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An Understanding of Double Entry Bookkeeping and Five Principles of Accounting

By Yann, published on 20/12/2018 We Love Prof - IN > Professional Development > Accounting > Learning More About Double Bookkeeping and the Five Basic Principles of Accounting

“Be the Mick Jagger of the mailroom, the Warren Buffet of bookkeeping and the Bono of stapler selling.” -Robin S. Sharma

In today’s modern world people do not have any time or do not possess the desire to do their bookkeeping or accounting.

Small business owners and working professionals are hiring finance professionals from renowned accounting firms or private practices to crunch their numbers, create invoices and find tax breaks to help them save their hard earned cash.

Due to this phenomenon, the accounting industry has boomed in recent years and to meet this demand the Institute of Certified Bookkeepers was established in the United Kingdom in 1996 and has since grown to become the largest bookkeeping organization in the world with approximately 150,000 students and/or members in over 100 countries offering educational courses and certifications.

To ensure a prosperous career and be involved in the business & finance sector, many young professionals are completing bookkeeping and accounting courses from the ICB and other bodies to acquire essential accounting-based knowledge. 

Superprof is here to instruct aspiring accountants or bookkeepers about essential aspects of the accounting trade such as double-entry bookkeeping and five fundamental principles of accounting.

What is Double Entry Bookkeeping?

learning important tasks New software has brought double-entry bookkeeping from the 15th century to the 21st century! (Source: pixabay)

Let’s start by saying that double-entry bookkeeping is not a new concept. It was first discovered in Venice in 1491 and is more than 500 years old, however, through the years it has remained one of the most fundamental methods used by accountants and bookkeepers.

Double-entry bookkeeping requires each financial transaction of a company to be recorded with an entry in at least two of its general ledger accountants. It is used to satisfy the following financial equation:

Assets = Liabilities + Equity

Debits & Credits

In a double-entry system, all transactions are recorded as debits and credits, which are some of the most common accounting terms. As any accountant professional could tell, the debits in one account offset the credits in another. Therefore, all debits and credits must have an equal sum in double-entry bookkeeping.

In the world of accounting, debit is shown on the left-hand side of an account ledger and credit is demonstrated on the right-hand side of an account ledger. Drawing a T-Account can assist new bookkeepers in visualising the effect of recording a debit or credit amount and the resulting balances of general ledger accounts. It is important to state that debits are not always associated with increases and credits are not always linked with decreases.

For example, a debit may increase an asset account but decrease the liability and equity accounts. This example perfectly supports the equation of assets = liabilities + equity. 

The main point of all this newly acquired knowledge is that debits and credits need to be balanced to avoid financial confusion and simply put, they go together like fish and chips!

It is important to note that the previously mentioned debits and credits are very different from the cards that are featured in our wallets!

Different Types of Accounts

Bookkeepers are indispensable members of a company since they measure, record and communicate an entity’s financial information.

Every financial interaction or economic event between buyers or suppliers should be classified into accounts to keep things registered in an orderly fashion. The following are the seven different types of reports that all business transactions can be classified:

  • Assets,
  • Liabilities,
  • Equities,
  • Revenue,
  • Expenses,
  • Gains,
  • Losses.

The job of a bookkeeper is quite simple in reality: to keep things organised using the double-entry bookkeeping and keep track of changes between the different types of accounts.

Benefits of Using a Double-Entry System

Accountants and bookkeepers have found many advantages in using the double-entry bookkeeping system. Some of the most commonly mentioned benefits include the following:

  • It is easier to prepare accurate financial statements,
  • The financial position is easy to observe at any given time due to the well organised double-entry method,
  • If it is done efficiently and effectively, errors are more accessible to detect and fix,
  • No accountant or bookkeeper likes to be disorganised when producing the year-end financial reports. Hence, the double-entry method is a great way to analyse the accounts in an orderly fashion and avoid additional accountancy fees.

The previously mentioned are just a few of the most common. While studying to become a professional bookkeeper or accountant, you will realise that the double-entry accounting system is your best friend!

Did you know that double-entry bookkeeping can be carried out using helpful accounting software?

Five Principles of Accounting

Accounting principles are rules, guidelines and standards that companies must follow when reporting financial data.

In the United States, the General Accepted Accounting Principles (GAAP) is the most common set of accounting standards. However, in the United Kingdom, accountants can either follow the guidelines of the UK GAAP or the International Financial Reporting Standards (IFRS) that both offer high quality and understandable accounting principles.

Accounting principles were established to govern the entire world of accounting according to general rules and concepts. They are the foundation of more complicated, detailed and legal standards of accounting.

While there different accounting principles in each country, there are some that are easily understood by accountants and financial professionals all over the world. We will now consider the characteristics of five very different principles of accounting.

Full Disclosure Principle

learning new things In order to keep your friends in the finance sector avoid gifting them too many financial documents when complying to the full disclosure principle. This can be slightly overwhelming! (Source: pixabay)

The full disclosure principle is an essential principle that all law-abiding entities need to put into practice. This principle claims that all information which could affect the reader’s understanding of the financial documents be included.

The full disclosure principle is considered by many auditors and financial advisors to be their least favourite accounting principle due to the intense amount of documents or paperwork that can potentially be presented to justify financial decisions. 

To avoid judgemental comments and looks from financial examiners, it would be best to prioritise the amount of disclosure and only provide information that is likely to have a positive or negative effect on the finances of the corporation or small business.

The following are some examples of full disclosure:

  • The reasons for the change from a specific accounting principle to another,
  • Reasons for non-monetary transactions,
  • The entire amount of material losses caused by the lower of cost.

The full disclosure concept is mainly intended for eternally used financial statements and documents.

Monetary Unit Principle

When studying accounting, many ask themselves, what is the monetary unit principle? Do not worry; there is no need to fret, the monetary unit principle can be explained in easy to understand lingo that makes sense to everyone.

The monetary unit principle is the general assumption that money itself is considered as a unit of measurement. Therefore, this means that all financial transactions recorded in the accounts of a business can be expressed in monetary terms by a specific currency such as the euro, the dollar or the British pound.

When using the monetary unit principle, non-quantifiable items, that cannot be measured in currency, are excluded from a company’s financial reports. Everything that is registered in an entity’s books must be measured in monetary terms by coins which are stable and reliable.

Examples of non-quantifiable items that cannot be included in financial statements are customer service quality, employee skill level, management expertise, employee motivation and time loss due to damages. 

An example that can be used to help individuals understanding this accounting principle is the following: the CEO of the corporation you work offers a motivational speech twice a year to motivate unity in the workplace, this lecture cannot be included in financial documents since it cannot be measured in money.

Are you getting the gist of things?

Revenue Recognition Principle

Like all accounting principles, the revenue recognition principle has a standard definition and specific rules that must be obeyed to complete the principle successfully.

The revenue recognition principle features similarities from both the accrual and matching accounting principles. 

According to this principle, revenues are acknowledged when realised and earned, not necessarily when they are received, and this means that services or goods have been delivered and accepted by the client but the payment will be received at a later time.

Another characteristic or requirement of this accounting principle is the fact that the revenue generating action must be wholly or partly completed during the respective accounting period. To ensure that this will occur, there must be proof or evidence that the earned revenue will be received.

Last but not least, to have characteristics that are similar to the matching principle, revenue and costs must be reported by accountants in the same accounting period. 

Time Period Principle

The time period principle or assumption is an essential accounting principle for corporations, business owners and working individuals.

According to this principle, a business should record or report their financial statements appropriate to a specific time period. A time period is often referred to as the accounting year, or the accounting time periods which can be monthly, quarterly, half yearly, yearly or any time interval that the business or individual prefers.

The time period principle has certain traits of both cash accounting and accrual accounting. 

It is important to note that financial statements tell a story about a particular company or entity. Therefore, the time period principle was established to inform all those interested in the time period when the financial statement was prepared.

Accountants can assign all revenues and expenses to specific accounting time periods. However, in some cases, transactions are difficult to gauge and may have to be estimated at a particular period. Income statements, balance sheets, statements of cash flows and reports of changes in equity are all financial documents that are specific to a certain time period.

Expense Recognition Principle

the correct information The expense recognition principle is a great way to track expenses and revenues in the same period and avoid overstating or understating for specific months. (Source: pixabay)

In this fundamental principle of accounting, expenses should be recognised in the same period as the revenues to which they relate. If the expense recognition principle was not exercised in financial matters, the costs would be known as incurred which would follow the period in which the amount of revenue in question is acknowledged.

To further understand this accounting principle let’s use an example that is easy to grasp. For example, let’s say an entity spends £50,000 on merchandise and then the next month sells the merchandise for £75,000. If the expense recognition principle is used, the £50,000 must not be acknowledged until the following month, when the related revenue or profit of £25,000 is also recognised. If this principle was not used the expenses would be overstated by £50,000 in the current month and understated by £50,000 in the month that follows.

Did you catch that? 

I know that all things accounting may at times confuse individuals and leave them feeling dumbfound. Nevertheless, if you are a budding accountant, learning these necessary principles before attending accounting courses would be a great idea to stay ahead of the rest and ensure future success.

Besides, the expense recognition principle also dramatically affects income taxes. In the previously mentioned example, the charges for the merchandise will be underpaid in the month of purchase, because the company’s expenses are too high, and overpaid in the following month or months when the overall costs are low.

It is important to note that the expense recognition principle is a vital component of the accruals accounting concept: revenues are recognised when earned and expenses when spent. 

The accounting principles mentioned in this article are just the tip of the iceberg. Aspiring accountants and interested individuals will be delighted to find out that there are many more accounting principles and concepts that can be discovered to help them become better skilled at their trade.

Reading more about a basic overview of all things accounting and how to effectively read a profit and loss statement can be accomplished on Superprof.

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