Today, we will learn what accounting and bookkeeping are, why we need them, how we need them, and when we need them.
We earn money, and we spend money. Money can be earned from many sources, such as payroll, business, property, gains from capital, and other sources. We can also be engaged in more than one activity mentioned above.
So, here we have many types of people—smart, fraudulent, loyal, etc. On the other side, we also have governments that run our regional economy. To run the economy, governments need funds, so they implement taxes. Every person and every earning method may have different problems, pros, and cons, so governments implement different types of tax laws and tax rates. We pay taxes on our earnings.
So, if we are individuals, we pay tax on our payroll because we know how much we have earned through payroll slips, gross receipts, etc. But what about business owners and people who are engaged in other activities? How do they know how much they have earned?
For example, a business may sell products or provide services depending on the type of business it is engaged in. The business may have sales and expenses to make those sales and produce the products. The business may have costs to produce the product and expenses to run the office. It may also need staff, and those employees need to be paid.
Now, how does a business owner know whether the business is making a profit or a loss?
A business may have many types of expenses that make sales possible. After deducting these expenses from the sales or income, the business will finally know whether the income is positive or negative.
This is where accounting and bookkeeping become important.
1. What Is Accounting and Bookkeeping?
Now, a businessperson or any other person who earns income from sources other than payroll needs to find out how much income they have earned, right?
To find the income, they need to record their expenses. Further, they need to record those expenses category-wise so they can find out how much they have spent.
For example, a business needs to keep track of:
- How much they paid to employees as salaries
- The cost of producing a product or providing a service
- Electricity expenses
- Office supplies
- Marketing expenses
- Other expenses related to running the business
These expenses belong to the business and not to the individual personally. Therefore, they need to be identified and recorded properly so that the business can deduct the applicable business expenses from its income and find out how much income it actually earned from that activity.
Bookkeeping
Bookkeeping is the process of identifying financial transactions, recording them, and keeping records of daily expenses. These transactions can be in many forms, such as payroll, bills, material purchases, sales, and other business transactions.
Recording all these transactions, keeping track of expenses, and maintaining the books and ledgers for different types of transactions is called bookkeeping.
Accounting
Now, we have recorded and kept track of all the expenses and income that we have during our daily business activities. We maintain the books and create ledger accounts for different types of expenses and income, right?
While doing these activities, we can make mistakes or errors. We may also want to know how much we have spent and whether everything has been recorded correctly.
This is where accounting comes in.
In accounting, we summarize the expenses and income, check the accounts, and analyze the data. If we find something suspicious or identify a problem, we can take appropriate action and make strategies, plans, or budgets to control the expenses.
So, these types of activities are called accounting.
In simple terms, accounting is broader than bookkeeping. It includes activities such as analyzing, summarizing, budgeting, planning, and reviewing financial information.
Who Needs It?
Now we understand what accounting and bookkeeping are. The next question is:
Who needs accounting and bookkeeping?
We understand that businesspeople and people who earn income from activities other than payroll need to find out their earnings and income.
But what about people who already know their income because they receive a payroll?
Accounting is not only for businesses or people who earn income from different activities.
If we think about our future financial activities—such as savings, investments, expenses, and financial planning—all of these involve money.
Any person who cares about their money, expenses, and income can use accounting principles in their individual financial activities.
They can get an exact figure of how much they have spent on particular things. They can track, summarize, and analyze their expenses and make strategies to control unnecessary spending.
They can also make future financial plans, decide how much they should save, and prepare budgets.
So, accounting and bookkeeping can be useful for businesses as well as individuals.
Why Do We Need It?
Now we understand the meaning and purpose of accounting and bookkeeping.
But why do we need so many rules and processes?
Why can’t we simply maintain a register or purchase an app to record our expenses and income and then deduct the expenses from income to find out the income?
Let’s understand.
a. Government Rules and Regulations
We can do this to some extent, but think about the world we live in.
There are governments, fraudulent people, smart people, and many different types of activities. Some people may try to cheat the government by showing less income or showing a loss so that they do not have to pay the proper amount of income tax.
Because of this, governments create agencies and institutions that establish rules about how income and expenses should be recorded.
They decide the limits or caps for certain expenses and determine how expenses should be identified and which expenses can be deducted from income.
b. Taxes and Tax Rules
Governments decide tax rates for different types of taxpayers, such as individuals, salaried people, businesses, NGOs, and other organizations.
For this purpose, they create laws and implement different types of taxes and tax rates.
For example:
- State tax
- Federal tax
- GST
- Sales tax
- Income tax
- Property tax
The tax that we directly pay to the government, such as income tax or property tax, is generally called a direct tax.
The tax that we pay indirectly while purchasing goods or services is called an indirect tax. For example, when we purchase something, the tax may be included in our bill.
Governments also provide deduction limits and decide above which income a person, institution, or company will have to pay income tax.
They also decide which expenses can be deducted and how much can be deducted.
But why do governments decide which expenses can be deducted?
Because a person or business could otherwise deduct every expense from their income, whether the expense is actually related to the business or not. This could reduce their taxable income and result in them paying less tax.
Therefore, governments establish rules and limits.
Different Rules for Individuals and Businesses
The limits and rules can be different for individuals, firms, and companies.
But why?
Because their activities and nature of expenses are different.
An individual may spend money for their own personal needs, lifestyle, and livelihood. These are personal or individual expenses.
On the other hand, expenses made by a business are generally related to running and operating the business.
For example, a business may have expenses for:
- Purchasing materials
- Marketing
- Office expenses
- Employee salaries
- Electricity
- Equipment
- Other business activities
These expenses are made to run the business.
Depending on the applicable tax rules, certain business expenses and taxes paid on purchases may be deductible or recoverable.
Businesses may also be required to pay or collect different taxes, such as state tax, federal tax, GST, sales tax, or other applicable taxes.
So, for these purposes, businesses need to identify and record their expenses properly.
They need to find out how much sales tax and other tax obligations apply to them.
During this process, expenses may be added intentionally or accidentally, or an expense may be recorded incorrectly.
That is why we need accounting and bookkeeping.
How Do We Do This?
Now we understand why we need accounting and bookkeeping.
The next question is:
How do we do it?
We understand that we need three important things:
- Theory
- Technical knowledge
- Laws and rules
All of these help us perform accounting and bookkeeping properly.
Let’s understand how.
Theory and Professional Rules
Institutions and professional bodies establish rules and guidelines for recording financial transactions and maintaining accounting records.
If we follow these rules when recording transactions, it becomes easier to maintain the records systematically, reduce errors, and keep the financial information organized.
These rules help us understand how to identify, classify, and record income and expenses.
Government Laws
Government laws decide many important things related to taxation and accounting.
For example, they can determine:
- How much tax you need to pay
- The applicable sales tax rate
- Which expenses can be deducted
- The limit for particular deductions
- How depreciation should be calculated
- How certain business assets and expenses should be treated
Therefore, accounting and bookkeeping need to be performed according to the applicable laws and rules.
Technology
We can maintain records using traditional methods, such as registers and physical documents.
However, this can create many problems.
We need to consider:
- Maintenance
- Storage
- Security
- Time
- Manual errors
- Keeping records for a long period
Because of these challenges, technology companies have developed accounting software and other financial technology solutions.
Today, instead of maintaining everything manually, we can use software to record transactions and maintain financial records.
We simply record the income or expense, and the software can automatically calculate, organize, summarize, and generate financial information based on the data entered.
This makes accounting and bookkeeping easier, faster, more systematic, and less prone to manual errors.
Basics of Accounting and Bookkeeping: What They Are and Why They Matter
Money comes in, money goes out—and every business needs to know where it is coming from, where it is going, and how much is actually being earned.
This is where bookkeeping and accounting become important.
What Is Bookkeeping?
Bookkeeping is the process of identifying and recording financial transactions and maintaining proper records of income and expenses.
A business may have transactions such as:
- Sales and income
- Employee salaries
- Material purchases
- Office expenses
- Electricity and utilities
- Marketing expenses
- Bills and other payments
Recording these transactions properly and maintaining them in books and ledgers is the foundation of bookkeeping.
What Is Accounting?
Accounting goes a step further.
Once transactions have been recorded, accounting helps us summarize, check, analyze, and understand the financial information.
It helps answer important questions such as:
- How much did the business earn?
- How much did it spend?
- Is the business making a profit or a loss?
- Where are expenses increasing?
- Are the records accurate?
- How can expenses be controlled?
- What should be planned for the future?
In simple terms, bookkeeping records the financial transactions, while accounting helps us understand and use that information.
Who Needs Accounting and Bookkeeping?
Accounting and bookkeeping are not only for large businesses.
Businesses need them to determine their actual income, expenses, profit, and tax obligations. Individuals can also use accounting principles to track their income, expenses, savings, investments, and financial plans.
Whether you are running a business or managing your personal finances, having a clear view of your money helps you make better decisions.
Why Do We Need Accounting and Bookkeeping?
At first, it may seem simple: record income, record expenses, and deduct expenses from income.
But financial activities are not always that simple.
Governments establish tax laws, deduction rules, tax rates, and reporting requirements. Different rules may apply to individuals, firms, companies, and different types of business activities.
For a business, it is also important to distinguish between business expenses and personal expenses. Not every expense can automatically be deducted from business income.
Proper bookkeeping helps identify and record transactions correctly, while accounting helps review and analyze those records.
This can help businesses:
- Maintain accurate financial records
- Understand their actual income and expenses
- Monitor profitability
- Prepare for tax requirements
- Control unnecessary expenses
- Plan future budgets
- Make better financial decisions
How Do We Do Accounting and Bookkeeping?
Accounting and bookkeeping are supported by three important areas:
Theory and professional practices help us understand how transactions should be recorded and classified.
Government laws and tax rules determine how income, expenses, deductions, depreciation, and taxes should be treated.
Technology and accounting software make the process easier by helping businesses record transactions, organize information, calculate figures, and generate financial reports.
Accounting and Bookkeeping: The Foundation of Financial Management
Accounting and bookkeeping are more than simply recording numbers.
Bookkeeping creates the records. Accounting turns those records into useful financial information.
When both are done properly, a business can understand its financial position, control expenses, plan ahead, and make informed decisions.
For any business, accurate financial records are the starting point for better financial management and long-term growth.
What Is the Accounting Process and How Do We Do It?
So, what is the process, and how do we actually do accounting and bookkeeping?
Well, while performing this process, our main purpose is to identify financial transactions and summarize them in a way that helps us understand and conclude what we have.
Basically, we want to identify:
- Assets
- Liabilities
- Capital
- Profit
- Expenses — category-wise
To understand all of these, we generally prepare three main financial statements:
- Balance Sheet
- Profit and Loss Statement / Income Statement
- Cash Flow Statement
These three statements summarize almost everything about the financial activities of a business.
We identify each financial transaction and determine which account it belongs to. For example, whether the transaction is related to an asset, liability, capital, income, expense, or cash.
We then categorize every transaction into its appropriate account.
The Accounting Cycle
To identify, record, and summarize financial transactions, we follow a process called the Accounting Cycle.
The basic accounting cycle can be understood as:
Source Documents → Identify Transactions → Record Journal Entries → Trial Balance → Make Adjustments → Prepare Financial Statements → Close the Accounts
Let’s understand this process step by step.
1. Source Documents
First, we need some evidence or supporting documents for a financial transaction.
These can include:
- Bills
- Invoices
- Receipts
- Bank statements
- Payroll records
- Purchase documents
- Sales documents
- Other financial documents
These documents help us identify what financial transaction actually took place.
2. Identify the Transaction
Once we have the source document, we identify the transaction.
We need to understand:
What happened?
For example, did we make a sale? Did we purchase material? Did we pay an employee? Did we pay electricity expenses? Did we receive money from a customer?
We then determine which account or category the transaction belongs to.
3. Record the Journal Entry
After identifying the transaction, we record it in the accounting books using a journal entry.
The purpose is to properly record the financial effect of the transaction so that the accounts remain balanced.
4. Prepare the Trial Balance
After recording the transactions, we summarize the accounts and prepare a trial balance.
The trial balance helps us check whether the accounting records are properly balanced and whether the total debits and credits agree.
5. Make Adjustments
Sometimes, all financial information is not completely recorded or updated at the time of preparing the statements.
Therefore, we may need to make certain adjusting entries to ensure that the financial information is properly presented.
6. Prepare Financial Statements
Once the accounts have been reviewed and adjusted, we prepare the financial statements.
The three main statements are:
Balance Sheet → Shows assets, liabilities, and capital/equity.
Profit & Loss / Income Statement → Shows income and expenses and helps determine profit or loss.
Cash Flow Statement → Shows how cash has moved into and out of the business.
7. Close the Accounts
Finally, we close the relevant accounts for the accounting period and prepare the books for the next accounting period.
The Basic Accounting Equation
To record transactions properly, we need to follow accounting rules so that everything remains balanced.
One of the fundamental relationships is:
Assets = Liabilities + Capital
This means that the assets of a business are supported by its liabilities and the owner’s capital.
Every financial transaction has an effect on one or more accounts, and the accounting process ensures that these effects are properly recorded and balanced.
Do Individuals Need This Process?
For individuals, we generally do not prepare detailed financial statements like a business does, although they can be prepared if needed.
An individual may simply track their income, expenses, savings, investments, and other financial activities.
For a business, however, detailed financial records are generally much more important because the business may need them for compliance, government requirements, investors, management, tax purposes, and financial decision-making.
Why Is It Called the Accounting Process?
Earlier, we discussed that institutions and professional bodies establish rules and guidelines for accounting.
These rules define how financial transactions should be identified, recorded, classified, summarized, and reported.
The process is called the Accounting Process or Accounting Cycle because we repeatedly follow these steps while performing accounting and bookkeeping.
In simple terms:
We start with the source document, identify the transaction, record it, check and adjust the accounts, prepare the financial statements, and close the accounts.
This repeated process helps us convert individual financial transactions into meaningful financial information that tells us what the business owns, what it owes, how much it earned, how much it spent, and how its cash is moving.
Double-Entry Bookkeeping and Journal Entries
Now, in the accounting cycle, while recording transactions, we follow a dual-account system called Double-Entry Bookkeeping.
The recording of a financial transaction is called a Journal Entry.
What Does Double-Entry Bookkeeping Mean?
When we record a financial transaction, we record its effect in at least two accounts. This means that every transaction has a dual effect.
To record these effects, we use Debit and Credit.
Every transaction affects two or more accounts, and the effect can be different depending on the type of transaction. For example, one account may increase while another decreases. In another transaction, two accounts may increase or two accounts may decrease.
The important rule is:
Total Debit = Total Credit
This is how we keep the accounting records balanced and maintain the accounting equation:
Assets = Liabilities + Equity
For example, if a business purchases office equipment for cash, the equipment increases, while the cash decreases.
If a business purchases equipment on credit, the equipment increases, and accounts payable also increases.
So, double-entry bookkeeping does not simply mean that one account increases and another decreases. It means that every transaction has at least two accounting effects, and the total debit must equal the total credit.
Don’t worry if terms such as Debit, Credit, Account, Journal, Ledger, and Accounting Equation are new to you. We have mentioned these terms in our terminology section, where you can understand their meanings in simple language.
Rules and Concepts Behind Journal Entries
While recording transactions or preparing journal entries, we also follow accounting rules, regulations, and concepts.
Remember that we previously discussed the role of government laws and regulations.
Governments can make different tax and reporting rules for different regions, countries, industries, and types of taxpayers. However, the basic principles of double-entry accounting remain consistent, while specific accounting and tax requirements can vary depending on the applicable rules.
Therefore, while preparing journal entries, we need to understand not only the transaction itself but also the applicable accounting and tax requirements.
Role of Government in Journal Entries
Government rules can also affect how certain transactions are recorded.
For example, when a business makes payments to employees or contractors, applicable tax laws may require the business to withhold or deduct a certain amount of tax from the payment and remit it to the government on behalf of the recipient.
Likewise, there are accounting rules and concepts related to areas such as:
- Depreciation
- Amortization
- Goodwill
- Payroll
- Tax Withholding
- Other Financial Transactions
These rules can affect how transactions are recorded and how they appear in the financial statements.
Don’t worry—we will discuss these concepts and their rules in separate articles.
We will also learn how a journal entry affects the three financial statements we discussed earlier: the Balance Sheet, Profit and Loss/Income Statement, and Cash Flow Statement.
In other words, we will learn how one simple transaction can create an effect across the accounting records and ultimately flow into the financial statements.