What are the basic elements of Accounting?

The purpose of accounting is to present a precise financial picture of your business operations. By convention, financial accounting consists of five basic elements, and when you prepare financial records, each activity will touch at least one of these elements. The accounting convention further explains how to record these elements, whether as increases or decreases in debit and credit columns. Debit and credit entries in an accounting journal are simply entries made in the respective right and left columns. Each transaction requires a double entry, one to record the debit and the other to record the credit.

Assets

Assets are the resources you use to conduct your business activities. To record an item as an asset, you must own it or have a right to control and use it. For example, if you own a delivery business, your delivery truck likely meets this requirement. Assets also must provide some future economic benefit to your business. Economic benefits can include cash and credit sales. Since you use your truck to deliver goods to your customers, your truck allows you to reap an economic benefit -- sales -- and meets this criterion as well. To record an increase in an asset, you debit the account, and a credit records an increase.

Liabilities

Liabilities are your company’s current obligations. They arise from past events such as obtaining a loan to buy equipment for your business. These past events create an obligation that you cannot avoid. You typically transfer assets to settle liabilities. For example, when you hire employees, you promise to pay cash for their services. Hiring the employee is the past event and your promise to pay is your obligation that you cannot avoid once the employee provides the service. Issuing a paycheck is the transfer of the asset, cash. An increase in liability is credited, while a decrease is debited.

Expenses

Expenses reduce assets or increase liabilities for a given period. For example, the fuel that your delivery truck consumes is an expense. When you buy gas for the truck, it reduces your cash, which is your asset. Similarly, if you buy gas using a credit card, it increases your liability. Expenses are often repeating events. For example, you must pay your vehicle leases by the same date each month. The moment you record an expense depends on the accounting basis you are using. Most businesses use the accrual basis. When you use the accrual basis, you record the expense before you pay it. The entry is to record a debit in the expense account and a credit in the liability payable account. Conversely, if you use cash-basis accounting, you record the expense only when you pay for it. In this case, you record a debit to the applicable asset account, usually cash, and a credit to the expense account.

Revenues

Revenue results from sales and the delivery of services. Revenues can result in increases to assets accounts or decreases in liability accounts. Selling merchandise on a cash basis results in increasing your assets. In the same manner, selling on credit terms reduces your liabilities since the customer promises to pay you at a later date. To record increase in revenue, you debit the account and enter a credit to the account to record a reduction in revenue.

Owner's Equity

Equity is the money or capital that you put into your business, hence the phrase "owner’s equity." Technically, equity represents all the ways in which your business draws its resources so that it functions or operates properly. Owner's equity is equal to assets minus liabilities, and this is the basic accounting equation. An increase in equity is credited, while a decrease in it is debited. Investments and revenues increase equity, while withdrawals and expenses reduce it.