Essential Accounting Concepts and Financial Statement Components

Basic Accounting Records

The Ledger

The Ledger shows the movements and the balance of an account.

Ledger Example

Example: The partners make a cash contribution to the company on 15/06/2010 for $1,000,000.

| Date       | Concept      | Debit (To) | Credit (Have) | Balance   |
|------------|--------------|------------|---------------|-----------|
| 15/06/2010 | Contribution |            | $1,000,000    | $1,000,000|

The General Journal (Book Diary)

The General Journal is where all transactions are recorded in chronological order.

The typical structure includes:

• Date
• Concept/Description
• Accounts to Debit (To)
• Accounts to Credit (By)

Inventory Accounting Systems

There are two primary methods for tracking merchandise inventory:

• Perpetual System
• Periodic System

The Perpetual Inventory System

Business transactions are recorded as they occur (e.g., a purchase, discount, or charge).

This system maintains a current, updated inventory account for merchandise.

The company records the cost of goods sold in a dedicated account called "Cost of Sales" immediately upon sale.

Requirements for Perpetual Inventory

• Requires that the company has technological resources to track inventory movements in real-time.

The Periodic Inventory System

Under the Periodic System, the company does not keep inventory updated continuously.

The company must take a physical inventory count at the end of the accounting period.

Calculating Cost of Goods Sold (COGS)

Cost of Sales is calculated using a formula:

COGS = Beginning Inventory + Net Purchases – Ending Inventory

The Balance Sheet (Statement of Financial Position)

The Balance Sheet is a statement showing the financial situation of an entity as of a given date. It is also known as the Statement of Financial Position.

The presentation of the Balance Sheet follows the fundamental accounting equation (Assets = Liabilities + Equity), which determines how items are classified.

The Balance Sheet presents the following three key elements of an entity:

1. Assets: This element shows all assets and rights owned by the company, through which future economic benefits (profit) are expected.
2. Liabilities: This represents all real debts owed to others. Liabilities are reasonable obligations an entity has to provide services or deliver goods in the future.
3. Equity (Net Assets): This group identifies the net assets of the company, consisting of capital contributions, accumulated profit, or loss.

Statement of Profit and Loss (Income Statement)

This financial statement is composed of nominal or result accounts, including revenues, costs, and expenses.

The main objective of preparing and presenting this statement is to show the surplus (profit) or deficit (loss) resulting from operations during an accounting period.

Social Capital (Share Capital)

Social Capital represents the value of property contributed by the members of a society (business). This value, which typically has no right of immediate return, is recorded in a balancing item known as Equity Accounting.

Amortization

Amortization may refer to the gradual reduction of both liabilities (debt) and assets (intangibles). In both cases, the value is usually large, with a duration that extends over several periods.

Amortization is the official process by which a debt is extinguished gradually through periodic payments, which may be identical or different.

Depreciation

Depreciation is an annual reduction in the value of a property, asset, or equipment.

This reduction in value is generated primarily by:

• Use or wear and tear.
• The passage of time (obsolescence).