by Steven Mars

Created on: January 14, 2009   Last Updated: February 12, 2012

Accounting is defined as the skill or practice of maintaining and auditing business accounts. The tools used in accounting include balance sheets, ledgers, and journals. A ledger is a record of business transactions (entries) using debits entries and credit entries. A balance sheet lists the assets and liabilities as of a specific date. An asset is an increase in the value of the business like cash, accounts receivable, or equipment. A liability is an account that must be paid. Examples of liabilities are accounts payable, salaries payable, and income taxes payable.

The balance sheet, like most accounting records, uses the debit-credit method. The debit is located on the left-hand side of the page and the credit is on the right-hand side. Accounts receivable is where money paid to the company is recorded. Every transaction (entry) is recorded as either a debit or credit. The debit side records the amount that is owed by the customer who has bought a product. When the customer pays the invoice (bill), the account is credited for that amount and cash is debited for that amount.

A debit entry is usually an increase in value of an asset on the balance sheet. A credit entry is usually an increase in a liability. The balance sheet lists the assets and liabilities, reporting net loss or net gain. A ledger is a record of transactions for specific accounts. A journal keeps records in chronological order.

The normal side for an account is the side that has an increase in balance. The debit side is the normal side for the asset and expense accounts. The credit side is the normal side for the liability, equity, and revenue accounts. The income statement calculates the net income using the formula net income=revenue minus expenses.

If a business decides to become a corporation, it sells stock to the public. It can be common stock, preferred stock, or both. The statement of stockholder's equity is a record of the common stock and preferred stock. To become a corporation, a business must file in the state in which they are incorporating. The IPO is the initial public offering by the corporation. There are advantages and disadvantages to both common and preferred stock. One advantage of preferred stock is the dividends are paid to preferred stockholders before the common stock holders. Common stock holders can vote on elections, mergers, etc. Preferred stock holders do not have any voting rights. Preferred stock holders also get paid off after corporate liquidation, although any creditors must be paid first. Common stock holders get periodic financial reports of the corporation.

Preferred stock has a convertible feature that is a set ratio preferred stockholders get if they change to common stock. Corporations pay a dividend if they have enough cash and a positive retained earnings balance. The transaction is recorded as a debit to dividends and a credit to dividends payable when the dividend is declared. For example, a $.25 dividend on one thousand shares of stock would be a $250 debit to dividends and a $250 credit to dividends payable. The date of the transaction is also recorded. This announcement to its shareholders is legally binding. The corporation must also set a date of record that will determine who gets the dividend when a shareholder sells his stock, the previous owner or the new owner of the stock. When the dividend is paid, dividends payable is debited and cash is credited.

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