Sometimes you just have to chase your dreams.
Before diving into the lesson about accounting systems, let’s perform a quick review. Carl woke up one morning with an entrepreneurial fever: he wanted to start his own clock business called Carl’s Clockworks. Carl realized that he needed money to get his business rolling so he went to see some creditors and investors. The creditors and investors wanted more information about his business before they would consider lending him money. The information they wanted is provided through the accounting financial statements. Carl learned about four financial statements (the balance sheet, income statement, statement of cash flows, and statement of retained earnings) from his friend Peter. Carl also learned about the infamous accounting equation assets = liabilities + owners’ equity.
To understand how an accounting system fits into all of this, let’s continue on with our story. Last we talked Carl had really only made one sale. Well this year things are really starting to heat up and Carl is making lots of sales. He’s also purchasing new clock inventory all the time and he is bringing on new creditors and investors to help finance his company’s growth. In short, he’s living the dream of being a business owner. Well, at the end of year two of operations for Carl’s Clockworks he sits down to update his financial statements. Try as he might he can’t remember all the business transactions that happened this year. He has no idea how to update his financial statements. This is not good because all of the investors and creditors are eagerly awaiting these financial statements to see how well Carl’s Clockworks is doing.
If this were a real business then Carl would be in pretty big trouble. In real life some companies have thousands of business transactions each day. Business transactions are defined as any economic event where assets, liabilities, or owners’ equity are exchanged. The most common transaction is the sale of inventory. These transactions need to be recorded so the financial statements can be generated. Apart from that, it’s probably just a good idea to have records of your transactions so you can see how well the business is doing.
Purpose of an Accounting System
In order to keep track of all of these transactions, companies implement an accounting system. An accounting system is simply a set of processes that are used to capture all of a business’s transactions. Once the transactions are captured (recorded), the information from these transactions is used to create the financial statements.
Nowadays most accounting systems are computerized. Accounting software plays a very important role in the accounting system, but it is not the accounting system itself. Software helps automate the processes, but it still takes a human to identify most transactions. It’s usually considered bookkeeping work to enter all the transactions of a company into the accounting software. The bookkeeper or accountant who performs this job needs to have a good idea of how the business works so that he or she will be able to identify the transactions.
In the olden days, business transactions were kept using paper and pencil. These papers formed a book, hence the name bookkeeper.
In review, an accounting system is the process of collecting transactional information in order to evaluate the financial position of a company. The financial position is reflected in the financial statements that are required by GAAP. In the next lesson we will talk about how debits and credits are used to keep track of these transactions.
Now that you and Carl know what an accounting system is, let’s talk about how debits and credits are used to keep this system running smoothly.
If you know an accountant or someone who is studying accounting then chances are you have heard about debits and credits. In fact if you have a bank account then you have probably heard the term, “we’re crediting your account.” The lesson today will help you know what the bank is talking about. In today’s lesson Carl learns all about debits and credits.
Another Accounting Equation
The first main accounting equation Carl learned was assets = liabilities + owners’ equity. Unfortunately, Carl now has another equation to learn. Yes, it’s true that Carl was promised that accounting isn’t that math-intense, but it does have another equation:
Next Lesson: Lesson 9.1 – Rules for Debits and Credits
