Accounting Methods
Accounting Methods
Very small businesses often use a single-entry system to record cash earned when received and expenses when they are paid. A traveling massage business named “Magic Fingers” for example, may choose to record all cash received from clients as revenue and cash paid for things like massage oil as expenses. At the end of the year Magic Fingers will add up all revenue items for cash received and sum expenses into accounts like travel and supplies. From there, Magic Fingers will create a basic income statement (profit and loss statement) where it will take revenue minus expenses to arrive at a profit or loss in order to see how money is being earned. This information will be used to make business decisions and prepare tax filings at year end. Rules for recording these transactions may be governed by authorities such as the Internal Revenue Service, the tax collection agency for the United States. Generally accepted accounting principles governed by various self-regulated governing bodies do not allow single-entry systems.
Academic and business accounting will generally be performed using a double entry system. The double entry system requires that every transaction affects two accounts (classifications). For example, say a business deposits $1,000 in the checking account. To record this event the cash account increases $1,000. Now the accountant must decide on how to classify the other side of the transaction which will help answer: Where did the cash come from? This $1,000 could have been a transfer of cash, a loan received, an investment received, revenue earned for providing goods and services, refund from returning something to the store, and any number of other things. In this example, the $1,000 came from a loan (liability). Therefore, the accountant will manually record or use accounting software to both increase cash (assets) for $1,000 and increase notes payable (liabilities) for $1,000.
The double entry system creates checks and balances to ensure that all transactions are recorded. “Gooder Consulting” business for example, might have hundreds of revenue transactions which increased cash. Cash also decreased with expenses when Gooder paid for travel and office expenses. At the end of the accounting time period (usually every 3 months or a year) the accountant will have recorded each transaction against cash and the appropriate revenue or expense account. Ending cash in this example will need to match the bank statement or bank reconciliation if there are outstanding checks and deposits. The summary of all transactions will be recorded into the final balance sheet in which both sides of the financial statement must equal each other or “balance.” This process of balancing ensures that all cash transactions have been recorded, but does not necessarily guarantee accuracy.
- In double entry accounting every transactions affects at least two accounts
- Accounting records must balance on the balance sheet
Cash Basis Accounting
Cash basis accounting uses the flow of cash to determine when to recognize transactions on the accounting record. Revenue earned for services will be recorded when cash is received (as a transfer or check) and expenses recorded when paid out using cash or credit. The system is still double entry as the account