The accounting process is a systematic series of steps that organizations follow to record, classify, and summarize financial transactions to produce accurate financial statements. This helps individuals or companies monitor their financial performance, analyze financial health, and prepare for tax obligations, ensuring informed decision-making and compliance with regulations.
Let us illustrate the Accounting Process with below example:
Scenario:
Name: Ava
Occupation: Freelance Graphic Designer
Location: USA
MONTHLY FINANCIAL ACTIVITIES
Income:
Website Redesign for a Client: $2,000
Branding Package for a Startup: $1,200
Social Media Graphics for a Non-Profit: $800
Expenses:
Design Software Subscription (Adobe Creative Cloud): $50
New Laptop (allocated monthly cost): $150
Website Domain and Hosting: $30
Marketing and Advertising (social media ads): $100
Co-working Space Rental: $200
Office Supplies (paper, printer ink): $40
Accounting Process
1. Recording Transactions:
Ava diligently records each income and expense in accounting software or a spreadsheet, capturing the date, amount, and purpose.
2. Classifying Transactions:
She categorizes the transactions into income (e.g., "Client Payments") and various expense categories (e.g., "Software," "Marketing," "Supplies") for clarity.
3. Summarizing Financial Data:
At the end of the month, Ava prepares financial statements:
Income Statement: Total income of $4,000 and total expenses amounting to $570.
Net Income Calculation: $4,000 (Total Income) - $570 (Total Expenses) = $3,430
4. Analyzing Financial Health:
Ava analyzes her income and expenses to understand her profitability, looking for trends that might help her improve her business, like focusing on the most profitable services or reducing unnecessary expenses.
5. Preparing for Taxes:
Ava maintains organized records of all her transactions to facilitate accurate tax reporting. As a freelancer in the USA, she tracks her income for estimated quarterly taxes and keeps receipts for deductible expenses (such as software and office supplies) to reduce her taxable income.
By implementing effective accounting practices, Ava can gain insights into her freelance business, ensure compliance with tax regulations, and make informed financial decisions to support her growth.