Bookkeeping 101: A Beginning Tutorial
Bookkeeping in a business firm is the basis of the firm's accounting system. Bookkeepers are responsible for recording and classifying the accounting transactions of the business firm and techniques involving recording those transactions.
If you are a small business owner, you either have to set up your own accounting system or you have to hire someone to set it up for you. If you are self-employed and it is a one-person business, you will do it yourself. If you are hiring staff and anticipate a lot of growth, you may hire a controller to handle your financial management and accounting. If your business is going to grow but you anticipate slow growth, you may simply hire an accountant or bookkeeper to handle the accounting system.
Accountant vs. Controller
Where the bookkeeper records and classifies the financial transactions of the company, the accountant takes the next steps and analyzes, reviews, reports, and interprets financial information for the company.
The controller is actually a company's chief accounting officer. He/she is responsible for setting up and maintaining the company's accounting system. The controller is responsible for financial and managerial accounting; in other words, responding to the firm's accounting data in an appropriate and responsible manner. A controller is usually hired as a business gets larger.
Bookkeeping With and Without a Computer Program
This tutorial on bookkeeping teaches you basic bookkeeping without using a computer program. Why do you need to know that since there are so many computer programs out there you can use? Have you ever heard the saying, "Garbage in, garbage out?" You have to understand the basic bookkeeping behind what you enter into the computer program in order to enter in the correct information. A later tutorial will deal with using a computer program to handle bookkeeping for your business organization.
Should You Use Single or Double Entry Bookkeeping?
Single-Entry bookkeeping is much like keeping your check register. You record transactions as you pay bills and make deposits into your company account. It only works if yours is a small company with a low volume of transactions.
If your company is of any size and complexity, you will want to set up a double-entry bookkeeping system. Two entries, at least, are made for each transaction. A debit is made to one account, and a credit is made to another accounting. That is the key to double-entry accounting.
Should You Use Cash or Accrual Accounting?
One of the first decisions you have to make when setting up your bookkeeping system is whether or not to use a cash or accrual accounting system. If you are operating a small, one-person business from home or even a larger consulting practice from a one-person office, you might want to stick with cash accounting. If you use cash accounting, you record your transaction when cash changes hands. Cash can be anything from actual money to electronic funds transfer. Sometimes firms start their business using cash accounting and switch to accrual accounting as they grow.
If you are going to offer your customers credit or if you are going to request credit from your suppliers, then you have to use an accrual accounting system. Using accrual accounting, you record purchases or sales immediately, even if the cash doesn't change hands until a later time, such as in the case of Accounts Payable or Accounts Receivable.
The Basics - Understanding Assets, Liabilities, and Equity
Before you set up your bookkeeping system, you have to understand the firm's basic accounts - assets, liabilities, and equity. Assets are those things the company owns such as its inventory and accounts receivables. Liabilities are those things the company owes such as what they owe to their suppliers (accounts payable), bank and business loans, mortgages, and any other debt on the books. Equity is the ownership a business owner, and any investors have in the firm.
Balancing the Books
To balance your books, you have to keep careful track of these items and be sure the transactions that deal with assets, liabilities, and equity are recorded correctly and in the right place. There is a key formula you can use to make sure your books always balance. That formula is called the accounting equation:
Assets = Liabilities + Equity
The accounting equation means that everything the business owns (assets) is balanced against claims against the business (liabilities and equity). Liabilities are claims based on what you owe vendors and lenders. Owners of the business have claims against the remaining assets (equity).
Initial Bookkeeping Terms Related to the Accounting Equation
Let's take a closer look at assets, liabilities, and equity so you will have a complete understanding of what comprises each one.
- Assets: If you look you look at the format of a balance sheet, you will see the asset, liability, and equity accounts. Asset accounts usually start with the cash account and the marketable securities account. Then, inventory accounts receivable, and fixed assets such as land, buildings, and plant and equipment are listed. Those are tangible assets. You can touch them. Firms also have intangible assets such as customer goodwill.
- Liabilities: The liability accounts on a balance sheet include both current and long-term liabilities. Current liabilities are usually accounts payable and accruals. Accounts payable are usually what the business owes to its suppliers, credit cards, and bank loans. Accruals will consist of taxes owed including sales tax owed and federal, state, social security, and Medicare tax on the employees which are generally paid quarterly.
- Equity: The equity accounts include all the claims the owners have against the company. The business owner has an investment, and it may be the only investment in the firm. If the firm has taken on other investment, that is considered here as well.
Income Statement Basics - Revenue, Expenses, Costs
The income statement, covers revenue, expenses, and costs.
Revenue is all the income a business receives in selling its products or services. Costs also called cost of goods sold, is all the money a business spends to buy or manufacture the goods or services it sells to its customers. The Purchases account tracks goods purchased. Expenses are all the money that is spent to run the company that is not specifically related to a product or service sold. An example of an expense account is Salaries and Wages.
A bookkeeper is responsible for identifying the accounts in which transactions should be recorded. For example, if the business makes a cash sale to a customer and your business uses double-entry bookkeeping, you would record the cash received in the asset account called Cash and the sale would be recorded in the revenue account called Sales. Here is another example of a bookkeeping entry for a cash sale. This one throws in another variable - what the bookkeeper has to do when sales tax is involved.