Why Companies Create Accounting Systems

To monitor the financial progress of a business entity, a business owner must have skills and knowledge about running an accounting system. An accounting system allows the business to monitor all kinds of financial transactions that the company is involved in which includes purchases, sales, and liabilities. On the other hand, the accounting system is responsible for the generating comprehensive statistical reports that offer the management or any other interested party with a clear set of data which they can employ in the decision-making process. In essence, the accounting system measures the performance of an organization financially, against a backdrop of set standards allowing the owners to adjust and come up with new measures to steer the organization towards the right direction (Alkaswna, Oqool, & Bshayreh, 2014). However, it is important to note that as opposed to the past where all accounting systems were tons and tons of papers stored in a safe room today’s accounting is more automated and computer-based which ensures accuracy and security of such records.

Assets, Liabilities and Stockholders’ Equity

Assets

In business and accounting terms, an asset refers to anything valuable or a resource that can be converted into cash. In essence, it implies anything valuable that a business entity owns and utilizes it in the generation of income, and changes quickly into money. Assets appear in the balance sheet in four distinct categories for accounting. These include current assets such as cash, accounts receivables, and other liquid items, intangible assets such as trademarks patents and copyright, long-term assets which include equipment and real estate, and prepaid and deferred assets such as rent and interest among others.

Liabilities

These are legally binding obligations on a person or a business to settle a debt in the form of future performance of services as well as payment of assets in the future that stem from transactions in the past. Similar to assets they also appear on the balance sheet. For accounting purposes, liabilities are in two categories which include long-term liabilities which are to be settled within a period exceeding one year or beyond the normal operating cycle and current liabilities, which are those that are to be satisfied within the normal operating cycle or a within a year.

Stockholders’ Equity

Also identified as the book value, stockholders equity refers to the remaining amount of assets at the shareholders’ disposal after the settling of all liabilities. It is the difference between the liabilities and assets and represents claims by the business owners on the company’s assets. Settling of stockholders’ equity can be in the form of capital, donated capital or retained earnings which are earnings still held by the business.

Relationships

Assets=Liabilities+ Stockholder’s Equity

The three major parts of accounting share an inherent relationship with each other, implying that a change in one will most definitely affect the remaining two items in the relationship. The total liabilities and stockholders’ equity will, therefore, provide for the assets. On the other hand, Stockholders equity refers to the assets less the liabilities while the total liabilities will be obtained by the assets less the stockholder’s equity.

Basic Financial Statements and how they are affected by revenues, expenses, and dividends

Income statement

An income statement is used to report on the company’s financial performance over a fixed accounting period. In essence, it highlights the economic failure or success of a firm’s operations within the stipulated timeframe (Drake, Quinn, & Thornock, 2017). Furthermore, it contains useful information that can be used by employers to predict net income. Based on their beliefs regarding a business’ future performance Investors will purchase and sell stock. On the other hand, to predict future earnings, creditors will use the income statement. Net incomes are the revenues less the expenses. However, it is worthwhile noting that amounts obtained from stocks issuance do not count as revenues whereas those issued as dividend payments are not expenses.

Balance Sheet

This is a financial statement which records assets, liabilities and stockholders’ equity at a given point in time and provides ground for calculating the return rates as well as evaluation of capital structure. It offers a clear picture regarding what the company owes and owns as well as the amounts invested by shareholders.

Cash Flows Statement

To obtain the financial position on the cash payments and cash receipts within a business for a specific period cash flow statements must be created. It highlights the effects of cash of a company’s, investing, operating and financing activities necessary for parties that use such information.

Retained earnings statement

Similar to the income statement this statement indicates the amount and reasons for changes in retained earnings within a specific period. This is initiated by the retaining an amount, followed by addition of net income by the firm while subtracting the dividends to obtain the end of the period retain earnings (Drake, Quinn, & Thornock, 2017).

Difference between Net income and cash flow statements

Net income implies the revenues identified within a period of reporting minus the expenses reported within the same period. It is obtained through an accrual basis of accounting where the costs are determined within the same time as the revenues to which they relate. On the other, the amount of cash that a business generates or loses within a reporting period hand is known as cash flow and will be estimated on the final day of reporting. Determining changes in final cash balances from period to period, instead of the accrual accounting basis provides the cash flow.

Closing Statement

The balances held in temporary accounts are moved to an income and retain earning statements upon the completion of an accounting period, which resets the temporary account balances to zero, initiating the subsequent accounting period. Temporary accounts are often closed since permanent accounts act as the initial balance for the coming accounting periods. Starting on a zero balance is easier since tracking revenues are easier, allowing for comparison to previous years.

References

Alkaswna, R., Oqool, M., & Bshayreh, M. (2014). The Importance of the Accounting Information and the Role of the Scientific Accounting Research in Developing the Economic Development Service in the Developing Countries (Case Study Jordan). Research in Applied Economics, 6(1), 240-256.

Drake, M., Quinn, P., & Thornock, J. (2017). Who Uses Financial Statements? A Demographic Analysis of Financial Statement Downloads from EDGAR. Accounting Horizons, 31(3), 55-68.