The single entry bookkeeping is the method for recording single line transactions, reflecting the credit/debit of cash. Single entry bookkeeping takes into account records of cash accounts, accounts receivable, accounts payable and paid taxes. It also captures records, such as assets, liabilities, inventory, expenses and revenues; the above can lead to an inadequate portrayal of the financial records when not properly maintained.
Double-entry bookkeeping is the foundation of general accepted accounting principles, in this method double entry makes two entries for every single transaction. For example, a credit entry is made for revenue brought into an organization and a debit entry is done for every transaction paid. The sum effect is that, these two entries will offset each other such that both sides will sum up to zero. As such, double-entry accounting system provides the following advantages over the single-entry accounting system with regards to bookkeeping:
1. Checks against bookkeeping errors are automatically detected, theft inclusive. This entails that all transactions are recorded, and the total sum of debit entries is the same as the total sum of credit entries.
2. The processing of financial statements can be done with ease, due to the accurate, reliable and continuous calculation of profits (credit) & loss (debit).
3. Having both entries recorded on (sales and purchases); it is easier to track the company’s creditors and debtors.
4. The company’s balance sheet is vividly illustrated and can be accessed promptly for effective business planning, control and decision making.
5. There being a higher degree of required entries, double-entry book keeping has an accurate approach in creating detailed records of all economic resources so that the organization does not lose track of any income.
6. Double-entry bookkeeping captures all internal transactions, such as entry adjustments, which creates more accurate information at the end of every fiscal year.
7. Omission of important data is not a challenge because each transaction is categorically recorded twice in two separate columns (debits/credits).
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Accrual accounting requires that revenues from goods sold or services performed be recognized in the period in which they are earned, rather than when cash is received. In addition, expenses are to be recognized during the period in which goods are used or services are received, rather than when they are paid for. Net Under accrual accounting, income is therefore, the difference between revenues and expenses for a given accounting period. Cash- basis accountingsrecognizerevenues in the period in which cash is received and recognize expenses in the period in which cash is paid. Net income, therefore, is the excess of cash inflow from revenues over the cash outflows for expenses for a given period. Cash-basis accounting often does not properly match the efforts of an entity to produce revenues with the revenues earned. Thus, neither the revenue recognition principle nor the matching principle applies to the cash-basis accounting.
Fundamental accounting assumptions are the factors that are used in explaining the conceptual structure of accounting. Conversely, accounting principles constitute the ground rules for financial reporting and are referred to as “the generally accepted accounting principles (GAAP)”. Below are assumptions and principles discussed:
The Entity Assumption
An accounting entity is any economic unit that controls resources and engages in economic activities. Individuals, business enterprises, governmental agencies, non-governmental organizations and all non profit making entities are accounting entities regardless of the form of organization. The accounting entity of concern is assumed to be separate and distinct from all other entities regardless of the form of organization.
The ‘Going – concern’ Assumption
In accounting for an accounting entity, it is to be assumed that the accounting entity will continue in operation for an extended time. It is assumed that the accounting entity has no plan or no need to liquidate, or to reduce the scale of its operations. This assumption provides the foundation for accrual accounting. This shows the possibility of continuity of the firm.
The Periodicity Assumption
The results of an accounting entity would be the most accurately measurable at the time when the entity liquidates. Users of accounting information, however, cannot wait indefinitely for such information. They need regular, periodic measurements for the decision-making purposes. The periodicity or the time assumption implies that the assumed indefinite life of the accounting entity can be divided into artificial time periods. During this indefinite life, there are relatively short time intervals when accountants measure progress and changes in financial position of the entity.
The Unit of Measure Assumption
Accountants need a means of relating and bringing transactions together in a way that makes sense. According to docstoc.com, accountants conclude that money is the best standard of measure, out of the several available, for the purpose of measuring financial transactions. Accountants assume that the monetary unit (money) is a stable unit of value capable of acting as a common denominator of values. The impact of transactions is quantified and assessed in terms of some unit of measure.
Generally Accepted Accounting Principles
The Cost Principle
Wikipedia notes that a number of different measurement bases are employed, currently in practice, to different degrees and in varying combinations in preparing and presenting financial statements. Generally accepted accounting principles require that transactions and events be recognized in the financial statements as either, the amount of cash and cash equivalent paid/ received, or the value ascribed to them when they took place. Historical cost is usually definite and verifiable. As per this principle, assets are initially recorded at cost. In most cases, no adjustment is made to this valuation in later periods. Often, as the assets expire, a portion of the original cost is allocated to expense. At the time the asset is acquired, cost represents the fair market value as evidenced by an arm’s-length-transaction.
The Revenue Realization Principle
Accountants face a problem regarding when to recognize revenue. All the divisions of an entity contribute to the revenue including the security department, the production department, the accounting department and the marketing department, among others. This principle provides guidance in answering the question of when revenue should be recognized. In general, revenue should be recognized at that point where it can be objectively determined. Some uniformity regarding when revenue is recognized so as to make financial statements more meaningful and comparable is essential. Revenue is considered realized when the following conditions are met:
- The earning process is essentially complete. The entity must have completed a significant portion of its responsibility.
- Objective evidence exists as to the amount of revenue earned, which must be measurable objectively.
- A major portion of the costs associated with the revenue has been incurred or can be estimated.
- The actual collection of cash is reasonably assured.
At the point of sale, revenue is recognized as the earning process is essentially complete and the exchange value can be determined. There are exceptions where the point of sale may not give a fair result. The other acceptable methods of recognizing revenue include
- End of production
- Receipt of cash
- Revenue recognition during production
- Cost recovery.
The Matching Principle
This principle provides guidance in answering the question of when should a cost be recognized. To measure the profitability of an economic entity, the entity’s revenue is matched against the costs associated in generating that revenue. The matching of business enterprise’s expenses (the cost of goods and services used to obtain revenue) with its revenue, is the primary activity in the measurement of the results of operations for that period
Ways how costs are matched with revenue
- Direct association of costs with specific revenue transactions. This is where a cause and effect relationship exist and where the revenue and expense occur simultaneously.
- Systematic allocation of costs over the ‘useful life’ of the expenditure.
Direct write off is made to the income statement where no association can be identified with reasonably either a particular type of revenue or accounting period.
The Objectivity Principle
The term ‘objectivity’ refers to measurements that are unbiased and subject to verification by independent entities. The principle requires that the value of transactions, assets and liabilities be verifiable. It implies that valuation must be independent of the person valuing the asset or liability. While different parties may disagree on an asset’s expected future cash flows, they would most likely agree on its historical cost which is objective and verifiable.
The Consistency Principle
The principle of consistency implies a consistent treatment of similar or the same items from one accounting period to another. This adds to the usefulness of financial reports since reports from one period are comparable to those of another period. This also facilitates the detection of trends. In principle, once an accounting procedure has been adopted for a class of items, it should be consistently applied from period to period. This principle does not mean that a company should not make changes to the current accounting method, if a new accounting method will provide more useful information.
The Full Disclosure Principle
Docstoc.com (2012), states that ‘accounting reports must disclose all facts that may influence the judgment of an informed reader’. This means that all the relevant information concerning the position and the consequences of the entity’s operations should be provided either in the financial statements or in the notes accompanying the financial statements. Several approaches of disclosure exist; parenthetical explanations, supporting schedules, cross-references and footnotes. Full disclosure should enable an informed reader to make better decisions and avoid misinterpretation.
- My credit is my most valuable asset: Many people dream of starting a business. However, startups require a sizable amount of cash, as capital might not be available. In that case, credit is an important asset for starting or expanding a business.
- When I give credit, I debit my customer’s account. When credit is given, that becomes revenue realized under the accrual method; it becomes an account receivable, some cash that will be paid at an agreed date. That is why we debit the customer’s account.
The equation shows the relationship between the economic resources belonging to a business, and the claims against those resources. Another term for economic resources is assets and claims consist of creditors’ claims (liabilities) and the claims of owners (owners’ equity). The equation may thus be re-written as:
Assets = Liabilities + Owners Equity
Assets – these are economic resources controlled by an entity from which the future economy may be obtained either directly or in combination with other assets. The future benefits are mainly in the form of cash flows or promise to receive cash flows.
Liabilities – according to Wikipedia, these are obligations of ‘an entity which arise from past events or transactions, the settlement of which may’ require the outflow of economic benefits in the future. Settlement of liabilities results in the reduction of economic resources, the incurrence of other liabilities, or the provision of services.
Equity – this refers to the owners’ claims on the resources (assets) of the entity. It thus refers to the residual interest after deducting the liabilities from the assets.
A creditor is the one to whom a debt is owed ; an employee is the one who works part-time or full-time under an employment contract, whether oral, written, express, or implied, and has recognized rights and duties. Owner is the party that has the exclusive right to hold, use, and benefit-from, enjoys, convey, transfer, and otherwise dispose of an asset or property. One can be a creditor by contributing to the capital of a business; one can be an employee, if he works for the same business whether directly or indirectly; one can be the owner, if he funds all the capital individual or partnering, for example, in partnerships and sole proprietorship models of business.