Purpose of Accounting and the Accounting Cycle
FoundationAccounting identifies, records, classifies, summarises and reports business transactions so that internal and external users can make decisions. The accounting equation — assets equal liabilities plus capital — runs through every account, and the accounting cycle repeats each period: record, post, prepare the trial balance, then the financial statements.
- Accounting identifies, records, classifies, summarises and reports transactions to support decisions by internal and external users
- The accounting equation: assets = liabilities + capital, and the two sides stay equal after every transaction
- Internal users (owner, managers) and external users (banks, investors, the tax authority) focus on different things
文體小知識：商業知識說明文——講解會計的功能、會計等式與會計循環的流程，是學習複式記帳與財務報表的入門基礎。
§Text Passage
1Accounting is often called the language of business. Firms carry out numerous transactions every day, such as buying and selling goods, paying rent and collecting receivables. Accounting identifies, records, classifies and summarises these transactions into financial statements, which communicate the firm's financial position and operating results to users. Without accounting, an owner would never know whether the business is profitable and could not make sound commercial decisions.
2Users of accounting information fall into two groups. Internal users are the owner and managers, who use the data to assess profitability, control costs and plan ahead. External users include banks and creditors, investors, suppliers and government departments: the Inland Revenue Department assesses profits tax from the books, while banks read the financial statements before deciding whether to approve a loan.
3The accounting equation is the foundation of all accounting: assets equal liabilities plus capital. Assets are economic resources owned by the business, such as cash, inventory and equipment; liabilities are debts owed to others, such as bank loans and accounts payable; capital is the funds invested by the owner and the owner's claim on the business. After every transaction the two sides of the equation remain equal.
4The accounting cycle traces the full journey from a transaction to the financial statements: transactions are first recorded in the journals in date order, then posted to the accounts in the ledger. At the end of the period, balances are totalled and a trial balance is prepared to check that debits equal credits; finally the profit and loss statement and the statement of financial position are prepared. The cycle repeats every accounting period, keeping the firm's financial data orderly.
1Summary 重點摘要
Accounting identifies, records, classifies, summarises and reports business transactions so that internal and external users can make decisions. The accounting equation — assets equal liabilities plus capital — runs through every account, and the accounting cycle repeats each period: record, post, prepare the trial balance, then the financial statements.
2Vocabulary cards Vocabulary
The information system that identifies, records, classifies, summarises and reports business transactions to support decision-making.
The fixed sequence from recording transactions, posting, preparing the trial balance to preparing the financial statements, repeated each period.
Assets equal liabilities plus capital; the two sides remain equal after every transaction.
Resources owned by the business that bring future economic benefits, such as cash, inventory and equipment.
Debts owed by the business to outsiders, such as bank loans and accounts payable.
The funds invested by the owner and the owner's claim on the business: assets minus liabilities.
Business dealings that change the assets, liabilities or capital of the firm, such as purchases, sales and paying expenses.
The recording part of accounting — entering transactions in the journals and ledger; narrower in scope than accounting.
The output of the accounting cycle, mainly the profit and loss statement and the statement of financial position.
Internal users (owner, managers) and external users (banks, investors, the tax authority) who rely on financial information for decisions.
3Step by step Steps
- Step 1: What accounting is forAccounting is an information system that identifies, records, classifies, summarises and reports a firm's transactions, and communicates the financial information to users for decision-making. Resources are limited, so an owner must know where funds came from, how they were used and whether the firm is profitable. For example, a cafe reads its accounting records to learn its monthly rent and staffing costs before deciding whether it can afford a second branch — accounting and business decisions are inseparable.
- Step 2: The four functions of accountingThe functions of accounting can be summarised as four: recording, writing down every transaction in date order; classifying and summarising, grouping similar transactions into the same account and totalling them; reporting, preparing financial statements to communicate the results; and analysing and interpreting, explaining what the figures mean. For example, a supermarket classifies tens of thousands of transactions a year into sales, purchases and wages, so the annual profit can be worked out quickly at year end.
- Step 3: Users of accounting informationUsers are internal and external. Internal users are the owner and managers, who use the information for daily operations, pricing, cost control and planning. External users include banks and lenders, investors, suppliers, government departments and employees. For example, a bank reads the financial statements to assess repayment ability before granting a loan, while the tax authority assesses profits tax from the books — different users focus on different aspects.
- Step 4: The accounting equationThe accounting equation states that assets = liabilities + capital. Assets are resources owned by the business that bring economic benefits, such as cash, inventory and equipment; liabilities are debts owed to outsiders, such as bank loans and accounts payable; capital is the owner's investment, the portion left for the owner after liabilities are repaid. For example, if a small shop's assets total $100,000 and it owes suppliers $30,000, capital is $70,000 — the two sides always stay equal.
- Step 5: The accounting cycle (1): recording and postingThe first stage of the cycle is recording and posting. When a transaction occurs, evidence such as invoices is collected; the transaction is then entered in the journal in date order, showing its debit and credit sides; afterwards the entries are posted to the ledger so that similar transactions gather in one account. For example, when a shop pays rent of $5,000 on 5 March, the entry is first made in the journal, then posted to the debit of the rent account and the credit of the cash account.
- Step 6: The accounting cycle (2): trial balance and statementsThe second stage takes place at the end of the period: total each ledger account, prepare the trial balance and check that total debits equal total credits, testing arithmetical accuracy; then prepare the profit and loss statement to work out the profit or loss for the period, and the statement of financial position to list assets, liabilities and capital. For example, a bookstore first completes its trial balance and only prepares the financial statements after confirming the balance — the order must not be reversed.
- Step 7: Accounting versus bookkeepingBookkeeping covers only the recording part of the cycle, entering transactions in the journals and ledger. Accounting is broader: designing the accounting system, preparing and analysing financial statements, and interpreting data to support decisions. For example, the owner of a small grocery who keeps the books is doing bookkeeping; an accountant who reviews the accounts, explains the fall in gross profit and suggests cost control is performing the analysis function of accounting. Distinguish the two in answers.
5Worked example Example
Mr Chan opened Man Hin Bookstore on 1 April 2025. On that day the shop held cash of $50,000, inventory of $30,000 and equipment of $20,000, and had borrowed $40,000 from a bank to meet expenses. Calculate Mr Chan's capital, and arrange the following tasks in the order of the accounting cycle: (1) preparing the trial balance; (2) recording transactions in the journals; (3) preparing the financial statements; (4) posting to the ledger.
- Write out the accounting equation: assets = liabilities + capital, so capital = assets − liabilities.
- Total assets: cash 50,000 + inventory 30,000 + equipment 20,000 = $100,000.
- Capital = 100,000 − 40,000 = $60,000.
- Order of the cycle: (2) record in the journals, (4) post to the ledger, (1) prepare the trial balance, (3) prepare the financial statements.
- Answer: Total assets are 50,000 + 30,000 + 20,000 = $100,000 and liabilities are $40,000, so capital = 100,000 − 40,000 = $60,000. Check: liabilities 40,000 + capital 60,000 = $100,000, which equals total assets — the equation holds. The correct order is: record transactions in the journals, post to the ledger, prepare the trial balance, then prepare the financial statements.
6Common mistakes Mistakes
7Quick check Quick check
Q1What is the accounting equation?
Q2If a firm's assets are $100,000 and liabilities $40,000, what is the capital?
Q3What is the correct order of the accounting cycle?
Q4Among the owner, a bank and managers, which are external users of accounting information?
Q5What is the difference between accounting and bookkeeping?
8Recap Recap
- Accounting identifies, records, classifies, summarises and reports transactions to support decisions by internal and external users
- The accounting equation: assets = liabilities + capital, and the two sides stay equal after every transaction
- Internal users (owner, managers) and external users (banks, investors, the tax authority) focus on different things
- The cycle: journals, ledger, trial balance, financial statements — repeated every period
- Bookkeeping is only recording; accounting also covers reporting, analysis and decision support