Background: I'm a qualified accountant, and have taught courses on accounting and finance.
My thoughts on OP:
I read through the first two parts of the first course on this site:
- Part 1 Introduction to Accounting Basics, A Story for Relating to Accounting Basics
- Part 2 Income Statement
Based on what I read, I could not recommend this. You could get to the end of the 'income statement' part, without encountering any definition of 'profit', which is the very thing that the income statement is meant to show.
If you want a solid introduction to accounting, I'd recommend Frank Wood's book "Business Accounting 1". You don't need the latest (15th edition). The principles haven't changed. I used the 10th edition: Business Accounting Volume 1 https://www.amazon.co.uk/dp/0273681494/
If you're a mathy person, you might find this brief explanation is enough to get going. Where I say 'you', I mean 'your company', not you personally.
* Assets: things you own (e.g. tractor, money in bank, money owed by customers)
* Liabilities: things you owe (e.g. unpaid supplier bills, loan owed to bank)
* Assets and liabilities are both measured in a single currency (e.g. $).
* Equity (aka 'book value'): A measure of the value of the company. Calculated as Assets minus Liabilities.
Two ways to write the equation above:
* Equity = Assets - Liabilities
* Equity + Liabilities = Assets
Equity changes in response to (i) company operations, and (ii) financing activities.
Financing activities are things like:
- selling new shares
- buying back shares (or paying dividends)
- borrowing money (bank loans, or issuing bonds)
If there were no financing activities in the period, then profit is the derivative of equity with respect to time. It's a measure of the change in (book) value over a period.
If book value went up, you made a profit. If book value went down, you made a loss.
(Of course, book value would also go up if you just sold some shares, and profit doesn't count those changes, as they're just financing activities.)
Summarized: a ledger is a directed graph of accounts, where edges are transactions, and each transaction is recorded twice: in the "from" node and the "to" node.
But “a ledger” is not a directed graph of accounts, is it? There is no ‘from - to’ in a ledger. A ledger simply reorganizes the transactions from chronological order (aka journal entries) into subject/account headings. Not the same, but similar to clicking ‘subject’ column tab on your email client to reorganize your emails from descending date to subject attribute.
But I guess you could model each transaction as an edge, with the direction specifying which account is debited and which credited, and the weight determining the amount.
I don't find that particularly helpful myself, but I put that down to my unfamiliarity with graph data structures and the associated algorithms. Maybe there's something you can do more easily with a graph database, than you can if you have the same info in a table?
Sure. Just like blockchain- or any other decentralized ledger- may be a tremendously disruptive technology for property recording, sale/transfer, and financing in the future (compared to the current archaic system of deeds/titles for real property or UCC financing recording for secured transactions); so to, a graph database may clearly illustrate the point of bookkeeping along with the share of assets creditors and investors are entitled to realtime.
I found it an interesting and useful explanation, but the bit in the middle where he just says "now categorize each node, I colored them in!" is the bit I always had more trouble with, so I was disappointed to see basically the same explanation as I've heard before.
In your chart of accounts, each account corresponds to exactly one of these:
- Asset
- Liability
- Equity (changes in this affect the income statement)
Whenever a transaction takes place, the debits and credits must sum up. For example, when you take a bank loan, your assets increase (debit) but your liabilities also increase (credit) by the same amount.
Sometimes something touches more than two accounts. For example, if you sell a cup of coffee for $2, using up $0.50 worth of beans:
CR Revenue $2
DR COGS $0.50
DR Cash $2
CR Materials $0.50
The first two lines increase the book value of the business by $1.50.
The last two lines increase the assets of the business by $1.50 (cash up by $2, bean inventory down by $0.50).
AFAIK, borrowing money does not change Equity, because it increases Assets (more money in the bank) and Liabilities (more debt) by the same amount so Equity stays the same.
1. Profit/loss measures changes in equity resulting from operating activity, as opposed to financing activities (which just rearrange how the company is financed).
2. Examples of financing activities are taking out (or paying back) loans, issuing (or buying back) shares, and issuing dividends.
3. Some (not all, as you point out!) of those financing activities will increase or decrease equity. So, when thinking about profit as the rate of change of book value, you should be careful add back any changes that are the result of financing activities. (specifically: ignore changes in equity due to money going to, or coming from, shareholders)
Not until the interest accrues. You could (no idea why you would) borrow $1MM and immediately pay it back before owing any interest. You would need to reflect this on your books but nothing material has changed.
> You could (no idea why you would) borrow $1MM and immediately pay it back before owing any interest.
Can you in fact do that? It's possible with a residential mortgage in the US, because there are laws prohibiting prepayment penalties. And I think even those don't apply to refinanced mortgages?
I feel you. One of the classes I failed during my brief time in college was symbolic logic. But I was a music major so who cared. A few years later I taught myself to program, and of course C & assembly were filled with Boolean operations and truth tables...
I found it in 2005 or 2006, a year or two after my MBA, and a few months after I started studying for professional accountancy exams.
I wish I'd found it earlier. It was more in-depth than the MBA material on financial reporting, and was presented more logically than the study guides I'd been using.
I think it was variances that tipped me over the edge. However what little latent knowledge I managed to stash away in my brain seemed to stand me in good stead later on. I guess another thing that stuck and thought was actually useful as a student was how to reconcile my bank account and cheque book.
I do not believe that either GAAP or IFRS has a standard definition for "profit". Even GAAP under 703(a) refers to it as net income (and several other related numbers like gross profit).
But you wouldn't know that if you read those two sections of the text. They use the word 'profitability' several times, without ever defining it.
Right at the end of part 2 (income statement), they say this:
"The difference (or "net") between the revenues and expenses for Direct Delivery is often referred to as the bottom line and it is labeled as either Net Income or Net Loss."
The above is true, but it's kind of hard to grasp for someone whose only exposure to accounting is this site. And the previous sentence again refers to 'profitability' without being explicit that 'profit' and 'net income' are the same thing.
The IFRS standards presume the reader is familiar with accounting principles and practice. They provide guidance specific to (i) certain more complex/unusual situations, e.g. business combinations, and (ii) specific verticals, e.g. consumer lending and insurance.
Your comments throughout the thread are insightful & actionable. Yet, I will say that accountingcoach.com is the online resource that provides reliable and clear definitions & explanations for accounting terms. At least in the US when trying to figure out what is required of US GAAP, for example, accountingcoach.com provides clear definitions to differentiate between direct costs, manufacturing overhead, operating expenses, and inventoriable costs in general. This is in contrast to a lot of other online sources- including articles written by CPAs or accountancy websites!- where the writing is either too tortured to learn from or outright wrong!
Thanks for this perspective. It's helpful to hear from someone who has used the site for more than 5 mins :)
From what you've written, it sounds like a good/great reference resource for specific topics, once you already know the basics/fundamentals.
But, based on a 5 min look at the first two pieces of content in the 'accounting basics' section, I didn't think it would be good for someone who wants to learn accounting from zero.
Of course, I may be wrong, as I sampled less than 1% of the content.
> Based on what I read, I could not recommend this. You could get to the end of the 'income statement' part, without encountering any definition of 'profit', which is the very thing that the income statement is meant to show.
The thing is, that while cash is a matter of fact, profit is a question of opinion. This is a fundamental truism in accounting. You cannot really teach how accounting allows you to express your opinion until you first understand which facts you have to work with.
If that's the case, it seems even more strange to have the first two parts of the first section repeatedly refer to 'profitability'.
But I don't agree that you have to start with facts. I think you can start with the account equation, then go on to types of asset/liability/equity, and only then move on to concrete examples of transactions, and how they impact the balance sheet. And then you compare two snapshots of your balance sheet to show what profit is.
You can do all this with concrete examples with virtually no risk (e.g. a lemonade stand where people pay cash before they are served, with almost no equipment to depreciate, no long-lived inventory etc.).
Any advice for intermediate or advanced accounting? I studied finance in school, so I'm confident it the broad-strokes basics, but getting into deeper stuff is still intimidating.
One more thing - I think it's enlightening to, at least once, build financial statements from a set of transactions, and then to dig back from the summary, to the original transactions, i.e.
1. Export all the transactions from your accounting software (from the start of time, to the end of last month).
2. Export the chart of accounts from your accounting software.
3. Load these into two separate tabs in Excel.
4. Add a column to #1, that maps the account to the relevant account type (e.g. 'assets') and statement (BS or P&L), using #2 as a lookup table.
5. Create a pivot table from #1, to create a balance sheet.
6. Create another pivot table from #1, but this time use time (month or year) as a dimension.
7. See if you can relate some of the balance sheet and P&L values from your spreadsheet, with the values on the statements produced by your accounting software.
8. Assuming they match, go back to the balance sheet pivot table and double-click on one of the non-zero values. You will see a history of every transaction that changed that account.
My thoughts on OP:
I read through the first two parts of the first course on this site:
- Part 1 Introduction to Accounting Basics, A Story for Relating to Accounting Basics
- Part 2 Income Statement
Based on what I read, I could not recommend this. You could get to the end of the 'income statement' part, without encountering any definition of 'profit', which is the very thing that the income statement is meant to show.
If you want a solid introduction to accounting, I'd recommend Frank Wood's book "Business Accounting 1". You don't need the latest (15th edition). The principles haven't changed. I used the 10th edition: Business Accounting Volume 1 https://www.amazon.co.uk/dp/0273681494/