A Transaction is any good, service or event that financial impact on a business or organization. It could also be the monetary exchange between a buyer and a seller for a service or product. In every transaction, there are always two parties involved, the person giving something, and the person receiving something. We recently learned in our CFA class that accounting is based on the Double-entry system which records the dual effects on an entity. In the Double-entry system of accounting, every debit must have a corresponding credit, the sum of debit entries needs to equal the sum of credit entries for the account to balance.
In a business, transactions follow the accounting cycle that has the following flow:
Source documents >Journal entry > Ledger > Trial balance >Adjusted trial balance > Closing account and Stock evaluation >Financial Statement.
The source document is a document or paper trail for transactions where data is first recorded. They are internal documents like receipts, invoices, deposit slips, purchase orders and credit memos. Bank statements that contain data used to record financial statements.
Journal entry is a document that shows the chronological order of transactions.
A ledger is a book of accounts or chart of accounts with debit and credit.
The trial balance is used to check that debit and credit are equal in the account.
Adjustments of the trial balance are used to check that there are no errors in the recordings in the trial and if any adjustments need to be made and then we proceed to closing account and stock evaluation. After these are completed, the Financial Statement of the company is prepared.
Financial statements are the formal records of a company that show the state and financial activities of a business. The financial statement is to show are true and fair view of the financial position of an organization and is the medium that organizations use to give up-to-date reports to third parties. It includes the Balance sheet or Statement of Financial Position (SFP), Income Statement, Statement of changes in equity, Statement of cash flows, and Notes to the financial statement. Let us look more into these components of a financial statement.
Balance Sheet /Statement of Financial Position is a report that shows the financial position or the state of your business of a company as of a date. It is a snapshot of a company’s financial health. It includes Assets, Liabilities and Owners’ Equity. In a balance sheet, the assets must equal the sum of liabilities and equity.
The income Statement shows the result of the flow of transactions over a period of time. It shows transactions that produced revenue for the business in the period being represented. It includes revenue, gross margin, operating expenses, cost of goods sold, taxes and the profit in that time.
Statement of changes in equity shows the major transactions that affect the third parties (owners/shareholders) in the company. It includes dividends, retained earnings, share capital, share premium and net income earned.
Statement of cash flows shows the sources and uses of the company’s cash funds during a period.
Notes to the Financial Statement are explanatory notes written by the accountant that provide additional information for those reading the financial statement to understand better.
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Debits and Credits: The Reverse of Bank Alerts!