Accounting Principles

Financial Accounting – It is the process of recording, summarizing and reporting the myriad
of transaction resulting from business operations over a period of time. It includes balance
sheet, income statement and cash flow statements that record the company’s operating
performance over a specific period.
Accounting consists of 3 basic operations namely:
1. Identifies
2. Records
3. Communicates the economic events of the organizations to the interested users.
Who uses accounting Data?
1. Internal users: They plan, organize and run the business. These include marketing
managers, production supervisors, finance directors and company officers.
Managerial accounting provides internal reports to help users to take decisions about
the company.
2. External users : they are individuals and organizations outside the company who want
the financial information about the company. The two most common types of external
users are: creditors and investors. Investors use accounting information to decide
whether to buy, hold or sell ownership shares of a company. Creditors evaluate the
risk of granting credit or lending money.

GAAP (Generally Accepted Accounting Principles)

The accounting profession has developed standard that are generally accepted and universally
practiced. This common set of standards is called generally accepted accounting principles.
The primarily accounting standard setting body in the US is the Financial Accounting
Standards Board (FASB). The Securities and Exchange Commission (SEC) is the agency
of the US government that oversees US financial markets and accounting standard setting body.
Many countries outside of US have adopted the accounting standards issued by International
accounting Standards Board (IASB). These standards are called International Financial
Reporting Standards (IFRS).
Measurement Principles
1. Relevance means that the financial information is capable of making a difference in
decisions.
2. Faithful Representation means that the numbers and description matched with what
really existed or happened.
3. Historical Cost Principle means that the companies record the assets at their cost in
which it was brought.
4. Fair Value Principle states that the asset and liabilities should be reported at air value
(the price received to sell or settle liability).
Assumption
1. Monetary Unit Assumption – It requires that the accountants record the transaction data
that can be measured only in money terms. This assumption enables accounting to
quantify or measure economic events.
2. Economic Entity Assumption – An economic entity can be any organization or entity
in a society. It states that the activities of the entity should be kept distinct and separate
from the activities of the owner.
3. Proprietorship – A business owned by just one person is generally a proprietorship. The
owner is the manager/operator of the business. Here, the owner receives the profits,
suffers any losses and is personally liable for any debts in the business.
4. Partnership – a business owned by two or more person is called a partnership. In a
partnership agreement there exists a term of initial investments, duties of each partner
, division of net income etc. In a partnership also the transaction must be kept separate
from the personal activities of the partners.
5. Corporation – a business organized as a separate legal entity under the state corporation
law and having ownership divided into transferable shares of stocks is a corporation.
The holders of the share enjoy limited liability that is they are not personally liable for
the debts of the corporate entity. Stockholders may transfer some or all part of their
ownership shares to other investors at any time. Hence, the corporation enjoys a
unlimited life.

BASIC ACCOUNTING EQUATION

Assets = Liabilities + Owner’s equity

Assets – they are the resources that the business owns. The business uses its assets for carry
out various activities such as production and sales.
Liabilities- liabilities are claims against assets. They can b of the following types:- accounts
payable, notes payable, salaries and wage payable
Owner’s Equity – the ownership claim on total assets is owner’s equity. Since the claim of
the creditors must be paid before the ownership claims, owner’s equity is often referred to as
residual equity.
Investment by Owner – they are the assets the owners put in the business.
Revenues- they are the gross increase in the owner’s equity resulting from the business
activities entered into the purpose of earning income.
Drawings – An owner may withdraw some assets for his own personal use. Those are classified
as drawings.
Expenses- they are the cost of the assets consumed or services used in the process of earning
revenue. They are the decrease in owner’s equity that result from operating the business.
EXPANDED ACCOUNTING EQUATION
Assets = Liabilities + Owner’s Capital – Owner’s Drawing + Revenues – Expenses

TRANSACTION ANALYSIS
1. INVESTMENT BY OWNER – Ray Neal starts a smartphone app development
company which is named as Softbyte. On September 1, 2017, he invests $15000 cash
in the business.
Assets = Liabilities + Owner’s Equity
Cash = Owner’s Capital
$15000 $15000

2. PURCHASE OF EQUIPMENT FOR CASH – Softbyte purchases computer equipment

for $7000 cash.
Assets = Liabilities + Owner’s Equity
Cash Equipment Owner’s Capital
15000 15000
(7000) 7000
8000 7000 15000

3. PURCHASE OF SUPPLIES ON CREDIT – Softbyte purchases for $1600 from Mobile

Solutions headsets and other computer accessories expected to last several months.
Mobile Solutions allows Softbyte to pay this bill in October.
Assets = Liabilities + Owner’s Equity
Cash Supplies Equipment Accounts Payable Owner’s Capital
15000 15000
(7000) 7000
1600 1600
$16600 $16600

4. SERVICES PERFORMED FOR CASH – Softbyte receives $1200 cash from

customers for app development services it has performed.
Assets = Liabilities + Owner’s Equity
Cash Supplies Equipment Accounts Payable Owner’s Revenues
Capital
15000 15000
(7000) 7000
1600 1600
1200 1200
17800 17800
 5. PURCHASE OF ADVERTISMENT ON CREDIT - Softbyte receives a bill for $250
from the Daily News for advertisement on its online website but postpones the payment
until a later date.
Assets = Liabilities Owner’s Equity
+
Cash Supplies Equipment Accounts Owner’s Revenues Expenses
Payable Capital
9200 1600 7000 1600 15000 1200

250 (250)

17800 17800

6. SERVICES PERFORMED FOR CASH AND CREDIT – Softbyte performs $3500 of

app developments services for customers. The company receives a cash of $1500 from
customers and it bills the balance of $2000 on account.
Assets = Liabilities Owner’s Equity
+
Cash Supplies Accounts Equipment Accounts Owner’s Revenues Expenses
Receivable Payable Capital

9200 1600 7000 1350 15000 1200 (250)

1500 2000 3500

21300 21300

7. PAYMENT OF EXPENSES – Softbyte pays the following expenses in cash for

September: office rent $500, salaries and wages of employees $900 and utilities $200.
Assets = Liabilities Owner’s Equity
+
Cash Supplies Accounts Equipment Accounts Owner’s Revenues Expenses
Receivable Payable Capital

10700 1600 2000 7000 1350 15000 4700 (250)

(1700) (1700)
19600 19600
 8. PAYMENT OF ACCOUNTS PAYABLE – Softbyte pays its $250 Daily News bills in
cash.
Assets = Liabilities Owner’s Equity
+
Cash Supplies Accounts Equipment Accounts Owner’s Revenues Expenses
Receivable Payable Capital

9000 1600 2000 7000 (1350) 15000 4700 (1950)

(250) (250)
19350 19350

9. RECIEPT OF CASH ON ACCOUNT – Softbyte receives $600 in cash from customers

who had been billed for services.
Assets = Liabilities Owner’s Equity
+
Cash Supplies Accounts Equipment Accounts Owner’s Revenues Expenses
Receivable Payable Capital

8750 1600 2000 7000 1600 15000 4700 (1950)

600 (600)
19350 19350

10. WITHDRAWAL OF CASH BY OWNER – Ray Neal withdraws $1300 in cash from
business for his personal use.
Assets = Liabilities Owner’s Equity
+
Cash Supplies Accounts Equipment Accounts Owner’s Revenues Expenses
Receivable Payable Capital Owner’s
Drawings
9350 1600 1400 7000 1600 15000 4700 (1950)

(1300) 1300

18050 18050
The 4 elements of preparing financial statements:
1. An income statement presents the revenues and expenses and resulting net income or
net loss for a specific period of time.
2. An owner’s equity statement summarizes the changes in owner’s equity for a specific
period of time.
3. A balance sheet reports the assets, liabilities and owner’s equity at a specific date.
4. A statement of cash flows summarizes information about the cash inflows and outflows
for a specific period of time.

Income statement
It reports the revenues and expenses for a specific period of time. Net income results when the
revenues exceeds the expenses. Net losses occurs when expenses exceed revenues.
 The Recording Process
Account – An account is an individual accounting record of increases and decreases in a
specific asset, liability or owner’s equity item.
Debit – The debit indicates the left side of the account.
Credit – The credit indicates the right side of the account.
When comparing the totals of the two sides, an account shows a debiting account if the total
of the debit amounts exceeds the credit. An account shows credit balance if the credit amounts
exceeds that of the debits.
DR./CR. PROCEDURES FOR ASSETS & LIABILITIES
Debit Credit
Increase assets Decrease Assets
Decrease Liabilities Increase Liabilities

Asset accounts normally show debit balances. Liability accounts normally show credit
balances.
Assets
Debit for Increase Credit for Decrease
Normal Balance

Liabilities
Debit for Increase Credit for Decrease
Normal Balance

Owner’s Capital
Debit for Increase Credit for Decrease
Normal Balance

Owner’s Drawings
Debit for Increase Credit for Decrease
Normal Balance

Revenues
Debit for Increase Credit for Decrease
Normal Balance
Expenses
Debit for Increase Credit for Decrease
Normal Balance

Steps in the Recording Process:

1. Analyze each transaction for its effects on the accounts.
2. Enter the transaction information in a Journal.
3. Transfer the journal information to the appropriate accounts in the ledger.

Journal
The companies initially record transactions in chronological order. The journal is referred to as
the book of original entry.
1. It discloses in one place the complete effects of transaction.
2. It provides a chronological record of transaction.
3. It helps to prevent or locate errors because the debit and credit amounts can be easily
compared.

Ledger
The entire group of accounts maintained by a company is the ledger. The ledger provides the
balance in each of the accounts as well as keep track of changes in these balances. A general
ledger contains all the assets, liability and owner’s equity.
Posting
Transferring the journal entries to the ledger accounts is called posting.
Trial Balance
A trial balance is a list of accounts and their balances at a given time. It provides the
mathematical equality of debit and credit after posting.

Q1) Presented below is the information related to Hammond Real Estate Agency.
Oct 1 Lia Berge begins business as a real estate agent with a cash investment of $30,000.
Oct 2 Paid Rent, $700, on office space.
Oct 3 Purchase office equipment for $2800, on account.
Oct 6 Sells a house and a lot for Hal Smith; bills Hal Smith $4400 for realty services performed.
Oct 27 Pays $1100 on the balance related to the transaction of October 3.
Oct 30 Receives bill on October utilities, $130
Ans: JOURNAL ENTRY
Date Account Title & Explanation Debit Credit
Oct 1 Cash 30000
Owner’s Capital 30000
Oct 2 Rent Expense 700
Cash 700
Oct 3 Equipment 2800
Account Payable 2800
Oct 6 Account Receivable 4400
Services Revenue 4400
Oct 27 Account Payable 1100
Cash 1100
Oct 30 Utilities Expense 130
Account Payable 130

Ledger accounts
Cash
Date Account Debit Credit
Title
10/1 Owner’s 30000
Capital
10/2 Rent 700
Expense
10/27 Account 1100
Payable
Total 28200

Owner’s Capital
Date Account Debit Credit
Title
10/1 Cash 30000
Total 30000

Rent Expense
Date Account Debit Credit
Title
10/2 Cash 700
Total 700
Equipment
Date Account Debit Credit
Title
10/3 Account 2800
Payable
Total 2800

Account Payable
Date Account Debit Credit
Title
10/3 Equipment 2800
10/27 Cash 1100
10/30 Utilities 130
Expense
Total 1830

Account Receivable
Date Account Debit Credit
Title
10/6 Service 4400
Revenue
Total 4400

Services Revenue
Date Account Debit Credit
Title
10/6 Account 4400
Receivable
Total 4400

Utilities Expense
Date Account Debit Credit
Title
10/6 Account 130
Payable
Total 130
Q) Bob Sample opened the Campus Laundromat on September 1, 2017. During the first
month of operations, the following transactions occurred:
Sept 1. Bob invested $20000 cash in business.
Sept 2. The company paid $1000 cash for store rent on September.
Sept 3. Purchased washers and dryers for $25000, paying $10000 in cash and signing a
$15000, 6 month, 12% note payable.
Sept 4. Paid $1200 for one year accident insurance policy.
Sept 10. Received a bill from Daily News for online advertising of the Laundromat $200.
Sept 20. Bob withdrew $700 cash for personal use.
Sept 30. The company determined that cash receipts for laundry services for the month were
$6200.

GENERAL JOURNAL for the month of September.

Date Account Title Debit Credit
9/1 Cash 20000
Owner’s Capital 20000
9/2 Rent Expense 1000
Cash 1000
9/3 Equipment Expense 25000
Cash 10000
Notes Payable 15000
9/4 Prepaid Insurance Expense 1200
Cash 1200
9/10 Advertisement Expense 200
Account Payable 200
9/20 Owner’s Drawing 700
Cash 700
9/30 Cash 6200
Service Revenue 6200

LEDGER
Cash
Date Account Title Debit Credit
9/1 Owner’s Capital 20000
9/2 Rent Expense 1000
9/3 Equipment 10000
9/4 Prepaid Insurance 1200
9/20 Owner’s 700
Drawings
9/30 Service Revenue 6200
Total 13300

Owner’s Capital
Date Account Title Debit Credit
9/1 Cash 20000
Total 20000

Rent Expense
Date Account Title Debit Credit
9/2 Cash 1000
Total 1000

Equipment Expense
Date Account Title Debit Credit
9/3 Cash 10000
9/3 Notes Payable 15000
Total 25000

Notes Payable
Date Account Title Debit Credit
9/3 Equipment 15000
Total 15000

Prepaid Insurance Expense

Date Account Title Debit Credit
9/4 Cash 1200
Total 1200

Advertisement Expense
Date Account Title Debit Credit
9/10 Account Payable 200
Total 200

Account Payable
Date Account Title Debit Credit
9/10 Advertising 200
expense
Total 200
 Owner’s Drawings
Date Account Title Debit Credit
9/20 Cash 700
Total 700

Service Revenue
Date Account Title Debit Credit
9/30 Cash 6200
Total 6200

TRIAL BALANCE
Account Title Debit Credit
Cash 13300
Owner’s Capital 20000
Rent Expense 1000
Equipment Expense 25000
Notes Payable 15000
Prepaid Insurance 1200
Advertisement Expense 200
Account Payable 200
Service Revenue 6200
Owner’s Drawings 700
41400 41400
ADJUSTING THE ACCOUNTS
The accountants divide the economic life of a business into artificial time periods. This
convenient assumption is referred to as Time Period Assumption.
Fiscal & Calendar Years
Accounting time periods are generally for a month, a quarter or a year. An accounting period
that is one year in length is a fiscal year. A fiscal year generally starts at the first day of a
month and ends 12 months later on the last day of the month. Many business uses a calendar
year.
Accrual versus Cash-Basis Accounting
Under the accrual basis, companies record transactions that change a company’s financial
statements in the periods in which the events occur.
Under cash basis accounting, companies record revenues when they receive cash.
Accrual basis accounting is therefore in accordance with generally accepted accounting
principle (GAAP).
Recognizing Revenues and Expenses
Revenue Recognition Principle
When a company agrees to perform a service or sell a product to a customer, it has performance
obligation. When the company meets this performance obligation, it recognizes revenue the
revenue recognition principle therefore requires revenue in the accounting period in which the
performance obligation is satisfied.
Expense Recognition Principle
Match expenses with revenues in the period when the company makes efforts to generate the
revenues.
Need for adjusting entries
Adjusting entries ensure the revenue recognition and expense recognition principles are
followed. Adjusting entries are required every time a company prepares financial statements.
Every adjusting entry will include one income statement account and one balance sheet
account.
Types of Adjusting Entries
Deferrals
1. Prepaid expenses – EXPENSES PAID IN CASH BEFORE THEY ARE USED OR
CONSUMED. Ex – Supplies, Insurance, Depreciation
2. Unearned Revenues – CASH RECEIVED BEFORE SERVICES ARE PERFORMED.
Accruals
1. Accrued Revenues – REVENUES FOR SERVICES PERFORMED BUT NOT YE
RECEIVED IN CASH OR RECORDED.
 2. Accrued Expenses – EXPENSES INCURRED BUT NOT YET PAID IN CASH OR
RECORDED.

Practice Problems
1. The Green Thumb Care Company began operations on April 1. At April 30, the trial
balance shows the following balances for selected accounts.
Prepaid Insurance $3600
Equipment $28000
Notes Payable $20000
Unearned Service Revenue $4200
Service Revenue $1800

Analysis reveals the following additional data.

1. Prepaid insurance is the cost of 2-year insurance policy, effective April 1.
2. Depreciation on the equipment $500 per month.
3. The notes payable is dated April 1. It’s a 6 month, 12% note.
4. 7 customers paid for the company’s 6-month lawn service of $600 beginning in
April. The company performed services for these customers in April.
5. Lawn services performed for other customers but not recorded at April 30 totaled
$1500.

Solution
Date Account Title Debit ($) Credit ($)
April 30 Insurance Expense 150
Prepaid Insurance 150
April 30 Depreciation Expense 500
Accumulated Depreciation Expense 500
April 30 Interest Expense 200
Interest Payable 200
April 30 Unearned Service Revenue 700
Service Revenue 700
April 30 Accounts Receivable 1500
Service Revenue 1500

Problems
1. Logan Krause started her own consulting firm, Krause Consulting on May 1, 2017.
The trial balance at May 31 is as follows:
 KRAUSE CONSULTING
TRIAL BALANCE
MAY 31, 2017
Account Debit Credit
Number
101 Cash 4500
112 Accounts Receivable 6000
126 Supplies 1900
130 Prepaid Insurance 3600
149 Equipment 11400
201 Accounts Payable 4500
209 Unearned Service Revenue 2000
301 Owner’s Capital 18700
400 Service Revenue 9500
726 Salaries & Wages Expense 6400
729 Rent Expense 900
34700 34700

Other data:
1. $900 of supplies have been used during the month.
2. Utilities expense incurred but not paid on May 1, $250.
3. The insurance policy is for 2 years.
4. $400 of the balance in the unearned service revenue account remains unearned at the
end of the month.
5. May 31 is a Wednesday, and employees are paid on a Friday, Krause Consulting has
2 employees, who are paid $920 each for a 5 day work week.
6. The office furniture has a 5 year life with no salvage value. It is being depreciated in
$190 per month for 60 months.
7. Invoices representing $1700 of services performed during the month have not been
recorded as of May 31.

Account Account Title Debit Credit

Number
May 31 Supplies Expense 900
Supplies 900
May 31 Utilities Expense 1250
Accounts Payable 1250
May 31 Service Revenue 1600
Unearned Service Revenue 1600
May 31 Insurance Expense 150
Prepaid Insurance 150
May 31 Salaries and Wages Expense 1080
Salaries and Wages Payable 1080
May 31 Depreciation expense 190
 Accumulated Depreciation Expense 190
May 31 Accounts Receivable 1700
Service Revenue 1700