Accounting is a profession that requires its practitioners to abide by a strict set of rules. Each journal entry must be done using the double entry accounting system. This system uses a series of journal entries consisting of debits and credits that must equal each other before the journal entry can posted to the general ledger. Accrual accounting and the accounting formula are prime examples of the rules that must be followed in accounting.
What is Accrual Basis Accounting?
Accrual basis accounting is the accounting practice of matching revenues and expenses to the accounting period in which they occurred. Accrual basis accounting requires that the company record a sale when it is made, regardless of when the cash payment from the sale is received. Expenses are required to be recorded when the order is placed, instead of when the payment is made to the vendor for the products received or services rendered.
The Accounting Formula (Equation)
Accrual basis accounting requires that the assets of an organization equal the liabilities and owner's equity of the firm. This is most easily seen on the company's balance sheet, which lists the company's assets, liabilities and owner's equity. The assets are listed first on the balance sheet; the liabilities and owner's equity are listed below the assets on the balance sheet. The assets must equal the liabilities and owner's equity for the balance sheet to be in balance.
What are Assets?
The assets of an organization refer to the resources that are available for use. Common example of assets in a business include cash, cash equivalents such as investments in mutual funds and other securities, accounts receivable, prepaid expenses and all property, plant and equipment. The assets of a company are vital to the smooth operation of the firm.
What are Liabilities and Owner's Equity?
The accrual accounting formula requires that assets must equal liabilities and owner's equity. Liabilities refer to the obligations that the company must pay. Liabilities are paid to vendors with the company's assets. Common examples of liabilities include accounts payable, loans, mortgages and accrued payroll costs. Owner's equity is the amount of the company that is actually owned by the owners and is calculated by subtracting the liabilities from the assets.
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