Key Accounting Principles and Financial Statements

Posted on Feb 13, 2025 in Accounting and Finance

Chapter 1: Fundamental Accounting Concepts

Internal Users: Marketing managers, production supervisors, finance directors, and company officers.

External Users: Investors and creditors.

GAAP (Generally Accepted Accounting Principles): A common set of accounting standards and procedures.

Cost Principle: Companies must record assets at their original cost.

Monetary Unit Assumption: Companies record only transactions that can be expressed in monetary terms.

Economic Entity Assumption: Activities of an entity must be kept separate and distinct from the activities of its owner and all other economic entities.

Dividends: Reduce retained earnings.

Four Financial Statements:

  • Income Statement: Lists revenues and expenses to determine net income or loss.
  • Retained Earnings Statement: Calculates ending retained earnings: Beginning Retained Earnings +/- Net Income/Loss – Dividends = Ending Retained Earnings.
  • Balance Sheet: Reports assets, liabilities, and stockholders’ equity.
  • Statement of Cash Flows: Reports the inflows and outflows of cash for a specific period.

Chapter 2: The Recording Process

Accounts with a Normal Credit Balance: Liabilities, Common Stock, Retained Earnings, and Revenues.

Process: Analyze, Journalize, Post.

General Journal: A complete list of transactions in chronological order, helping to prevent or locate errors.

General Ledger: Groups every account individually.

Trial Balance

A list of accounts and their balances at a given time. Steps:

  1. List the account titles and their balances.
  2. Total the debit and credit columns.
  3. Prove the equality of the two columns.

Chapter 3: Adjusting Entries

Cash Basis Accounting: Companies record revenue when they receive cash.

Accrual Basis Accounting: Companies record transactions in the periods in which the events occur.

Types of Adjusting Entries:

Deferrals:

  1. Prepaid expenses paid in cash before they are used or consumed.
  2. Unearned revenues: Cash received before services are performed.

Accruals:

  1. Revenues for services performed but not yet received in cash.
  2. Expenses incurred but not yet paid in cash or recorded.

Adjusting Entries: Always debit the expense account (e.g., Supplies Expense, Insurance Expense, Salaries and Wages Expense, Interest Expense, and Depreciation Expense). Always credit the related account.

For Unearned Revenue: Credit the revenue account and debit unearned revenue.

For Unrecorded Revenue: Debit Accounts Receivable and credit revenue.

Chapter 4: Closing Entries

All temporary accounts (RED: Revenues, Expenses, and Dividends) are closed using closing entries in the general journal.

  • To close Revenues: Debit Revenues, Credit Income Summary.
  • To close Expenses: Credit Expenses, Debit Income Summary.
  • To close Income Summary: Debit Income Summary, Credit Retained Earnings.
  • To close Dividends: Credit Dividends, Debit Retained Earnings.

Post-closing trial balance is prepared to prove debits equal credits for only permanent account balances.

Classified Balance Sheet

Assets

  • Current Assets: Cash, short-term investments, accounts receivable, notes receivable, inventory, supplies, prepaid insurance.
  • Long-term investments.
  • Property, Plant, and Equipment (PPE): Includes accumulated depreciation (less).
  • Intangible assets.

Liabilities and Stockholders’ Equity

  • Current liabilities.
  • Long-term liabilities.
  • Stockholders’ Equity.