Essential Concepts in Accounting

Bookkeeping is usually described as the process of recording all the daily transactions of a company.

Accounting, on the other hand, is the process of taking the book-keeper’s work and turning it into a set of accounts.
How often should you do your accounts? 
It is recommended that everyone does their accounts at least quarterly and preferably monthly.

Each of the items that make up the balance sheet is called a nominal account.

Instead of just one nominal account, accountants typically have a nominal account for each different type of asset.

The sum of all these assets would add up to the total assets of that particular category (e.g. fixed assets can be broken up into many smaller components). This makes it easy to derive the P&L from the balance sheet.

All the nominal accounts make up the nominal ledger – this contains details of each of the nominal accounts.

Purchase ledgers are used for companies to keep detailed records of all transactions with suppliers.

They are linked to the nominal ledger so that whenever a change is made to the purchase ledger, the relevant nominal accounts in the nominal ledger are automatically updated.

Keep in mind that the nominal ledger is the most important of the three. The sales and purchase ledgers are very useful but are not the essence of the accounting system.

When you buy goods from a supplier, there are many documents involved:

• Purchase Order: this records the fact that the goods have been ordered.

• Delivery Note: this is enclosed with the goods to indicate what is included in the delivery.

• Invoice: this lists the goods purchased, the tax point date (the official date of the sale and purchase for VAT purposes), the amount charged for the goods and any applicable VAT.

• Statements: the supplier sometimes issues statements to its customers, itemizing all the invoices that are still unpaid.

This is the official record of the transaction to buy the goods and it is what we use to make entries into the accounting system.

When you buy something in a shop, you might just be given a receipt from the till. While this does not match an invoice in terms of the amount of information provided, it is still the source document for that purchase.

A journal entry is a change you make to the balance sheet that is made directly to the nominal ledger. It is often an end of period adjustment.

The bank is looking at your bank account from the point of view of its balance sheet. If you deposit money with your bank, it owes you that money – you have a claim over their assets. From its point of view, your bank account appears on the claims side of its balance sheet and is thus a credit balance.

On your balance sheet, that cash is an asset and thus a debit balance.

This resulted in the cash nominal account going up by £10,000 and the share capital nominal account going up by £10,000.

We can describe this transaction as follows:
Debit: Cash £10,000
Credit: Share capital £10,000

The car became a fixed asset of the company. Thus the cash nominal account went down by £9,000 and the fixed assets nominal account went up by £9,000.

We can describe this transaction as follows:
Credit: Cash £9,000
Debit: Fixed assets £9,000

A trial balance (TB) is just a list of all the nominal accounts in the nominal ledger showing the balance in each at a point in time. Each balance takes into account every transaction and adjustment the company has ever made up to that point.

• It is the end of the process of getting all our transactions and adjustments into the accounting system.

• It is also the starting point for the process of producing our balance sheet , P&L – both of which are derived from the TB.

A chart of accounts allows you to summarize your data by grouping nominal accounts together. This also allows you to see the cumulative effect of every transaction that’s ever been carried out by a company.

Chart of accounts identifies: 
• which of the nominal accounts are part of retained profit.
• which nominal accounts should be listed under each of the categories on the balance sheet.

Value Added Tax (VAT) is a tax on the value added in products and services. Most products and services are subject to VAT.

Companies fall into two groups as far as VAT is concerned – those that are VAT registered and those that are not.

The rate of VAT is different in most countries and is subject to change every once in a while.

Let’s assume that the VAT is 20% and you sell some consulting work that you charge €1,000 for. You would have to add 20% to that, making the total charge to the customer €1,200.

The customer owes you the VAT but the liability of that VAT is not on you so it does not affect retained profit.

Similarly, when you make purchases, you will be charged VAT but this also does not affect retained profit.