Introduction To Accounting
Introduction To Accounting
The Account
The account is a detailed record of changes that have occurred in a particular asset,
liability, or stockholders’ (owners’) equity item during a period of time.
The account is grouped into three categories, according to the accounting equation:
assets, liabilities or owners’ equity
- Assets
Assets are the economic resources that benefit the business now and in the future.
Cash shows the cash effects of a business’s transactions. It includes money and any
medium of exchange that a bank accepts.
Accounts Receivable represents a promise for future receipt.
Inventory (Merchandise, Merchandise Inventory) is merchandise held for sale to customers
Notes Receivable is a written pledge that the customer will pay.
Prepaid expenses refers to expenses paid in advance.
Land is a record of the cost of land a business owns and uses in its operation.
Buildings are the cost of a business’s buildings, e.g. office, manufacturing plant.
Equipment, Furniture, and Fixtures accounts record separate asset accounts for each
type of equipment.
- Liabilities
Liabilities are the debts of the company.
Notes Payable includes the amounts that the business must pay on promissory notes.
Accounts Payable represents the promise to pay off debts arising from credit purchases.
Accrued Liabilities are expenses that have not yet been paid, e.g., Interest Payable,
Salary Payable, and Income Taxes Payable.
- Stockholders’ (Owners’) equity
The stockholders’/owners’ equity is the owners’ claims to the assets of a corporation.
- A proprietorship uses a single account
- A partnership uses separate accounts for each owner’s capital balance and
withdrawals
- A corporation uses separate capital accounts for each source of capital
Common Stock represents the owners’ investment in the corporation.
Retained Earnings shows the cumulative net income earned by the corporation over its
lifetime, minus cumulative net losses and dividends.
Dividends indicates a decrease in retained earnings when dividends are paid by the
corporation.
Revenues are reported in a separate account for each increase in stockholders’ equity
created by delivering goods or services to customers, e.g., Sales Revenues, Service
Revenues, Rent Revenues, Interest Revenues.
Expenses are reported in a separate account for each type of expense, e.g., Cost of Sales,
Salary Expense, Rent Expense, Advertising Expense, Utilities Expense.
Double-entry Accounting/Bookkeeping
The Double-Entry System: Each transaction affects at least two accounts
Working definition: A way of systematically recording the financial transactions of a
company so that each transaction is recorded twice.
Formal definition: The most commonly used system of bookkeeping based on the
principle that every financial transaction involves the simultaneous receiving and giving of
value, and is therefore recorded twice.
The T-Account
The left side is called the debit side, and the right side is called the credit side.
Every business transaction involves both a debit and a credit.
Assets (debit-balance accounts) are on the opposite side of the equation from liabilities
and stockholders’ equity (credit balance accounts)
- Increases and decreases in assets are recorded in the opposite manner from those
in liabilities and stockholders’ equity
- Liabilities and stockholders’ equity, which are on the same side of the equal sign,
are treated in the same way
Additional Stockholders’ Equity Accounts: Revenues and Expenses
- Revenues: increases in stockholders’ equity from delivering goods to customers
- Expenses: decreases in stockholders’ equity due to the cost of operating the
business
The accounting equation can be expanded to include revenues and expenses
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Using T-accounts expanded
Accounts that are increased with debits Accounts that are increased with credits
and have normal debit balances and have normal credit balances
# Double-entry checks
- Sales and purchases
There will never be a debit in a sales account or a
credit in a purchases account. Assets and liabilities
never pass through these accounts.
- Returns
Sales and purchases returns have their own accounts.
You will never find a credit in a sales return account
or a debit in a purchases return account.
- Assets and expenses
When making the initial entries you never credit a fixed assets or expenses account.
Recording Transactions in the Journal
Accountants record transactions first in a journal: a chronological record of an entity’s
transactions. The steps of the journalizing process are:
- Identify the transaction from source documents, such as bank deposit slips, sale
receipts, and check stubs
- Specify each account affected by the transaction and classify it by type (asset,
liability, stockholders’ equity, revenue, or expense)
- Determine whether each account is increased or decreased by the transaction
- Determine whether to debit or credit the account to record its increase/decrease
- Enter the transaction in the journal, including a brief explanation for the entry
- Enter the debit side first and the credit side next
A complete journal entry includes:
a. The date of the transaction
b. The title of the account debited (left)
c. The title of the account credited (indented)
d. The dollar amount of the debit (left)
e. The dollar amount of the credit (right)
f. A short explanation of the transaction
Conceptual Framework
Accounting provides information useful for decision-making.
To be useful information must be: relevant, reliable, comparable, understandable
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Strict application of certain accounting principles and criteria may be waived when the
quantitative or qualitative materiality of the variation arising as a result is of little
significance and, therefore, does not affect fair presentation. When items or amounts are
not material, these may be aggregated with other items of a similar nature or function.
A large company has a building in the hurricane zone during Hurricane Sandy. The company
building is destroyed and after a lengthy battle with the insurance company, the company reports
an extra ordinary loss of $10,000. The company has net income of $10,000,000. The materiality
concept states that this gain is immaterial because the average financial statement user would
not be concerned with something that is only 1% of net income.
Assume the same example above except the company is a smaller company with only $50,000 of
net income. Now the loss is 20% of net income. This is a substantial loss for the company.
Investors and creditors would be concerned about a loss this big. To the smaller company, this
$10,000 would be considered material. -
A small company bookkeeper doesn't do a are very good job of keeping track of expenses. Most
random expenses get recorded in the miscellaneous expense account. At the end of the year the
miscellaneous expense account has a total of $1424.25 in it. The total net income of the
company is $36,940. The miscellaneous account is immaterial to the overall financial picture of
the company and there is no need to reclassify the expenses in it.
Chapter 4: The accounting process
The Business Cycle
Businesses pay cash to buy goods and services.
Businesses sell goods and services, receiving cash to complete the cycle.
Updating the Accounts for the Financial Statements: The Adjustment Process
The adjustment process begins with the trial balance.
The unadjusted trial balance lists the accounts and their balances after the period’s
transactions have been recorded.
These trial balance accounts are incomplete because they omit certain revenue and
expense transactions that affect more than one accounting period.
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The accrual basis requires adjustment at the end of the period to produce correct
balances for the financial statements.
* Consider the Supplies account
- Supplies is adjusted once a month
- The amount on the trial balance represents the cost of supplies available for use
during the month
- The supplies on hand at the end of the month must be counted to determine the
correct amount to report on the balance sheet:
The adjustment of Supplies (and Supplies Expense) at the end of the accounting period
The adjusting entry updates both the Supplies asset account and the Supplies Expense account
Accountants make adjusting entries in the journal at the end of the period to enter
adjustments into the accounting records
Adjusting entries update the asset and liability accounts through the assignment of
revenues to the period in which they are earned and expenses to the period in which they
are incurred.
Adjustment of an asset/liability for which the business paid or received cash in advance
- Prepaid expenses
- Unearned revenues I s ya ha pagado , abrado con antelacion
- Depreciation
Systematic allocation of the cost of a plant asset to expense over the asset’s useful life.
- Accruals
accrued accin ;
The recording of an expense or a revenue before paying or receiving cash
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diner ; 2 . accin
- Accrued expenses -
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- Accrued revenues
Prepaid Expenses
Prepaid expenses are expenses paid in advance.
Because they provide future economic benefit, prepaid expenses are classified as assets.
Before financial statements are prepared, prepaid expenses are adjusted to reflect the
amount used during the period of the statements.
Adjusting prepaid expenses:
Adjusting supplies:
Unearned Revenues
An unearned revenue is an obligation arising from receiving cash in advance of providing a
product or a service. Revenue is recognized when the services are provided.
An unearned revenue is a liability, not a revenue.
Unearned Service Revenue is a liability because it represents Air & Sea’s obligation to perform
service for the client.
The book value is the net amount of a plant asset (cost — accumulated depreciation):
balance sheet
Accrued Expenses
An accrued expense is a liability that arises from an expense that the business has
incurred but has not yet been paid.
Accrued Revenues
An accrued revenue is a revenue that has been earned but not received in cash.
Debit Retained Earnings for the sum of Credit each expense account for the
the expenses amount of its debit balance
The second entry transfers the sum of the revenues to the credit side of R. Earnings:
Debit each revenue account for the Credit Retained Earnings for the sum of
amount of its credit balance the revenues