Accounting

      Accounting is the process of systematically collecting, analyzing, and reporting financial information. Bookkeeping is essentially record keeping that is a part of the overall accounting process. A private accountant is employed by a specific organization to operate its accounting system and to interpret accounting information. A public accountant performs these functions for various individuals or firms, on a professional&-fee basis. Accounting information is used primarily by management, but it is also demanded by creditors, suppliers, stockholders, and government agencies.

     The accounting process is based on the accounting equation: Assets = liabilities + owners' equity. Double&-entry bookkeeping ensures that the balance shown by the equation is maintained.

     There are five steps in the accounting process: (1) Source documents are analyzed to determine which accounts they affect. (2) Each transaction is recorded in a journal. (3) Each journal entry is posted in the appropriate general ledger accounts. (4) At the end of each accounting period, a trial balance is prepared to make sure that the accounting equation is in balance at the end of the period. (5) Financial statements are prepared from the trial balance. Once statements are prepared, the books are closed. A new accounting cycle is then begun for the next accounting period.

     The balance sheet, or statement of financial position, is a summary of a firm's assets, liabilities, and owners' equity accounts at a particular time. This statement must demonstrate that the equation is in balance. On the balance sheet, assets are categorized as current (convertible to cash in a year or less), fixed (to be used or held for more than one year), or intangible (valuable solely because of the rights or advantages they confer). Similarly, current liabilities are those that are to be repaid in one year or less, and long&-term liabilities are debts that will not be repaid for at least one year. For a sole proprietorship or partnership, owners' equity is reported by the owner's name in the last section of the balance sheet. For a corporation, the value of common stock, preferred stock, and retained earnings is reported in the owners' equity section.

     An income statement is a summary of a firm's financial operations during a specified accounting period. On the income statement, the company's gross profit on sales is computed by subtracting the cost of goods sold from net sales. Operating expenses are then deducted to compute net income from operations. Finally, nonoperating expenses and income taxes are deducted to obtain the firm's net income after taxes.

     The information contained in these two financial statements becomes more meaningful when it is compared with corresponding information for previous years, for competitors, and for the industry in which the firm operates. A number of financial ratios can also be computed from this information. These ratiosprovide a picture of the firm's profitability, its short&-term financial position, its activity in the area of accounts receivables and inventory, and its long&-term debt financing. Like the information on the firm's financial statements, the ratios can and should be compared with those of past accounting periods, those of competitors, and those representing the average of the industry as a whole.