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Concepts and Accounting

Concepts and Accounting

The most challenging aspect of accountancy is not the mathematics; it’s the concepts behind it.

When students are studying accounting, I often hear a variety of comments, such as:

“Accounting is boring and tedious”

This is typically expressed by those who might not want to admit they can’t grasp a lesson right away.

“Accounting, oh yeah, that’s difficult”

This is usually said in a whisper by people who are more honest about their struggles, offering a sincere opinion.

Some have even referred to accountancy as a “dark art,” which is quite dramatic but illustrates their perception of the subject’s complexity.

I believe that many people abandon their accounting studies because the concepts can be very confusing, and I also think these concepts are often taught poorly. I speak from experience, as I struggled with accounting myself for years as a student. It wasn’t until I read numerous books on the subject and gained practical experience working as an accountant that I had my breakthrough.

You’ll often hear people say

“Yeah, the accountant, that’s the person who keeps track of the money, watches the cash, knows where it’s coming from, and knows where it’s going.”

While this is true, it only covers a part of what accountants do. In reality, accounting is filled with numerous non-cash transactions. But what does “non-cash transaction” mean? It refers to transactions that represent the exchange of concepts or physical things without actual money changing hands. These non-cash transactions often stump students trying to understand what’s happening.

Let’s look at an example to illustrate this point. Imagine you own a petrol/gasoline station that serves vehicles stopping to fill their fuel tanks. It’s a familiar scenario, right? Now, imagine your station has a big underground tank that supplies all the fuel to your pumps. One day, your fuel management system alerts you that the tank is running low, with only 5,000 liters left out of a 30,000-liter capacity. You need to reorder fuel from your supplier to avoid running out.

You place an order for 20,000 liters of fuel from your supplier on February 14, 2023. The supplier agrees to a price of €2 per liter. The next day, a large fuel truck arrives and pumps 20,000 liters into your station’s main tank. The truck drives off without any money changing hands at that moment.

So, what happened here? Is this even a financial transaction? No money was exchanged, just a fuel tank being filled. One might think the transaction occurs when the bill is paid, right?

Actually, no. The physical act of filling the tank is as much a transaction as the day you pay the supplier for the fuel. Understanding this concept is a key part of an accountant’s responsibilities.

You might be thinking, “The fuel tank being filled is a transaction? I don’t get that. We just received fuel; no money was involved. And the supplier drove away with nothing but an empty truck. How is that a transaction?”

This is a tricky concept. Transactions often involve money, correct? But here, there’s no money, just fuel. However, we can express the fuel in terms of money. Is that possible? We’ve already expressed the fuel in terms of volume (20,000 litres), so why not in terms of money?

Think about it: the supplier agreed to provide fuel at €2 per litre. The truck arrived on February 15, 2023, pumped 20,000 litres into your tank, and your system confirmed this. We can express this fuel not just in volume but also in monetary terms. €2 x 20,000 litres = €40,000.

So, on February 15, 2023, you received €40,000 worth of fuel. But what about the fuel supplier? They seem to have gotten nothing on that day, just an empty truck.

Consider this: Is the supplier like Santa Claus, giving away fuel for free? Or are they in business to make a profit? Did they really receive nothing, or did they receive something intangible? Of course, they received a promise from your gas station to pay €40,000 in the future.

fuel truck pumping gasoline into your tank is a financial transaction

Thus, the physical act of the fuel truck pumping gasoline into your tank is a financial transaction. No money changed hands on the day, yet it had a clear financial effect on both your books and those of the supplier.

This example illustrates a non-cash transaction, which can be deceptively difficult to grasp. The brain needs to make several conceptual leaps here.

Expressing a physical liquid in terms of money, without it actually being money, is a strange concept. Similarly, expressing a future obligation to pay in monetary terms can be perplexing. Have you ever looked at a loan account you need to pay back, with interest in the debit column and your payments in the credit column? What does this represent?

So, an accountant must track not only cash and bank payments but also:

  • Goods purchased by the organization
  • Goods sold by the organization
  • Goods and services consumed by the organization
  • Services sold and purchased by the organization
  • Obligations due to/from the organization

These obligations can be satisfied by cash or by the receipt/delivery of goods and services, another challenging concept.

Accountants also have to be very aware of the measurement of time, time is as an essential measurement in accounting as money measurement. Let’s revisit our example of the fuel truck delivering fuel to our gas station. In accounting, there are always debits and credits. Where there is a debit, there must also be at least one credit. This method is how we express transactions. How would we express the transaction in our example using debits and credits?

The first phase of any accounting transaction is a journal entry

The journal acts like a program that inputs various transactions into the accounts. The journal number is the primary key for the entry, differentiating it from others.

Date Account Journal No. Details Debit (€) Credit (€)
2023-02-15 Inventory 1 Resupply of fuel 40,000
2023-02-15 Creditor - Supply Company 1 Resupply of fuel 40,000

Account Name: Inventory

Now let’s look at the two accounts affected in our transaction. The account representing the fuel available for resale is called “Inventory.” This is a “real” account, representing something tangible, in this case, petroleum gasoline. We already had 5,000 liters in the tank, represented by the opening balance (assuming it was also purchased at €2 per liter).

Account Name: Creditor - Fuel Supplier

The second account represents the fuel supplier. These accounts, known as “personal” accounts, represent entities like people, companies, or organizations. Here, it represents the fuel supplier. The account has a credit balance, meaning we owe them €40,000. This is usually settled by cash but could also be by delivering goods or services.

Conclusion

Accounting is more than just crunching numbers; it’s about understanding and applying complex concepts. Non-cash transactions, in particular, illustrate the depth and breadth of accounting knowledge required. By breaking down these concepts and using practical examples, we can demystify accounting and make it more accessible to students and professionals alike.

In summary, the ability to grasp and apply accounting concepts is essential for success in the field. It’s not just about tracking money but understanding the broader picture of how transactions, both cash and non-cash, impact an organization’s financial health. By mastering these concepts, one can gain a deeper appreciation for the intricacies of accounting and its vital role in the business world.

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Course Outline

  1. Concepts and Accounting
  2. The Three Different Natures of Accounts
  3. The Accounting Equation
  4. Accrual Accounting
  5. Debits and Credits
  6. The Journal
  7. Bank Reconciliation
  8. Adjusting Entries
  9. Inventory and Cost of Sales
  10. Depreciation
  11. Income Statement
  12. Balance Sheet
  13. Chart of Accounts
  14. Accounting Principles
  15. Financial Accounting
  16. Financial Statements
  17. Working Capital and Liquidity
  18. Cash Flow Statement
  19. Financial Ratios
  20. Accounts Receivable and Bad Debts Expense
  21. Accounts Payable
  22. Inventory and Cost of Goods Sold
  23. Payroll Accounting
  24. Bonds Payable
  25. Stockholders’ Equity
  26. Present Value of a Single Amount
  27. Present Value of an Ordinary Annuity
  28. Future Value of a Single Amount
  29. Nonprofit Accounting
  30. Break-even Point
  31. Improving Profits
  32. Evaluating Business Investments
  33. Manufacturing Overhead
  34. Nonmanufacturing Overhead
  35. Activity Based Costing
  36. Standard Costing

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