Personal Accounting 101...Understanding the Basics to Accounting

I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs. -Thomas Jefferson (1743 - 1826), Letter to the Secretary of the Treasury Albert Gallatin (1802)

With the new year right around the corner, I have decided that one of my resolutions this year will be to track every dollar earned as well as every dollar spent in my personal finances. I am going to start up a new pseudo-company called "Jonathan Torian Inc." and become my own personal accountant. In order prevent failure and ensure a promising financial future, I am going to begin learning the basics in accounting and apply it to my every day life.

Two Types of Accounting

Cash Basis of Accounting

An accounting method wherein revenues are recognized when cash is received and expenses are recognized when paid. This method is inferior to the accrual basis of accounting where revenues are recognized when they are earned and expenses are matched to revenues or the accounting period when they are incurred (rather than paid). The cash basis of accounting is usually followed by individuals and small companies, but is not in compliance with accounting's matching principle. (Citation)

Accrual basis of accounting

The accounting method under which revenues are recognized on the income statement when they are earned (rather than when the cash is received). The balance sheet is also affected at the time of the revenues by either an increase in Cash (if the service or sale was for cash), an increase in Accounts Receivable (if the service was performed on credit), or a decrease in Unearned Revenues (if the service was performed after the customer had paid in advance for the service). (Citation)

Cash Basis Accounting is the most applicable to the individual consumer.

Main Financial Statements

1. Income Statement
2. Balance Sheet
3. Statement of Cash Flows

Income statements

Show how profitable you are during the time interval. Profits will be measured in the amount able to be saved after a given time period. This can be used to show what time of the year money is more likely to come in or go out. Profitability involves two things, amount of money earned (revenue) and expenses.

Revenues

The amount of money that a company actually receives during a specific period, including discounts and deductions for returned merchandise. It is the "top line" or "gross income" figure from which costs are subtracted to determine net income. (Citation)

Expenses

The economic costs that a business incurs through its operations to earn revenue. (Citation)

Matching Principle

The principle that requires a company to match expenses with related revenues in order to report a company's profitability during a specified time interval. Ideally, the matching is based on a cause and effect relationship: sales causes the cost of goods sold expense and the sales commissions expense. If no cause and effect relationship exists, accountants will show an expense in the accounting period when a cost is used up or has expired. Lastly, if a cost cannot be linked to revenues or to an accounting period, the expense will be recorded immediately. An example of this is Advertising Expense and Research and Development Expense. (Citation)

Balance Sheet

A financial statement that reports the amount of a company's assets, liabilities. (Citation)

A "snapshot" of a individual's financial position at a given moment in time.

Previous Article about using Financial Snapshots

Assets

Assets are things that an individual owns and are sometimes referred to as the resources of the individual. (i.e. Personal vehicle(s), its cash in the bank, home, etc.)

cost principle

The accounting guideline requiring amounts in the accounts and on the financial statements to be the actual cost rather than the current value. (Citation)

Depreciation

Depreciation is required by the basic accounting principle known as the matching principle. Depreciation is used for assets whose life is not indefinite—equipment wears out, vehicles become too old and costly to maintain, buildings age, and some assets (like computers) become obsolete.

In accounting, an expense recorded to allocate a tangible asset's cost over its useful life. (Citation)

Liabilities

Obligations of the company; they are amounts owed to others as of the balance sheet date. (i.e. Loans, credit cards, etc.) (Citation)

Statement of Cash Flows

Shows how Direct Delivery's cash amount has changed during the time interval shown in the heading of the statement. Good for helping to determine your financial circumstance and whether or not things need to be adjusted.

The goal of these articles will be to get a basic understanding of accounting principles then determine ways to integrate them into my personal finance. I am hopeful in being able to become the Chief Financial Officer of my finances for 2009.

Too often we rely on others' book keeping to determine if our finances are balanced. How many times do you check your bank account after you receive a bill to make sure that the power company debited the correct amount? How many times have you been overcharged by a department store or did not receive a store credit for returning an item. Unfortunately, I believe we can attribute much of the economic woes today due to not tracking expenses correctly and understanding the underlying debt trap that many Americans laid out.

By tracking my expenses, I hope to avoid this trap and being in less debt than what I owe today.

What are some of the financial resolutions you plan on doing for 2009?

Stay Disciplined!