KCQ's - Chapter 1

Key Concepts

Please find below the key concepts I gathered from Chapter 1.

·         Accounting is a model of each firm’s economic and business realities.

·         Firms are constantly creating and exchanging value with other firms and with individuals through various markets, which include input markets, product markets and capital markets.

·         Firms can be involved in providing services to customers, retailing products, or manufacturing products.

·         Businesses can be organized in several ways and the different types include sole traders, partnerships, companies and trusts.

·         Double entry accounting is a system of recording transactions of a firm to ensure the relationship between the different elements of the business model that underpins accounting, is kept intact.

·         Accounting uses two types of books: journals and ledgers.  A journal contains the daily transactions of a firm, whereas the ledger contains these same transactions but arranged in individual accounts.  However, in our digital age these two separate sets of books rarely exist.

·       A proprietor or owner of a firm is separate and distinct from the firm itself.  This realization introduces a duality to all transactions of a firm and these two sides or aspects to every transaction are called debits and credits.

·         The fundamental accounting equation that underpins all accounting is:

      Equity = Assets – Liabilities

·         A firm has five key elements: assets, liabilities, equity, revenue and expenses.  The relationship of the five elements of accounting can be viewed as:

      Assets = Equity + (Revenue – Expenses) + Liabilities

Key Questions

Please find listed two questions that relate to Chapter 1.

1.    Why would a business appoint a trust?  What are the advantages/disadvantages?

2.    Is it essential for all businesses to practice ‘double entry accounting’? Why or why not?

Summary

I studied Business Principles throughout high school and although I always achieved high grades, I didn’t necessarily understand the idea of accounting.  I had always thought of it as simply a process for keeping financial accounts.  After reading Chapter 1, the most significant insight for me was to discover that accounting is much more than just financial records/numbers; it’s about creating value by using quality information to connect to a firms economic and business realities. 

As I continued reading, I noted the importance of understanding the types of businesses.  I was aware that firms can be involved in providing services to customers, retailing products and manufacturing products, however I had never delved into the different ways a business may be organized.  I found sole traders, partnerships and companies to be rather self explanatory; however I am still struggling to comprehend how a trust relationship works.   

A key concept that I found to be extremely interesting was the history/evolution of double entry accounting.  I have had the opportunity to work as an accounts team member and although I practiced this method of book keeping, I never considered where or how the concept originated.  In a world of rapid change, I found it fascinating to learn that most of the accounting principles that we use today were established centuries ago.

I feel that Chapter 1 really emphasizes the importance of double entry accounting and that equity owners of firms are separate to the firm itself.  My understanding is that when using the double entry system, every business transaction is recorded in two accounts.  One account will receive a ‘debit’ entry and another account will receive a ‘credit’ entry.  To illustrate, if Integrated Research paid $20 000 cash for a delivery van, the asset Delivery Vehicle will increase with a debit and the asset Cash will decrease with a credit.

Even though I have practiced the extended accounting equation in previous subjects, I had never attempted to understand why the formula works.  Charles F Kettering summed it up perfectly, ‘there is a great difference between knowing and understanding: you can know a lot about something and not really understand it’.  By acknowledging two relatively simple principles, that is assets, liabilities and equity provide a measure of value and revenue and expenses represent the changes in value, I have gained a much greater understanding of accounting.  Overall, I have found that by personally engaging with these reading, I am better able to connect with IR’s economic and business realities.