Section 2 Reading

In this section, you can learn the term accounting, process flow of the accounting system and the accounting entries in sequence. Thus, you can understand what the accounting is after you carefully read the Texts. It is especially important for an accountant to find out accounting assumption.

Text A What is Accounting

Accounting is a collection of systems and processes that analyze, record, classify, summarize, report and interpret business transactions. That is to say, it is the language of business. Accounting uses its own special words and symbols to convey financial information about one company to its users for economic decision making by managers, shareholders, creditors and many others.

A business transaction is an economic event that has a direct impact on business.

Transaction=an exchange of values between two business entities

Some examples are shown in Exhibit1-1.

Accounting is also an information system of gathering, summarizing, and communicating financial information for businesses, government, or other organizations. It enables decision makers to understand financial situation and use the results in planning for the future. What's more, accounting deals with all facets of an organization—purchasing, manufacturing, marketing, and distribution.

Accounting is one of the fastest growing fields in the modern business world. Every new store, restaurant, high-tech company, related to the emerging industry and any other kind of new enterprise increase the demand for accountants. Consequently, the demand of accountants is generally much greater than the supply.

In addition, it is very important for an accountant to know about accounting assumptions. They are shown as follows.

Accounting Entity Assumption

A business is regarded as being a distinct entity （or body）separated from the owners. Only transactions related to the business are recorded and reported.

This concept enables the accountant to distinguish between the transactions of the business and those of the owners. For example, if the owner brings cash to the business, it will result in increase in assets of the business and capital of the firm. This capital represents fir's liability to the owner.

Monetary Unit Assumption

All transactions are recorded in the common monetary units （i.e. currency of the country）. Monetary unit is supposed to provide a common yardstick to measure assets, liabilities and equity of business as they can be added together or subjected to any arithmetical calculations.

Going Concern Assumption

It is assumed that a business entity will continue to operate for an indefinitely long period of time, unless there is evidence to show that business is about to cease. This is also known as “Continuity Assumption”.

Accounting Period Assumption

Under going-concern assumption, business will continue in the foreseeable future. For a periodic calculation of revenue, expenses and net profit, the life span of an entity is divided into arbitrary periods, such as one year, for many financial reporting purposes. Therefore, the financial statements are prepared for an accounting period and the results thereof are reported on periodic basis.

Text B Process Flow of an Accounting System

The accounting process includes six steps described as below.

Analyzing: The accountant must analyze a transaction or an event and determine its importance to business. For example, when a company receives an invoice from its supplier, the accountant should determine if its information leads to an accounting entry or not.

Recording: The accountant must record all the financial transactions that are implemented by the business into an accounting system. It includes cash transactions, goods bought and sold, expenses incurred in running the business. It is also called“book-keeping”.

Classifying: The accountant must divide business transactions into groups or types in separate accounts according to different kinds of transactions. For example, if a company sells different types of goods, it is necessary for the management to know the sales figures of different products.

Summarizing: The accountant aggregates many similar events to their corresponding accounts and brings together data of various items of financial information to explain a result.

Reporting: The accountant communicates the results like profit or loss in order to show financial status of the company by means of table of numbers.

Interpreting: The accountant examines the financial statements and illustrates the significance of various matters and relationships. Percentage analyses and ratios are often used to help to explain the difference among accounting periods. Footnotes and special captions are also very important.

The process flow of an accounting system is shown in Figure 1-1.

Text C Accounting Elements

There are three basic accounting elements as follows.

1. Assets

Assets are future economic benefits owned or controlled by the business entity as a result of the past transactions or the other past events. The probability of their future benefits can be ascertained.

Assets in the financial statement （Balance Sheet）are divided into two kinds.

（1）Current Assets are used, sold, or collected within one accounting period, e.g. cash, accounts receivable, supplies, inventory and pre-paid insurance.

Current Assets are assets that are expected to be realized in cash, sold, or consumed within the year or accounting cycle.

（2）Fixed or Non-current Assets are assets where benefits arise in more than one accounting period, e.g. building, property, plant and equipment. Non-current Assets are used in the operation of the business rather than being held for sale as inventory.

2. Liabilities

Liabilities are future sacrifice of economic benefits that a business entity is presently obliged to make to other entities as a result of past transactions or events. Liabilities will require a future outflow of cash.

（1）Current Liabilities are debts that are due within a short period of time, usually within the accounting cycle, such as accounts payable, salary payable, notes payable, taxes payable.

（2）Non-current Liabilities （also known as long-term liabilities）are due in more than one accounting period, e.g. bank loan which is due in three years' time.

3. Owner's Equity

Owner's equity is the amount by which assets exceed liabilities. Owner's equity represents the owner's claims against the business assets. While assets and liabilities are presented in the same manner in the balance sheet of all the three types of business structure（sole proprietorship, partnership and company）, some differences exist in the presentation of the owner's equity.

Owner's equity is increased with revenue or capital contributions, and decreased by expenses or an owner's withdrawal. It refers to the amount of resources which the owner puts into the business （i.e. capital）as well as subsequent accumulated profits.

Owner's equity is expanded to include revenue, expenses, and drawing.

（1）Revenue represents the amount that a business charges customers for products sold or services provided. Revenue creates an inflow of assets. Revenue increases assets （such as cash, accounts receivable）and increases owner's equity. However, revenue is not equivalent to cash. Revenue is recorded when earned through the sale of a product or providing a service. If the sale is a cash sale, the cash account is increased. If not, another asset, accounts receivable, is increased.

（2）Expenses represent an outflow of assets （or increase in liabilities）as a result of the efforts made to generate revenue. Expenses decrease owner's equity. They are the outflow of resources （either decreasing assets or increasing liabilities）as a result of effects made to produce revenue.

If revenue is larger than expenses, the business has a net income （or net profit）. If revenue is smaller than expenses, the business has a net loss.

A company makes a profit or loss by deducting expenses from revenue:

Profit/Loss=Revenue – Expense

Drawing is withdrawals that reduce owner's equity as a result of the owner taking cash or other assets out of the business for personal use.

Dividends are distributions of cash to shareholders. Declaring dividends reduces cumulated profits （called Retained Earnings or Retained Profits）.

Retained Earnings/Profits represent the accumulated earnings of a company less the amount paid in dividends to shareholders. Retained Earnings account balances are cumulative. For profitable companies, the balance of this account typically increases every year.

Summary

In this unit, the readers had a direct impression on the accounting with the case of Miss Li. And then, by three reading materials, the readers came to understand the meaning of the accounting and the use of accounting assumptions; they knew about the process flow of the accounting system, which includes analyzing, recording, classifying, interpreting, reporting and summarizing; they learned about three accounting elements such as assets, liabilities, and owner's equity. It is very important for an accountant to understand the accounting.

Notes

Key Sentences:

1. Accounting is a collection of systems and processes that analyze, record, classify, summarize, report and interpret business transactions. 会计是分析、记录、分类、汇总、报告和解释企业业务活动的一系列系统和过程的集合。

2. Accounting entity assumption: a business is regarded as a distinct entity （or body）separated from the owners. Only transactions relating to the business are recorded and reported. 会计主体假设：企业被看作区别于所有者的一个独立的实体。只有与企业运营有关的业务活动才被记录和汇报。

3. Going concern assumption: it is assumed that a business entity will continue to operate for an indefinitely long period of time, unless there is evidence to show that business is about to cease. 持续经营假设：假定企业主体将无限期地经营下去，除非是有证据说明这个企业将要终止经营。

4. Assets are future economic benefits owned or controlled by the business entity as a result of past transactions or other past events. 资产是企业由于过去的经营交易或者其他过去的各项事项而拥有或者控制的未来的经济利益资源。

5. Current Assets are assets that are expected to be realized in cash, sold, or consumed within the year or accounting cycle. 流动资产是那些预计在年内或者一个会计周期内能够出售换成现金或者消耗掉的资产。

6. Current Liabilities are debts that are due within a short period of time, usually within the accounting cycle, such as accounts payable, salary payable notes payable, taxes payable.流动负债是在短期内，通常是一个会计周期内，到期的负债，如应付账款、应付工资等。

7. Retained Earnings/Profits represent the accumulated earnings of a company less the amount paid in dividends to shareholders. 留存收益或者利润是指一个公司的累计收益减去应支付给股东的红利得到的。