Most accounting is little more than applied common sense. However, there are two golden accounting rules that are not immediately obvious - and so it is worth getting to know them.
THE ACCRUALS PRINCIPLE
Your accounts should reflect things when they arise or are earned - which is not necessarily the same as when you actually pay or are paid for them. For example, your accountant will include an April sales invoice in your April accounts, even if your customer doesn't pay you until August.
REVENUE V CAPITAL PAYMENTS
Some of the things you spend money on will not be regarded by your accountant (or the taxman) as reducing your profits. For example, the money you pay to buy a new car or pay off a loan. Accounting conventions say that payments like these shouldn't appear in the profit and loss account, instead, their effect is confined to the balance sheet.
The key distinction here is between revenue and capital expenditure payments:
- Revenue payments are the running costs of the business - the type of expenses that buy goods and services which are used up quickly for example, wages, advertising, rent and stationery. This type of expenditure is shown in the profit and loss account and is often referred to as having been ‘expensed’.
- Capital payments, on the other hand, relate to things that continue to benefit the Company for several years for example, computers and cars. They also include paying off loans. This type of expenditure is shown in the balance sheet and is often referred to as having been ‘capitalised’.