Accounting Principles and Cycle: A Comprehensive Guide
Accounting Principles
Accrual Accounting (GAAP)
Revenues are reported in the period when a service has been performed or a product has been delivered.
Expenses are recorded when they are acquired.
Cash may or may not be received from customers during this period.
Matching Principle
Revenue and related expenses should be reported in the same period.
Book Value
The difference between the balance of a fixed asset account and the related accumulated depreciation account.
Depreciation
Loss of usefulness.
Depreciation expense (DR), Accumulated depreciation (CR – contra-asset).
Historical cost is the balance that remains in the fixed asset account. We don’t adjust it; instead, we use the contra account accumulated depreciation.
Revenue Recognition
According to the revenue recognition principle, revenues should be recorded when earned, which is when the services have been performed or products have been delivered to customers.
Net Income vs. Net Loss
Net Income: Revenues > Expenses
Net Loss: Revenues < Expenses
This amount is journalized to capital in the first step of the closing entries.
Adjusting Entries
Journal entries that bring the accounts up to date at the end of the accounting period, before preparing the financial statements.
Adjusted Trial Balance
The trial balance prepared after all the adjusting entries have been posted, to ensure debits and credits are balanced.
Deferrals
A future revenue or expense initially recorded as a liability or asset:
- Prepaid assets → expenses
- Unearned liabilities → revenue
10 Steps of the Accounting Cycle
- Journalize external transactions
- Post to the ledger
- Prepare an unadjusted trial balance
- An optional end-of-period spreadsheet is prepared.
- Journalize internal (adjusting) transactions
- Post to the ledger
- Prepare an adjusted trial balance
- Prepare financial statements
- Income Statement
- Statement of owner’s equity
- Balance sheet
- Statement of cash flows
- Journalize closing entries
- Post to the ledger
- Prepare a post-closing trial balance
Balance Sheet Classification
Assets
- Current Assets: Cash and other assets expected to be converted to cash, sold, or used up within one year or less.
- Property, Plant, and Equipment: Fixed assets (equipment, machinery, buildings, land).
- Except for land, all depreciate over time.
Liabilities
- Current Liabilities: Due within a short time (1 year or less).
- Long-Term Liabilities: Not due for a long time (more than 1 year).
- Note payable: A formal agreement, which could include interest.
Financial Statements
Income Statement
- Fees earned
- Expenses (ordered by size, miscellaneous last)
- Net income/net loss
Statement of Owner’s Equity
- Beginning balance of capital
- Additional investments
- Net income/net loss
- Withdrawals
- Ending balance of capital
Balance Sheet
- Assets
- Current assets (in order of liquidity)
- Property, plant, and equipment
- Total assets
- Liabilities
- Current liabilities
- Long-term liabilities
- Total liabilities
- Owner’s equity
- Capital
- Total liabilities and owner’s equity
Closing Entries
- Reset temporary accounts to zero for the new fiscal period.
- Revenue (DR) & Expenses (CR) to Capital (CR if positive, DR if negative)
- Drawing (CR) to Capital (DR)
Natural Business Year
A 12-month period for which a company prepares its accounts based on its typical activity levels, starting and ending when activity is low.
Fiscal Year
A standard fiscal year.
Worksheet
Also known as an end-of-period spreadsheet, it’s an optional tool for the adjusting and financial statement process.
Working Capital
Measures the liquidity and solvency of a company: Current Assets – Current Liabilities.
Current Ratio
Measures the liquidity and solvency of a company: Current Assets / Current Liabilities.