Essential Accounting Concepts and Financial Reporting

Fundamental Accounting Principles and Practices

Core Accounting Definitions

Assets = Liabilities + Owner’s Equity: This is the fundamental accounting equation, representing the balance of a company's financial position.

Double-Entry Accounting

The recording of both debit and credit parts of every transaction, ensuring the accounting equation remains balanced.

Objective Evidence Principle

Requires that a source document (e.g., invoice, receipt) be prepared for every entry in a journal, providing verifiable proof of a transaction.

File Maintenance

The process of arranging accounts in a general ledger, assigning account numbers, and keeping records current.

Opening an Account

Writing an account title and number on the heading of an account in the ledger.

Posting

The process of transferring information from a journal entry to a ledger account.

Adjusting Entries

Journal entries recorded to update general ledger accounts at the end of a fiscal period. These entries typically do not have a source document.

Generally Accepted Accounting Principles (GAAP)

A set of commonly followed accounting rules and standards for financial reporting, ensuring consistency and comparability.

Definition of Accounting

The systematic process of planning, recording, analyzing, and interpreting financial information to make informed decisions.

Key Accounting Concepts

Business Entity Concept

States that a business and its owner are considered two separate entities, and their financial activities should be accounted for independently.

Realization of Revenue Principle

Realization of Revenue: Occurs when revenue is physically collected by a company. In other words, a sale could be made at any time, but the revenue is not realized until payment is received.

Matching Expenses with Revenue Principle

Any business expenses incurred must be recorded in the same accounting period as the revenues they helped generate.

Full Disclosure Principle

All relevant and necessary information for the understanding of a company's financial statements must be included in public company filings.

Financial Statements Explained

Balance Sheet

A financial statement that reports the value of a business’ assets, liabilities, and owner’s equity on a specific date. It adheres to the accounting equation: Assets = Liabilities + Owner's Equity.

Income Statement

A financial statement showing the revenue and expenses for a fiscal period, resulting in a net income or net loss.

Normal Account Balances

Understanding normal balances is crucial for accurate recording:

• Normal Debit Balances: Expenses, Assets (e.g., Accounts Receivable), Drawing (Owner's Withdrawals)
• Normal Credit Balances: Liabilities, Capital (Owner's Equity), Revenue

The Accounting Cycle

The accounting cycle is a series of steps followed to record and process all financial transactions during an accounting period:

1. Transaction: Identification and analysis of business transactions.
2. Journal Entries: Recording transactions in a journal.
3. Posting: Transferring journal entries to ledger accounts.
4. Trial Balance: Preparing a list of all accounts and their balances to ensure debits equal credits.
5. Worksheet: An optional tool used to prepare adjusting entries and financial statements.
6. Adjusting Entries: Recording entries to update accounts at the end of a period.
7. Financial Statements: Preparing the Income Statement, Balance Sheet, and Statement of Owner's Equity.
8. Closing the Books: Preparing closing entries to reset temporary accounts for the next period.

Worksheet Preparation Notes

A worksheet typically includes sections for:

• Account Titles: Cash, Accounts Receivable, Supplies, Prepaid Insurance, Accounts Payable, Capital, Drawing, Income Summary, Sales, Expenses.
• Trial Balance Columns:
  • Debit Accounts: Cash, Prepaid Insurance (these are typically debit balances).
  • Credit Accounts: Accounts Payable, Capital (these are typically credit balances).
  • Drawing is debited, Sales is credited, Expenses are debited.
  • Note: Insurance and Supplies might initially be blank in expense columns before adjustments.
• Adjustments Columns:
  • Supplies and Prepaid Insurance are typically credited to reduce their asset balances.
  • Corresponding expense accounts (e.g., Insurance Expense, Supplies Expense) are debited.
  • To calculate adjusted balances, subtract adjustments from original trial balance figures.
  • Rule all columns under the Trial Balance and Adjustments sections.

Adjusting Entries: Debit and Credit Rules

When making adjusting entries:

• To increase a revenue account, credit it. To decrease a revenue account, debit it.
• To increase an expense account, debit it. To decrease an expense account, credit it.

Example of Posting Adjustments from Worksheet:

If an adjustment involves Supplies Expense and Supplies, the journal entry would typically be:

Date
    Supplies Expense          Debit
        Supplies                  Credit

Example of Supplies on Account:

If supplies are purchased on account, the entry would be:

Supplies                  Debit
    Accounts Payable          Credit

Income Statement Preparation Notes

To prepare an Income Statement:

• Begin with a "Revenue" section, listing Sales (a credit balance).
• Follow with an "Expenses" section, listing all expense accounts (debit balances).
• Calculate Net Income or Net Loss by subtracting total expenses from total revenue.
• Total expenses are typically listed under sales for calculation.

Balance Sheet Preparation Notes

To prepare a Balance Sheet:

• Assets Section: List all asset accounts (e.g., Cash, Accounts Receivable, Supplies, Prepaid Insurance) from the worksheet's adjusted trial balance. Sum these for "Total Assets."
• Liabilities Section: List liability accounts (e.g., Accounts Payable). Sum these for "Total Liabilities."
• Owner's Equity Section: List the Capital account (adjusted for net income/loss and drawing).
• Verification: Ensure "Total Liabilities and Owner's Equity" matches "Total Assets."

Closing Entries

Closing entries are made at the end of an accounting period to transfer temporary account balances to permanent accounts and prepare for the next period. Title the first row "Closing Entries."

1. Close Revenue Accounts to Income Summary:

   Sales                     Debit
       Income Summary            Credit
           

2. Close Expense Accounts to Income Summary:

   Income Summary            Debit
       All Expense Accounts      Credit
           

3. Close Income Summary to Capital:

   Income Summary            Debit (if net income)
       Capital                   Credit (if net income)
           

   (If net loss, Capital is debited and Income Summary is credited)

4. Close Drawing to Capital:

   Capital                   Debit
       Drawing                   Credit