Recording accounting entries

Published on February 28, 2017   15 min
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Hi, and welcome to part two, "Recording Accounting Entries" in this HSTalks series on Analysing Financial Statements. My name is Dr. David Bond. In this part, I'll introduce the accounting cycle, specifically how entities record accounting entries, and then how they ultimately create financial statements from these entries. This all happens within an entity's accounting information system, but it is useful to understand the process so we will set through it.
But before we dive in, we need to make the accounting equation. The basic accounting equation is as follows, Assets = Liabilities + Equity. The three accounting elements in the equation are: assets, these are resources controlled by the entity. For example, cash, inventory, machinery. Note that it is controlled, not owned. Accounting takes an economic not legal perspective. Liabilities, these are what the entity owes. And equity, this is the owners' stake, and is what is left over after liabilities are deducted from assets. If you own property this is familiar to you. The equity in your property is the value of the property, the asset, less the amount you owe the bank, the liability.
Let's now expand this out in building revenue and expenses. Revenues are what an entity owns from selling goods or services. Whilst expenses are the costs incurred to earn those revenues, i.e., cost of goods sold, wages, and so on. Revenues increase equity, while expenses decrease it. So now what we have is an expanded accounting equation: Assets = Liabilities + Equity + Revenues - Expenses. This equation and its five elements must stay in balance after every transaction. This means that whenever a transaction takes place, at least two accounts will be affected, otherwise the equation will end up out of balance.