Financial Accounting Fundamentals

Study Notes

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.

Description

Explore the essential concepts of financial accounting, including the systematic process of recording and reporting financial transactions. Dive into key financial statements such as the balance sheet and income statement, which provide insights into a company's financial health and performance.