The assets will use up (obsolete) by the business operations and activities now and in the future. The business does not have to own 100% of the asset to hold the legal title of the asset. The equity represent the percentage of ownership interest of asset of business. There will a lien against the legal title that will represent the creditors’ interest in the asset.
For example: Building will not own100% by the business. The business owner pay the down payment. The rest is financed through the creditor (lender, bank, financial institution).
Asset = Liability + Equity is the Accounting Equation. Asset + Expense = Liability + Equity + Income/Revenue is the modern extended accounting equation.
Definition of Accounting
Definition of AccountingNovember 15, 2012Irma Miller MBA, CPAE-mail: email@example.com
Disclaimer:• The views expressed in this presentation are my own and not necessarily those of the Kentucky Society of Certified Public Accountants, the American Institute Certified Public Accountants and the Internal Revenue Service.• The information is not a substitute for consultation with an expert and the creator is not liable for problems arising from following the advice on the site.• The laws and regulations are subject to change over time and recent changes after the date of this representation may not be reflected on this presentation
What is Accounting ? “the language of business” •large international corporation •single person •home based business •government agency •non-profit vehicle for reporting financial information about a business entity to many different groups of people
Definition of AccountingAccountancy is the process of communicating financialinformation about a business entity to users such asshareholders and managers. The communication isgenerally in the form of financial statements that show inmoney terms the economic resources under the controlof management; the art lies in selecting the informationthat is relevant to the user and is reliable. The principlesof accountancy are applied to business entities in threedivisions of practical art, named accounting,bookkeeping and auditing. (Elliot, Barry & Elliot, Jamie:Financial Accounting and Reporting, Prentice Hall,London, 2004 p.3)
Definition of Accounting (continued) The American Institute of Certified Public Accountants (AICPA) defines accountancy as “the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof. (Accounting Terminology Bulletin No.1 Review and Resume)
There are three types of accounting• Tax Accounting• Managerial Accounting• Financial Accounting
Tax Accounting• Tax Accounting helps determine how much is owed to the government for taxes• The government sets the rules for determining taxes• Taxes : – Tax Authorities : Federal - State - Local – Taxes : Business Corporate (Net Profit, Property) – Individual (Payroll, Sales, Property)
Managerial accounting• Designed to help people inside the business make decisions• There are no rules• Report is customized and designed to meet needs of users inside the business.
Financial Accounting• Designed to help people outside of the business make decisions (creditors, investors, suppliers, customers, governments, labor unions)• Multi purpose reports (one set of financial statements meets the need of all users outside the business)• Follows the rules of GAAP (Generally Accepted Accounting Principle)
Assets and Equity• Accounting “accounts for” two things: – the business assets and – the equity in those assets• Definition of assets by International Accounting Standard Board (IFRS Framework): “An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the enterprise”• An asset generally is something that the business owns and holds the legal title to.• Example: building, equipment, furniture
Assets and Equity (cont.)• Definition of equity by International Accounting Standard Board (IFRS Framework) F.49(c): “equity capital is the owners’ interest on the assets of the enterprise after deducting all its liabilities.”• Equity represents ownership.
Liabilities• Definition of liabilities by International Accounting Standard Board (IFRS Framework) F. 49(b): “A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.”• Liabilities are debts and obligations of the business.• Liabilities represent creditors’ claim on interest of ownership of business assets.
Assets = Liabilities + Owner’s EquityASSETS = • Cash LIABILITIES • Inventory (creditors’ ownership of interest of • Building assets) • Equipment + • Furniture • Supplies OWNER’S EQUITY • Vehicle (investors’ ownership of interest of assets) The Accounting Equation
Debits and Credits• Debits and Credits are the two fundamental aspects of every financial transaction in the double-entry bookkeeping system in which every debit transaction must have a corresponding credit transaction(s) and vice versa.• In financial accounting or bookkeeping, “Dr” (Debit) means left side of a ledger account and “Cr” (Credit) is the right side of a ledger account
The Five Accounting Elements• To determine whether one must debit or credit a specific account, we use the modern accounting equation approach which consists of five accounting elements.• Five accounting elements: – Asset – Liability – Equity – Income/Revenue – Expense• The Modern Extended Accounting Equation : Asset + Expense = Liability + Equity + Income/Revenue
The Five Accounting Elements• (Gross) Income/Revenue: is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. (The International Accounting Standard Board, IFRS Framework F.70)• Expense: decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. (The International Accounting Standard Board, IFRS Framework F.70)
The Five Accounting Elements Increase Decrease• An increase (+) to an Asset Expense Debit Debit Credit Credit asset or expense Liability Credit Debit account is a debit (Dr). Equity / Capital Income / Revenue Credit Credit Debit Debit Debit Credit• An increase (+) to a Asset + - liability, equity or Expense + - income/revenue account Liability - + Equity / Capital - + is a credit (Cr). Income / Revenue - +
Recording The Transactions• All accounts must first be classified as one of the five accounting elements.• Each transactions will consist of at least one debit to a specific account and one credit to another specific account.• Each transaction must be equal (balance).• Each transaction recorded in a general ledger or t-account. Bank (Asset) EquityDr. Cr. Dr. Cr.
Recording The Transactions(1) X made an initial investment of $ 20,000 cash to start the X Law Office, PLLC and open a business bank account. Journal Entry Dr. Cr. Cash (Bank) $20,000 Equity/Capital X $20,000 Bank (Cash) – (Asset) Equity / Capital X Dr. Cr. Dr. Cr. (1) $20,000 (1) $20,000
Recording The Transactions(2)X decided to obtain the loan from Bank Z to finance the entire purchase of $ 5,000 in office furniture and equipment. Journal Entry Dr. Cr. Office Furniture & Equipment $5,000 Loan from Bank Z $5,000 Office Furniture & Equipment (Asset) Loan Bank Z (Liability) Dr. Cr. Dr. Cr. (2) $5,000 (2) $5,000
Recording The Transactions(3) X Law Office, PLLC paid $ 5,000 for security deposit for leasing an office space Journal Entry Dr. Cr. Security Deposit $5,000 Bank (Cash) $5,000 Bank (Cash) - (Asset) Security Deposit (Asset) Dr. Cr. Dr. Cr. (3) $5,000 (1) $20,000 (3) $5,000 $5,000 $15,000
X Law Office, PLLC Assets = Liabilities + Owner’s EquityAssets: Liabilities:Bank/Cash $ 15,000 Loan Bank Z $ 5,000Security Deposit $ 5,000 Equity:Office Furniture &Equipment $ 5,000 Equity/Capital X $ 20,000 _______ _______ Total LiabilitiesTotal Asset $ 25,000 and Equity $ 25,000
Cost vs. BenefitThe accounting system considers cost versus benefit.This means when the business designs the accountingsystem, the cost of producing the information will notwant to exceed the benefit of having the information.Legal and regulatory considerations override the costand benefit analysis. The business is obligated to complywith any legal and regulatory considerations that areapplicable to the business.
What are the law office typical industry characteristics (based onour law office clients’ experience) ?• IOLTA Account• Retainer• Reimbursement (Business to Business) – Income Reimbursement – Expense Reimbursement (mark-up is optional)• More than a year account receivable / billing collection (cut off date at the end of fiscal year and necessary adjustment journal entry).