Accounting Basics

Accounting Basics
Accounting Basics
• Generally accepted accounting principles are a common set of

standards used by accountants
• The basic accounting equation is
Assets = Liabilities + Owner's Equity
• Assets are resources owned by a business.
• Liabilities are creditorship claims on total assets.
• Owner's equity is the ownership claim on total assets.
Accounting Basics
• The expanded accounting equation is:
Assets  Liabilities + Owner's Capital  Owner's Drawings + Revenues 
Expenses
• Owner's Capital is assets the owner puts into the business.
• Owner's drawings are the Assets the owner withdraws for personal use.
• Revenues are increases in assets resulting from income-earning
activities.
• Expenses are the costs of assets consumed of services used in the
process of earning revenue.
Accounting Basics
• Four financial statements
• Income statement presents the revenues and expenses, and resulting
net income or net loss for a specific period of time.
• Owner's equity statement summarizes the changes in owner's equity
for a specific period of time.
• Balance sheet reports the assets, liabilities, and owner's equity at a
specific date.
• A statement of cash flows summarizes information about the cash
inflows (receipts) and outflows (payments) for a specific period of time.
Accounting Basics
• The monetary unit assumption requires that companies include in
the accounting records only transaction data that can be expressed in
terms of money.
• The economic entity assumption requires that the activities of each
economic entity be kept separate from the activities of its owner(s)
and other economic entities.
• The going concern assumption states that the company will continue
in operation long enough to carry out its existing objectives and
commitments.
• The historical cost principle states that companies should record
assets at their cost.
Accounting Basics
• The fair value principle indicates that assets and liabilities should be
reported at fair value.
• The revenue recognition principle requires that companies recognize
revenue in the accounting period in which the performance obligation
is satisfied.
• The expense recognition principle dictates that efforts (expenses) be
matched with results (revenues)
• The full disclosure principle requires that companies disclose
circumstances and events that matter to financial statement users.
Accounting Basics
• The time period assumption assumes that the economic life of a
business is divided into artificial time periods.
• Accrual-basis accounting means that companies record events that
change a company’s financial statements in the periods in which
those events occur, rather than in the periods in which the company
receives or pays cash.
Adjusting entries
• Companies make adjusting entries at the end of an accounting
period.
• Such entries ensure that companies recognize revenues in the period
in which the performance obligation is satisfied and recognize
expenses in the period in which they are incurred.
• The major types of adjusting entries are deferrals (prepaid expenses
and unearned revenues) and accruals (accrued revenues and accrued
expenses).
Accounting Basics
• Deferrals are either prepaid expenses or unearned revenues.
Companies make adjusting entries for deferrals to record the portion
of the prepayment that represents the expense incurred or the
revenue for services performed in the current accounting period.
• Accruals are either accrued revenues or accrued expenses.
Companies make adjusting entries for accruals to record revenues for
services performed and expenses incurred in the current accounting
period that have not been recognized through daily entries.
Accounting Basics
• Companies may initially debit prepayments to an expense account.
• Likewise, they may credit unearned revenues to a revenue account. At
the end of the period, these accounts may be overstated.
• The adjusting entries for prepaid expenses are a debit to an asset
account and a credit to an expense account.
• Adjusting entries for unearned revenues are a debit to a revenue
account and a credit to a liability account.
Accounting Basics
• An account is a record of increases and decreases in specific asset,
liability, and owner’s equity items.
• The terms debit and credit are synonymous with left and right.
• Assets, drawings, and expenses are increased by debits and decreased
by credits.
• Liabilities, owner’s capital, and revenues are increased by credits and
decreased by debits.
Accounting Basics
• A journal (a) discloses in one place the complete effects of a
transaction, (b) provides a chronological record of transactions, and
(c) prevents or locates errors because the debit and credit amounts
for each entry can be easily compared.
• Posting - This phase of the recording process accumulates the effects
of journalized transactions in the individual accounts.
Accounting Basics
• A trial balance is a list of accounts and their balances at a given time.
Its primary purpose is to prove the equality of debits and credits after
posting.
• A trial balance also uncovers errors in journalizing and posting and is
useful in preparing financial statements.
Accounting Basics
• Closing entries - In closing the books, companies make separate
entries to close revenues and expenses to Income Summary, Income
Summary to Owner’s Capital, and Owner’s Drawings to Owner’s
Capital.
• Only temporary accounts are closed.
• A post-closing trial balance contains the balances in permanent
accounts that are carried forward to the next accounting period.
Accounting Basics
• Accounting cycle - The required steps in the accounting cycle are:
(1) analyze business transactions
(2) journalize the transactions
(3) post to ledger accounts
(4) prepare a trial balance
(5) journalize and post adjusting entries
(6) prepare an adjusted trial balance
(7) prepare financial statements
(8) journalize and post closing entries, and
(9) prepare a post-closing trial balance.
Accounting Basics
• Classified balance sheet
• Categorizes assets as current assets; long-term investments; property,
plant, and equipment; and intangibles.
• Liabilities are classified as either current or long-term.
• There is also an owner’s (owners’) equity section, which varies with
the form of business organization.
Depreciation
• Depreciation is the allocation of the cost of a plant asset to expense
over its useful (service) life in a rational and systematic manner.
• Depreciation is not a process of valuation, nor is it a process that
results in an accumulation of cash.
• Methods of depreciation – straight line, units of activity and declining
balance
Depreciation
• Effect of depreciation methods - Three depreciation methods are:
Method Annual Depreciation Formula
Straight-line Constant amount Depreciable cost ÷ Useful life
Units-of-activity Varying amount Depreciable cost per unit ×
Units of activity during the year
Declining-balance Decreasing amount Book value at beginning of
year × Declining-balance
rate

Accounting Basics

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Accounting Basics

• Generally accepted accounting principles are a common set of

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