financial information. It is based on the assumption that the information provided by the accounting system is as good as the data entered and the parameters used to collate and summarize that data.

Parameters refer to agreed rules, methods and standards used to record transactions, summarize data and present information. The major principles that underpin the accounting doctrine are:
Consistency—transactions of the same type are always treated and recorded in the same way.
Conservatism—projections such as budgets, income, expenses, provisions, etc are based on realistic, pragmatic estimates.
Disclosure—all financial information provided is transparent; information is neither hidden nor unnecessarily complex.
Materiality—appropriate monetary values are assigned and recorded. For instance, in-kind services are not overvalued and ‘assets’ are only recorded as assets where they are of significant value.

In order to ensure that these principles are met, transactions are entered or recorded using the following conventions:
Against the correct business entity—a business unit that is distinct, owns assets and is responsible for its financial position.
At historical cost—the cost of the transaction/purchase at the time it occurred.
In the relevant period—the ‘life’ of a business entity is divided into regular accounting periods so that performance over time can be measured and assessed.
In monetary terms—all transactions are expressed in monetary values even if they are not cash transactions—e.g., provisions, depreciation, etc.

In the new finance system, consistent use of these conventions will be critical. Consistent and accurate data entry will determine whether the information in the system can be relied upon for decision making and performance monitoring.