When you’ve been working at something long enough, you start to assume that everyone around you shares the same knowledge and basic understanding of your subject matter expertise. For this post, we thought we’d get back to basics with a simple primer to cover some general accounting concepts.
First, Asset vs. Expense. When a business owner makes a purchase, they must decide whether to depreciate it as an asset or claim it as a one-time expense. There are 3 simple guidelines to help determine which path to take:
Longevity. If the item will have an effective usage of several years, then it should probably be classified as an asset and depreciated.
Materiality. If the item is relatively low cost in comparison to other business purchases, then it should probably be classified as an expense.
Consistency. If the item type has been treated as an asset or expense in the past, then it is probably best to continue with that accounting pattern and classify as it was previously.
Second, Balance Sheet. When a business owner needs a “snapshot” of their overall financial condition, they are going to reference their balance sheet. This is a summary of the financial balances of the organization, complete with assets, liabilities and ownership equity. A balance sheet is the only accounting statement which can point to a single time in the business’ calendar year.
Third, Income Statement. When a business owner wants to know whether they made or lost money during a certain reported period, they are going to reference an income statement. Also referred to as a P&L statement, this accounting report shows how the overall revenue transforms into net income, displays cost and expenses such as write-offs and taxes.
Fourth, Accounts Payable. When a business owner wants immediate feedback on the amount they owe to their vendors for the purchase of goods or services used in the operation of their business (on a specific date), they will refer to their Accounts Payable. These are found in the liability section of the Balance Sheet, recorded individually in the Accounts Payable sub-ledger at the time of invoice.
Finally, Accounts Receivable. When a business owner wants immediate feedback on the amount owed to them by their customers for the purchase of their goods or services (on a specific date), they will refer to their Accounts Receivable. These are found in the asset section of the Balance Sheet, recorded individually in the Accounts Receivable sub-ledger at the time of invoice.
While these may be simple review for most, we felt it important to establish a baseline and define these here on our blog for quick reference for both our clients and any other site visitors that might have had a question about any of these concepts.