Accounting Guidance for Financial Transactions

The Accounting Guidance of financial transactions is the cornerstone of financial accounting. It is the process by which economic events that occur in an entity are translated into precise accounting language. This language reveals the true impact of these events on the entity’s assets, liabilities, and equity, as well as its revenues and expenses. Understanding the principles of Accounting Guidanceis essential for correctly recording accounting entries and preparing financial reports that accurately reflect the financial reality of the entity.

What is Accounting Treatment?

Accounting Guidanceis the process of analyzing and interpreting the financial transactions undertaken by an entity, determining their impact on various accounts, and then identifying the debit and credit sides of the accounting entry according to the double-entry system. Accounting Guidanceaims to transform abstract economic events into structured financial data that accurately reflects the financial position and operating results of the entity.

The Importance of Accounting Treatment:

• ACCURACY in Recording Financial Transactions: Proper Accounting Guidanceensures that all financial transactions are recorded accurately according to their nature and impact on the entity’s accounts.
• Preparation of RELIABLE Financial Statements: Correctly processed accounting entries are the foundation for preparing reliable financial statements that reflect the entity’s financial reality. These statements are used by various stakeholders, such as investors, creditors, and management, to make their decisions.
• Financial Performance ANALYSIS: Accounting Guidancehelps in analyzing an entity’s performance by providing accurate financial data that can be relied upon to measure profitability, liquidity, efficiency, and other financial indicators.
• COMPLIANCE with Accounting Standards: Correct Accounting Guidanceensures compliance with generally accepted accounting standards, such as International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP), which enhances the credibility of financial reports.  
• Enhancing TRANSPARENCY and ACCOUNTABILITY: Accurate Accounting Guidancecontributes to enhancing transparency and accountability by providing clear and understandable financial information to all stakeholders.
• Financial PLANNING: Financial data resulting from Accounting Guidanceis used in preparing budgets and future financial planning.
• Financial CONTROL: Accounting Guidancefacilitates internal and external financial control, as it allows for tracking financial transactions and detecting any errors or deviations.

Steps of Accounting Treatment:

The Accounting Guidanceof financial transactions involves the following steps:

1. IDENTIFY the Financial Transaction: Identify and describe the financial transaction that the entity has undertaken, such as purchasing an asset, selling goods, paying off a loan, or collecting an amount from customers.
2. ANALYZE the Financial Transaction: Understand the nature of the financial transaction and identify the accounts that have been affected (increased or decreased). This requires a good understanding of the types and classifications of accounts.
3. DETERMINE the Account Type: Identify the type of each account from the five main types:
   • ASSETS: (e.g., cash, bank, accounts receivable, inventory, machinery, real estate).
   • LIABILITIES: (e.g., accounts payable, notes payable, loans).
   • EQUITY: (e.g., capital, retained earnings).
   • REVENUES: (e.g., sales revenue, service revenue, interest revenue).
   • EXPENSES: (e.g., cost of goods sold, salaries expense, rent expense, depreciation expense).
4. APPLY the Double-Entry Rule: Determine the debit and credit sides of the financial transaction according to the nature of each account and the impact of the transaction on it (increase or decrease). Remember that:
   • ASSETS are inherently debit: they increase with a debit and decrease with a credit.
   • LIABILITIES and EQUITY are inherently credit: they increase with a credit and decrease with a debit.
   • REVENUES are inherently credit: they increase with a credit and decrease with a debit.
   • EXPENSES are inherently debit: they increase with a debit and decrease with a credit.
5. WRITE the Accounting Entry: Formulate the accounting entry clearly, specifying the debit and credit accounts, the amount of each account, a brief description of the financial transaction, and its date.

Principles and Foundations of Accounting Treatment:

Accounting Guidancerelies on a set of principles and foundations that ensure the consistency and accuracy of accounting entries. The most important of these are:

• Double-Entry Rule: As previously mentioned, this rule states that every financial transaction has two equal and opposite effects (debit and credit).
• Accrual Basis: Revenues are recognized when earned, and expenses are recognized when incurred, regardless of the timing of cash receipts or payments. For example, if a company provides services to a customer and has not yet received payment, the revenue is recognized in the period the service was provided, not when the amount is received.  
• Matching Principle: The expenses incurred during a period should be matched with the revenues they helped to generate, in order to determine net profit or loss accurately. For instance, when calculating the profits from sales of a particular item, the sales revenue must be matched against its cost.
• Consistency Principle: An entity should follow the same accounting methods and procedures from one financial period to another, making it easier to compare financial data over time. These methods can be changed if there is a strong justification for doing so, with disclosure of this change and its impact on the financial statements.
• Objectivity Principle: Accounting entries should be based on objective and verifiable evidence and documentation, such as invoices, receipts, and contracts.
• Entity Concept: The business is treated as being separate from its owners. Therefore the accounting entries only record the transactions for the business.
• Going Concern Principle: Assumes the entity will remain in business for the forseeable future. Therefore, assets and liabilities are accounted for with that assumption.
• Historical Cost Principle: Assets are initially recorded in the books at their original cost (historical cost), not their current market value.
• Conservatism (Prudence) Principle: States that expected losses should be accounted for and profit should not be reported until it is realised.

Accounting Records and the Treatment Process:

Accounting records are used to record and post accounting entries resulting from accounting treatment. The most important of these records are:

• Journal: Used to record all financial transactions day by day according to the date of their occurrence. The journal includes a description of each transaction, the debit and credit accounts, and the amount of each account.
• Ledger: Used to post accounting entries from the journal to the appropriate accounts. The ledger contains a separate page for each account, making it easy to track the activity of each account individually.

Trial Balance and its Relationship to Accounting Treatment:

The trial balance is a list of all ledger accounts and their balances at a specific date. The trial balance is used to verify the accuracy of the Accounting Guidanceand the accuracy of posting accounting entries from the journal to the ledger.

The trial balance achieves the following:

• Verifying the Balance of Accounting Entries: The total debit balances must equal the total credit balances in the trial balance, indicating that the accounting entries have been correctly processed and posted.
• Detecting Errors: The trial balance helps in detecting errors in Accounting Guidanceor in posting accounting entries.
• Facilitating the Preparation of Financial Statements: The trial balance is a necessary step before preparing the financial statements, as it provides a summary of all the entity’s accounts and their balances.

Practical Examples of Accounting Treatment:

1. Purchase of Goods for Cash:
   • FINANCIAL TRANSACTION: Purchase of goods for 5,000 Riyals in cash.
   • ANALYSIS:
     • Increase in Purchases account (Expense).
     • Decrease in Cash account (Asset).
   • ACCOUNT TYPE:
     • Purchases: Expense (Debit when increasing).
     • Cash: Asset (Credit when decreasing).
   • ACCOUNTING ENTRY:
     • 5,000 Riyals Dr. Purchases (Debit)
     • 5,000 Riyals Cr. Cash (Credit)
2. Sale of Goods on Account:
   • FINANCIAL TRANSACTION: Sale of goods for 8,000 Riyals on account.
   • ANALYSIS:
     • Increase in Accounts Receivable account (Asset).
     • Increase in Sales Revenue account (Revenue).
   • ACCOUNT TYPE:
     • Accounts Receivable: Asset (Debit when increasing).
     • Sales Revenue: Revenue (Credit when increasing).
   • ACCOUNTING ENTRY:
     • 8,000 Riyals Dr. Accounts Receivable (Debit)
     • 8,000 Riyals Cr. Sales Revenue (Credit)
3. Payment of Rent Expense by Check:
   • FINANCIAL TRANSACTION: Payment of rent expense of 1,500 Riyals by check.
   • ANALYSIS:
     • Increase in Rent Expense account (Expense).
     • Decrease in Bank account (Asset).
   • ACCOUNT TYPE:
     • Rent Expense: Expense (Debit when increasing).
     • Bank: Asset (Credit when decreasing).
   • ACCOUNTING ENTRY:
     • 1,500 Riyals Dr. Rent Expense (Debit)
     • 1,500 Riyals Cr. Bank (Credit)
4. Collection of an Amount from a Customer:
   • FINANCIAL TRANSACTION: Collection of 3,000 Riyals from a customer in cash.
   • ANALYSIS:
     • Increase in Cash account (Asset).
     • Decrease in Accounts Receivable account (Asset).
   • ACCOUNT TYPE:
     • Cash: Asset (Debit when increasing).
     • Accounts Receivable: Asset (Credit when decreasing).
   • ACCOUNTING ENTRY:
     • 3,000 Riyals Dr. Cash (Debit)
     • 3,000 Riyals Cr. Accounts Receivable (Credit)
5. Purchase of a Fixed Asset (Car) on Account:
   • FINANCIAL TRANSACTION: Purchase of a car for 25,000 Riyals on account.
   • ANALYSIS:
     • Increase in Cars account (Fixed Asset).
     • Increase in Accounts Payable account (Liability).
   • ACCOUNT TYPE:
     • Cars: Fixed Asset (Debit when increasing).
     • Accounts Payable: Liability (Credit when increasing).
   • ACCOUNTING ENTRY:
     • 25,000 Riyals Dr. Cars (Debit)
     • 25,000 Riyals Cr. Accounts Payable (Credit)
6. Deposit of Capital into the Bank:
   • FINANCIAL TRANSACTION: Deposit of 50,000 Riyals as capital into the entity’s bank account.
   • ANALYSIS:
     • Increase in Bank account (Asset).
     • Increase in Capital account (Equity).
   • ACCOUNT TYPE:
     • Bank: Asset (Debit when increasing).
     • Capital: Equity (Credit when increasing).
   • ACCOUNTING ENTRY:
     • 50,000 Riyals Dr. Bank (Debit)
     • 50,000 Riyals Cr. Capital (Credit)
7. Obtaining a Loan from the Bank:
   • FINANCIAL TRANSACTION: Obtaining a loan of 100,000 Riyals from the bank, deposited into the entity’s account.
   • ANALYSIS:
     • Increase in Bank account (Asset).
     • Increase in Loans account (Liability).
   • ACCOUNT TYPE:
     • Bank: Asset (Debit when increasing).
     • Loans: Liability (Credit when increasing).
   • ACCOUNTING ENTRY:
     • 100,000 Riyals Dr. Bank (Debit)
     • 100,000 Riyals Cr. Loans (Credit)
8. Providing a Service to Customers and Receiving Fees on Account:
   • FINANCIAL TRANSACTION: Providing a service to customers for 7,000 Riyals on account.
   • ANALYSIS:
     • Increase in Accounts Receivable account (Asset).
     • Increase in Service Revenue account (Revenue).
   • ACCOUNT TYPE:
     • Accounts Receivable: Asset (Debit when increasing).
     • Service Revenue: Revenue (Credit when increasing).
   • ACCOUNTING ENTRY:
     • 7,000 Riyals Dr. Accounts Receivable (Debit)
     • 7,000 Riyals Cr. Service Revenue (Credit)
9. Purchase of Furniture for 6,000 Riyals, Paying Half in Cash and the Rest on Account:
   • FINANCIAL TRANSACTION: Purchase of furniture with partial cash payment and the remainder on account.
   • ANALYSIS:
     • Increase in Furniture account (Asset).
     • Decrease in Cash account (Asset).
     • Increase in Accounts Payable account (Liability).
   • ACCOUNT TYPE:
     • Furniture: Asset (Debit when increasing).
     • Cash: Asset (Credit when decreasing).
     • Accounts Payable: Liability (Credit when increasing).
   • ACCOUNTING ENTRY:
     • 6,000 Riyals Dr. Furniture (Debit)
     • 3,000 Riyals Cr. Cash (Credit)
     • 3,000 Riyals Cr. Accounts Payable (Credit)
10. Sale of Goods for 12,000 Riyals, Receiving Half the Price in Cash and the Remainder on Account:
    • FINANCIAL TRANSACTION: Sale of goods with partial cash receipt and the remainder on account.
    • ANALYSIS:
      • Increase in Cash account (Asset).
      • Increase in Accounts Receivable account (Asset).
      • Increase in Sales Revenue account (Revenue).
    • ACCOUNT TYPE:
      • Cash: Asset (Debit when increasing).
      • Accounts Receivable: Asset (Debit when increasing).
      • Sales Revenue: Revenue (Credit when increasing).
    • ACCOUNTING ENTRY:
      • 6,000 Riyals Dr. Cash (Debit)
      • 6,000 Riyals Dr. Accounts Receivable (Debit)
      • 12,000 Riyals Cr. Sales Revenue (Credit)
11. Payment of Electricity Bill in Cash:
    • FINANCIAL TRANSACTION: Payment of an electricity bill of 500 Riyals in cash.
    • ANALYSIS:
      • Increase in Electricity Expense account (Expense).
      • Decrease in Cash account (Asset).
    • ACCOUNT TYPE:
      • Electricity Expense: Expense (Debit when increasing).
      • Cash: Asset (Credit when decreasing).
    • ACCOUNTING ENTRY:
      • 500 Riyals Dr. Electricity Expense (Debit)
      • 500 Riyals Cr. Cash (Credit)
12. Receiving a Commission from Selling Real Estate for Others:
    • FINANCIAL TRANSACTION: Receiving a commission of 4,000 Riyals in cash for selling real estate for a client.
    • ANALYSIS:
      • Increase in Cash account (Asset).
      • Increase in Commission Revenue account (Revenue).
    • ACCOUNT TYPE:
      • Cash: Asset (Debit when increasing).
      • Commission Revenue: Revenue (Credit when increasing).
    • ACCOUNTING ENTRY:
      • 4,000 Riyals Dr. Cash (Debit)
      • 4,000 Riyals Cr. Commission Revenue (Credit)
13. Depreciation of a Fixed Asset (Car):
    • FINANCIAL TRANSACTION: Depreciation of the car by 2,000 Riyals.
    • ANALYSIS:
      • Increase in Depreciation Expense of Car account (Expense).
      • Increase in Accumulated Depreciation of Car account (Contra-Asset – Reduces the value of the asset).
    • ACCOUNT TYPE:
      • Depreciation Expense of Car: Expense (Debit when increasing)
      • Accumulated Depreciation of Car: Contra-Asset (Credit when increasing)
    • ACCOUNTING ENTRY:
      • 2,000 Riyals Dr. Depreciation Expense of Car (Debit)
      • 2,000 Riyals Cr. Accumulated Depreciation of Car (Credit)
14. Creating an Allowance for Doubtful Debts:
    • FINANCIAL TRANSACTION: Creating an allowance for doubtful debts of 1,000 Riyals
    • ANALYSIS:
      • Increase in Bad Debt Expense (Expense).
      • Increase in Allowance for Doubtful Debts (Contra-Asset – Reduces Accounts Receivable).
    • ACCOUNT TYPE:
      • Bad Debt Expense: Expense (Debit when increasing)
      • Allowance for Doubtful Debts: Contra-Asset (Credit when increasing).
    • ACCOUNTING ENTRY:
      • 1,000 Riyals Dr. Bad Debt Expense (Debit)
      • 1,000 Riyals Cr. Allowance for Doubtful Debts (Credit)
15. Sale of a Fixed Asset (Furniture) at a Loss:
    • FINANCIAL TRANSACTION: Sale of furniture with a cost of 5,000 Riyals for 4,000 Riyals in cash.
    • ANALYSIS:
    • Increase in Cash account (Asset).
    • Decrease in Furniture account (Asset).
    • Increase in Loss on Sale of Fixed Assets account (Expense).
    • ACCOUNT TYPE:
      • Cash: Asset (Debit when increasing).
      • Furniture: Asset (Credit when decreasing).
      • Loss on Sale of Fixed Assets: Expense (Debit when increasing).
    • ACCOUNTING ENTRY:
      • 4,000 Riyals Dr. Cash (Debit)
      • 1,000 Riyals Dr. Loss on Sale of Fixed Assets (Debit)
      • 5,000 Riyals Cr. Furniture (Credit)

The Importance of Accounting Software in Accounting Treatment:

the Accounting Guidanceprocess. These programs contain a pre-defined chart of accounts and automatically apply the double-entry rule, reducing the likelihood of errors and saving time and effort. This software also helps in:

• AUTOMATICALLY Recording Entries: Reduces human errors and saves time and effort.
• Easily Generating Financial REPORTS: Helps in preparing financial statements with the click of a button.
• ANALYZING Financial Data: Provides tools for analyzing financial data and extracting useful information.
• Managing INVENTORY, CUSTOMERS, and SUPPLIERS: Offers integrated functions to manage all aspects of financial operations.

Examples of Popular Accounting Software:

• QuickBooks
• Xero
• Zoho Books
• FreshBooks
• Microsoft Dynamics 365 Business Central

Tips for Mastering Accounting Treatment:

• UNDERSTAND the Nature and Types of Accounts: Learn to classify accounts into assets, liabilities, equity, revenues, and expenses.
• PRACTICE Analyzing Financial Transactions: Practice analyzing various financial transactions and identifying the affected accounts.
• MASTER the Application of the Double-Entry Rule: Practice applying the rule to various examples.
• Use Modern ACCOUNTING SOFTWARE: Learn how to use accounting software to record accounting entries correctly.
• Refer to RELIABLE ACCOUNTING REFERENCES: Benefit from books and websites specializing in financial accounting.
• COMMUNICATE with Experienced Accountants: Don’t hesitate to ask questions and seek help from professional accountants.
• CONTINUOUS PRACTICE: The more you practice accounting treatment, the more skilled you will become.

Conclusion:

The Accounting Guidance of financial transactions is a fundamental process in financial accounting. It ensures that financial transactions are recorded accurately and objectively, and provides reliable financial information that helps in making decisions and evaluating performance.

Among the important concepts in this context are real accounts and nominal accounts, each of which plays an essential role in classifying financial transactions accurately, which facilitates the process of preparing financial statements and understanding the financial position of the entity. By mastering Accounting Guidance skills, accountants, business owners, managers, and investors can better understand the language of numbers and analyze financial data efficiently, contributing to success and growth in the business world. Understanding the principles of Accounting Guidancei s a fundamental step towards financial literacy.