This article explains some of the basic concepts in accounting and describes how they are implemented in Brightpearl.
Double-entry bookkeeping, or double-entry accounting, is a way of recording transactions where every entry to an account needs an equal and opposite entry to another account. Each transaction therefore has two sides: a debit side and a credit side.
Using double-entry accounting, every transaction will have the following characteristics:
- It will affect at least two accounts
- It will include at least one debit entry and one credit entry
- The debit total and credit total of the transaction will match ('balance')
In Brightpearl, transactions are recorded in the form of journal entries. Therefore every journal entry must also have the above characteristics.
For example, say you buy a book for £10. In your accounts, you would increase your inventory account by debiting it for £10, and decrease your bank account by crediting it for £10.
Every kind of account has a classification which determines its normal balance - i.e. whether it usually has a debit balance or a credit balance. If an account has a normal debit balance, debiting the account will increase it.
|Asset||A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.||Debit|
|Liability||A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.||Credit|
|Equity||The residual interest in the assets of the entity after deducting all its liabilities.||Credit|
|Income||Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.||Credit|
|Expense||Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.||Debit|
All definitions are taken from the IFRS.
The fundamental accounting equation
Double-entry accounting is based on the idea that the fundamental accounting equation must always hold true.
The fundamental accounting equation, also known as the balance sheet equation, is a form of expressing the relationship between a business's assets, liabilities and equity. It states:
Assets = Liabilities + Equity
The equation must always hold true - so, for example, if an asset account is increased (via a debit), then either another asset account must decrease (via a credit), or either a liability or equity account must increase (via a credit).
In the example of buying a book, the inventory account and the bank account are both assets. If a loan was taken out, an asset account would increase (a debit to the bank), and a liability account would increase (a credit to a loan liability).
The accruals principle in accounting means that transactions are to be recorded in the period in which they occur, not the period where there are cash flows associated with them.
For example, say rent is £12,000 a year, and is paid every quarter. Although a sum of £3,000 leaves the bank every three months, an expense of £1,000 would be recorded every month.
Brightpearl operates on the accruals basis - revenue is recorded when orders are invoiced, not when they are paid.
The matching principle states that when revenue is recorded, all related expenses should be recorded at the same time.
In Brightpearl, this particularly affects the cost of goods sold associated with a sale.
Because cost of goods is posted when a sale is shipped, and invoicing a sale is a distinct action from marking it as shipped, a sale can be shipped in one period and invoiced in another.
To mitigate this issue, there are some settings surrounding deferring cost of goods which can be enabled. Learn more here.