Double-entry Standards and the Accounting Process
The double-entry standards of accounting make it possible for companies to record and summarize the financial events that affect their business. This system is necessary in order to prepare financial statements and generate reliable financial information.
When a company has a double-entry accounting system, it means that every financial event must be recorded twice. Each transaction has a corresponding credit and debit. These entries are recorded in the general ledger. The debit entry must always be equal to the credit entry. This is known as the fundamental accounting equation.
Debits increase asset and expense accounts and decrease liability, equity, and revenue accounts.Credits have the opposite effect. Therefore, when entering a transaction, there must be an offsetting debit and credit.
The double-entry system creates a sense of balance in the records and allows the user to identify errors in the accounting process. This type of system also assigns a debit amount to one account and a credit amount to another account. The amounts must always equal so if there is an error, it must be corrected before it can be reported.
The double-entry system requires companies to classify their transactions in either asset, liability, equity, revenue, or expense accounts. An asset account is a resource controlled by the company. Liabilities are obligations that the company has incurred. Equity is the residual interest of the owners in the entity and it is usually separated into capital, retained earnings, and additional paid-in capital. Revenue is income that the company earns from providing services or selling products. Expenses are the costs of producing or providing the services or products.
Accrual-Based Accounting
The primary benefit of accrual-based accounting is its ability to match revenues and expenses in the correct period. This means that when revenue is earned, its associated cost of goods sold is matched and reported in the same period. For example, if a company sold a product in March, the revenue associated with the sale is recorded in March and the cost of the product is recorded in the same period. This is an improvement over the cash-based accounting system which would only record the transaction when the cash is actually received or paid.
Accrual-based accounting requires companies to record adjustments to accounts due to uncollectible accounts receivable, inventory shrinkage, and other similar events. These adjusting entries are necessary in order to make sure that the company’s financial statements are in compliance with generally accepted accounting principles.
The double-entry system and the accrual-based method of accounting are essential to the financial reporting process. They help companies to organize their financial records, better understand their financial standing, and prepare reliable financial statements. These systems ensure that businesses can generate accurate, complete, and understandable financial information.
