Accounting for Everyone Week 1
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Welcome to the first lesson. This lesson is very short on purpose as we do not want to overwhelm anyone. Let’s get going…
Everything is an account! It is the single most important thing to understand in accounting. Forget categories, sub-categories, classes and any of the other terms you may have heard. Later you will understand why, but for now it is enough to know that we have already simplified double-entry accounting: Everything is an Account. Period.
So, what exactly is an account? It is a way of tracking money. Examples we all know are bank accounts, credit card accounts, deposit accounts etc. If a business has a fleet of vehicles they will almost certainly open a diesel or petrol account at their local garage. But for the rest of us, we rarely think of an expense like ‘petrol’ as an ‘account’. But that’s the point. In the world of accounting, everything is an account, whether it is a bank, petrol, sales, loan, VAT, depreciation, stationery, telephone, rent, profit and loss etc. They are all accounts.
The second most important thing to understand is that there are no special accounts. Every account does the same thing. It records the flow of money. There are conventions for naming accounts, for example, accumulated depreciation account (enough to put anyone off!), but once you understand that all accounts are the same, it will really help you get your head around the subject. To summarize:
- Accounts track the flow of money
- Accounts have a meaningful name
- Accounts have a balance (which shows how much we have, how much we owe, how much we have spent, how much we have earned etc.)
So, what do we do with these accounts? First we need a place to show them. And that place is called the Chart of Accounts. It is a list of all the accounts used in a business. A list of accounts is great, but it also needs some structure so it makes a little more sense.
The most basic structure of a set of accounts is to group them into assets and liabilities. But before we explore what that means, here is a vital lesson on business: Always remember that there is ‘business’ and there is also the ‘owner of the business’. They are separate entities. There is you, and there is your business. If you become (or are) a bookkeeper or an accountant, the separation is exactly the same: You and your bookkeeping/accounting business. There are 2 reasons you need to understand this:
- (the first reason is a digression, but an important one) If you understand this concept, you can make better business decisions. You can look upon your business as something separate and remove the ‘personal’ side of it. This is a good thing to do. We are not talking about important issues such as customer service here, we are talking about being able to decide whether an investment in the business is good or not for the business. For example, a member of staff is causing issues. If you take it personally, you may not want to deal with it because you like the person. If you understand it is a decision for the good of the business and not yourself, you will almost certainly do the right thing. So what exactly has that got to do with accounting?…
- Accounts are split into groups. The basic groups are assets and liabilities:
- Assets are things the business owns (e.g. a vehicle, premises, computer and other equipment).
- Liabilities are things the business owes (e.g. loans, overdrafts, tax). The emphasis here is on the business.
Now, the important bit. The business also owes the owner of the business something. This is called Equity. If you want to see what the business is worth to its owner, look at the equity in the business.
OK. How do we show these groups? The most common way to see them is to look at a balance sheet. And what exactly is a balance sheet? It is a list of accounts split into groups, the most basic of which may consist of Assets, Liabilities and Equity.
We know that the core element of any bookkeeping/accounting system is an account. We know all accounts are the same (there are no special cases). We know all accounts record the flow of money. We know we need to structure these accounts into groups to represent what the business owns and what it owes.
There are 2 important things to note about an account:
- Its name
- Where it is placed in the account structure
Task 1: Write out a list of accounts. They can be of any type you like, bank, sales, expense. What matters is the name. Give them a name that exactly matches what it is they do. For example, ‘Bank’. As soon as you see the word ‘bank’ you know what it does. In the real world, you may name it after your actual bank (e.g. HSBC or Barclays). Another example is Consultancy Work. Does that mean money you have received from consulting work you have done, or is it an expense for consulting work you have had done for you? Try renaming it Consultancy Sales. It’s all in the name! Hint: if you are already in business, just look at all the things that either cost you money, that you receive money for doing, where you store your money or where you get money from. These are your accounts.
Task 2: Structure your accounts into Assets and Liabilities (forget Equity for the moment, equity is just another liability of the business).
- Task answers and explanation
- How does the Equity group fit into all this?
- More on structuring accounts
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