Financial Accounting Fundamentals

Fundamental Concepts

• Financial accounting is a systematic process of recording, summarizing, and reporting a company's financial transactions.
• It provides a snapshot of a company's financial health at a particular point in time.
• It uses standardized accounting principles and guidelines (GAAP or IFRS) to ensure consistency and comparability across businesses.
• The goal is to produce financial statements for internal management and external stakeholders (investors, creditors, etc.).

Key Financial Statements

• Balance Sheet: Presents a company's financial position at a specific date. It shows assets, liabilities, and equity.
• Assets are what a company owns (e.g., cash, accounts receivable, equipment).
• Liabilities are what a company owes (e.g., accounts payable, loans).
• Equity represents the owners' stake in the company.
• Income Statement: Reports a company's financial performance over a period of time (e.g., a quarter or a year). It shows revenues, expenses, and net income (or loss).
• Statement of Cash Flows: Details the movement of cash both into and out of a company over a period. It categorizes cash flows into operating, investing, and financing activities.
• Statement of Retained Earnings: Summarizes the changes in a company's retained earnings over a period, showing how net income/loss and dividends affect retained earnings.

Accounting Equation

• The fundamental accounting equation is Assets = Liabilities + Equity.
• This equation must always balance. Any transaction will affect at least two accounts to maintain the balance.

Accounting Principles and Standards

• Generally Accepted Accounting Principles (GAAP): A set of accounting standards followed in the United States. These provide a common language for financial reporting.
• International Financial Reporting Standards (IFRS): A globally recognized set of accounting standards that are more prevalent outside of the United States.

Double-Entry Bookkeeping

• This system requires every transaction to affect at least two accounts.
• One account is debited (increased), and another is credited (decreased).
• Debits and credits are recorded in a journal.
• The journal entries are then posted to the ledger, summarizing the changes in each account.

Important Accounts

• Assets: Cash, Accounts Receivable, Inventory, Prepaid Expenses, Property, Plant, and Equipment (PP&E).
• Liabilities: Accounts Payable, Salaries Payable, Notes Payable, Unearned Revenue.
• Equity: Common Stock, Retained Earnings.
• Revenue: Sales Revenue, Service Revenue, Interest Revenue.
• Expenses: Cost of Goods Sold, Salaries Expense, Rent Expense, Utilities Expense, Depreciation Expense.

Accrual Basis Accounting

• Records revenues when earned and expenses when incurred, regardless of when cash changes hands.
• Provides a more accurate picture of a company's financial performance compared to cash basis accounting.

Cash Basis Accounting

• Records revenues when cash is received and expenses when cash is paid.
• Simpler than accrual accounting but less detailed and informative.

Financial Reporting Cycle

• Identifying transactions, recording transactions, summarizing transactions, analyzing transactions.
• This involves various steps and documentation such as journals and ledgers.

Limitations of Financial Accounting

• Financial statements are prepared for the past and do not reflect future performance.

Key Concepts

• Matching Principle: Matching expenses with revenues in the period they are incurred to determine net income or loss.
• Conservatism Principle: When in doubt, understate assets and revenues, and overstate liabilities and expenses.
• Materiality: Financial information is only important if its omission or misstatement could influence the decisions of users.
• Going Concern: Assumes the company will continue operating in the foreseeable future; critical for assessing the accuracy of financial statements.