Accounting in Business Chapter 1

Users of Accounting Information

• External Users include investors, creditors, and government agencies evaluating a company's financial statements for decisions like loan approvals.
• Internal Users consist of management, employees, and internal auditors who utilize financial reports to analyze departmental performance and budgetary decisions.

Generally Accepted Accounting Principles (GAAP)

• Revenue Recognition Principle states revenue must be recognized when earned, not when cash is received; example: a 1,200subscriptionrecognizes1,200 subscription recognizes 1,200subscriptionrecognizes100 monthly, despite upfront cash.
• Expense Recognition Principle (Matching) mandates matching expenses to the revenues generated within the same period; example: sales commissions related to December sales are recorded in December, regardless of payment timing.
• Cost Principle requires assets to be recorded at purchase cost, not current market value; example: an equipment purchase for $50,000 remains valued at that cost on financial statements.

Role of Ethics in Accounting

• Ethics ensure accuracy and transparency in financial reporting; unethical practices involve concealing losses to misrepresent profitability while ethical accountants disclose all financial realities.

Elements of the Accounting Equation

• The fundamental equation is Assets = Liabilities + Equity; for instance, a company with 100,000inassets,100,000 in assets, 100,000inassets,60,000 in liabilities, and $40,000 in equity follows this principle.
• Transaction Impact Example: Buys a 10,000machineoncreditincreasesassets(Equipment+10,000 machine on credit increases assets (Equipment +10,000machineoncreditincreasesassets(Equipment+10,000) and liabilities (Accounts Payable +$10,000).

Analyzing Business Transactions

• Payment of 5,000individendsleadstoadecreaseinassets(Cash−5,000 in dividends leads to a decrease in assets (Cash -5,000individendsleadstoadecreaseinassets(Cash−5,000) and a corresponding decrease in equity (Retained earnings -$5,000).

4 Financial Statements

• Income Statement reflects revenues and expenses over a period, showing net income; e.g., 50,000inrevenuesagainst50,000 in revenues against 50,000inrevenuesagainst30,000 in expenses yields $20,000 net income.
• Statement of Retained Earnings illustrates changes in retained earnings; starting with 10,000,adding10,000, adding 10,000,adding20,000 net income, and subtracting 5,000individendsresultsin5,000 in dividends results in 5,000individendsresultsin25,000.
• Balance Sheet lists assets, liabilities, and equity at a specific date, e.g., 100,000inassets,100,000 in assets, 100,000inassets,40,000 in liabilities, and $60,000 in equity.
• Statement of Cash Flows summarizes cash inflows and outflows; e.g., 10,000cashinflowsfromoperations,10,000 cash inflows from operations, 10,000cashinflowsfromoperations,3,000 cash outflows for investing.

Ratio – Return on Assets (ROA)

• ROA is calculated as Net Income / Average Total Assets; example: net income of 50,000withaveragetotalassetsof50,000 with average total assets of 50,000withaveragetotalassetsof200,000 yields an ROA of 25%, indicating profit generation efficiency.

Source Documents

• Source documents like sales receipts validate transactions; e.g., a $500 receipt records a sale in company accounts.

Role of Accounts

• Assets include Cash, Accounts Receivable, and Equipment; liabilities include Accounts Payable and Notes Payable; equity includes Common Stock and Retained Earnings; examples of expenses are Rent Expense and Salaries Expense.
• When paying rent of $1,000, Rent Expense is debited, increasing the expense account, while Cash is credited, decreasing the asset account.

General Journal and General Ledger

• General Journal is where initial transactions are recorded; for instance, purchasing supplies on credit is noted as Debit Supplies and Credit Accounts Payable.
• General Ledger organizes all accounts and their balances; increases in supplies and accounts payable are posted here.

Debits and Credits – Double-Entry Accounting

• Debits increase assets and expenses; credits increase liabilities, equity, and revenues; e.g., receiving $1,000 cash for services involves debiting Cash and crediting Service Revenue.

Accounting Cycle – First 4 Steps

• Identify and Analyze financial events; Journalize recorded transactions; Post to General Ledger; Prepare Unadjusted Trial Balance to ensure debits equal credits.

Purpose of a Trial Balance

• A trial balance checks that total debits equal total credits and is essential for preparing accurate financial statements.

Journal Entries and Ledger Posting

• Example of a journal entry for a $5,000 credit sale includes debiting Accounts Receivable and crediting Sales Revenue, both of which are subsequently posted to the general ledger.

Ratio – Debt Ratio

• Debt Ratio is calculated as Total Liabilities / Total Assets; example: 40,000inliabilitiesagainst40,000 in liabilities against 40,000inliabilitiesagainst100,000 in assets equals a 40% debt ratio, indicating financial leverage risk.