Accounting is actually a very simple maths made complicated only by centuries old concepts and language. Still, these aspects are enough to make even the most intelligent members of our general community reach for the dummies' articles and books for help in translating this mysterious language into the common vernacular.
Now either way you look at it, you are going to need a certain amount of smarts to understand the science, the art and the numerology that is accounting. For instance, it has been humorosly quoted concerning accounting for tax: "It takes a significant amount of intelligence to keep accurate personal tax accounts, but a great deal more to keep inaccurate ones."
Now the good news is, accounting can be completely understood, but only if you build your understanding layer by layer by starting with the basic concepts.
Today I teach accounting to aspiring aboriginal business students and international students studying business in my home country, Australia. I take great delight in explaining accounting concepts in the language of this age. Now I say this age because archaeological evidence points to the existence of accounting systems dating back 10,000 years. Whilst we don't still use these exact systems today, most of our current accounting concepts are at least a few hundred years old. The most fundamental one of these is called, 'double entry bookkeeping', which was first published in 1494 by the Venetian monk, Luca Pacioli. That's 514 years ago!
Now I won't try to explain that particular concept just yet, because it is not a good start-point for your accounting education. I think the best start-point rests with the definition of accounting. i.e. "What is the reason for the existence of accounting"? Maybe, like many other definitions, it is often easier to ask the question in the negative with "What would happen if we did not have any accounting systems at all".
Well, how do you think you would survive if you were never told how much money you had in the bank? How would you know if you could afford a loan repayment without an accounting calculation? Not very well I would suspect and that's just you. What about governments with raising taxes and businesses with their need for profit reports.
We are beginning to understand why we need an accounting system - It helps us make decisions regarding financial matters. Bingo! Start point. So, accounting is not an end in itself, but it is rather an information system that provides the most relevant and reliable information which allows others to make the best possible financial decisions.
OK let's take this a bit further. We can begin to see two separate elements of accounting being formed here. Accounting incorporates both;
(1) the information process that identifies, classifies and summarises the financial events that take place within an organisation (this is the part typically handled by bookkeepers)
and
(2) the reporting system that communicates relevant financial information to interested persons which allows them to assess performance, make decisions and/or control the economic resources in the organisation. (this part is usually handled by qualified accountants)
There, a start-point in the series accounting for dummies' with the definition of accounting. OK, let's try and tackle some other basic accounting concepts.
Now, accounting is not rocket science. Physics is rocket science and one of their key equations looks like this (E=mc2). The key accounting equation on the other hand looks like this (A = L + OE). So, for all its scary numbering system, accounting only uses adding, subtracting and every now and then a percentage. You don't need to be a mathematical genius to be an accountant, just remember your fifth grade lessons.
Let's try and understand the ACCOUNTING FORMULA a little better. What does it mean for business? Well, basically it means that everything of value in the business is owned by someone. I told you it was not rocket science! Breaking it down further, A = assets (valuable things a business owns) is legally claimed by either people that have lent the business money (L = liabilities) or is the OE = owner's equity (the money invested in the business by the owners of that business).
Summarising, ASSETS are things of monetary value that a business owns, benefits from, or has use of and which have the potential to earn future income for the business. They may be (1) physical like cash, equipment and property (2) a legal claim against others like monies owed to the business from customers (3) certain intellectual property rights like patents and trademark and (4) goodwill which usually materializes when a business is sold.
LIABILITIES are the legal obligations of a business and is the money it owes to others. For example, they include monies owed to suppliers, loan funders and insurance, tax, salary, utility bills that have not yet been paid.
OWNERS EQUITY is simply the owner's rights to the assets of the business. It is what would be left over if you sold all the assets of the business and paid off all the liabilities. That's why it is often referred to as 'net worth'. Owners Equity is made up of the investments made by the owners and is increased by profits from the business and decreased by owners withdrawing their equity via drawings (personal takings) or dividends (payments to shareholders)
So what have we covered;
1 - The definition of accounting
2 - The accounting equation
3 - The definitions of Assets, Liabilities and Owners Equity.
For stage 1, that's probably enough, but if you would like to know more about Basic Accounting Concepts see my more comprehensive article by the same name.