Key Components of Accounting
Accounting is the process of recording, summarizing and reporting financial information within an organization. Accounting is important for businesses to understand where their revenues and costs originate as well as the extent of their available resources and outstanding liabilities. In the United States, the practice of accounting is guided by the generally accepted accounting principles (GAAP).
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GAAP
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Generally accepted accounting principles provide the standard guidelines of accounting used by accountants in the United States. GAAP is a large framework of rules for how financial data should be recorded, summarized and presented and how financial statements should be prepared. While GAAP is not formal law, it has been adopted in large part by Securities and Exchange Commission (SEC) regulations.
Assets, Liabilities and Equity
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Assets and liabilities refer to anything of value an organization either owns or owes. Assets are things of value owned by a company, such as cash, inventory, equipment, land and various other items. Liabilities are things owed by an organization, such as debt obligations and outstanding bills to suppliers. Equity refers to the value owned by the stockholders of a company. In accounting, assets must always equal liabilities plus equity.
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Debits and Credits
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One of the basic concepts of accounting is the use of debits and credits. A credit is any deduction from assets, while a debit is any addition to assets. For example, a payment to a supplier of $20,000 would result in a credit to cash. For every debit, there must be a corresponding credit of equal value.
Financial Statements
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Financial statements are the primary means of reporting an organization's financial information. The three primary financial statements are the balance sheet, the income statement and the statement of cash flows, although the statement of shareholders' equity is often considered a fourth financial statement. A balance sheet lists a company's assets, liabilities and owners' equity. An income statement shows a company's revenues and expenses. The statement of cash flows shows how changes in the balance sheet and income statement affect a company's cash and cash equivalents.
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