Introduction to Financial Accounting

Study Notes

Introduction to Financial Accounting

Financial accounting records, summarizes and analyzes financial transactions.
Financial accounting reports these transactions to interested parties, like investors, creditors, and regulatory agencies.

Key Concepts

Accounting Equation: Assets = Liabilities + Equity
- Explains the relationship between a company's resources (assets), obligations (liabilities), and ownership equity.
Double-entry System: Every transaction affects at least two accounts to maintain the balance in the accounting equation.
- This ensures that the accounting equation remains balanced after every transaction.
Accrual Basis Accounting: Revenues and expenses are recorded when earned or incurred, even if cash hasn't been received or paid.
- This provides a more accurate picture of a company's financial performance.
Cash Basis Accounting: Revenues and expenses are only recorded when cash is received or paid out.
- This method is less common and provides a less accurate picture of financial performance.
- Double-entry system uses Accrual basis of accounting.

Important Accounting Principles

Separate Entity: A business is treated as a separate entity from its owner.
- This ensures that personal assets and liabilities are kept separate from business assets and liabilities.
Money Measurement: Only monetary transactions are recorded in accounting books.
- This means that non-monetary events, like employee morale, are not recorded in the accounting system.
Going Concern: Assumes that a business will continue operating indefinitely.
- This allows for the valuation of long-term assets and liabilities.
Accounting Period: Transactions are recorded for a specific period of time, usually 12 months.
- This facilitates the preparation of periodic financial statements.
Revenue Recognition: Revenue is recognized when it is earned, irrespective of when cash is received.
- This is based on the principle that revenue has been earned when the business has completed the performance obligation.
Dual Aspect: Every transaction has two effects on the accounting equation, and therefore is recorded in two accounts.
Matching: Expenses should be matched with the revenue they generate.
- This involves matching expenses incurred during a period with the revenue earned during the same period.
Historical Cost: Assets are recorded at their original cost.
- This principle focuses on objectivity and verification in accounting.
Full Disclosure Principle: All relevant financial information should be disclosed to interested parties.
Consistency Principle: Companies should consistently use the same accounting methods.
- This enhances the comparability of financial statements over time.
Materiality Principle: Only significant financial information needs to be reported.
- This ensures that important information is reported, while avoiding reporting immaterial details
Conservatism Principle: When faced with uncertainty, companies should err on the side of caution and report the least optimistic estimate.
- This promotes transparency and reduces the risk of misleading investors.

Common Accounts and Their Classifications

Assets: Represents resources controlled by a company that are expected to generate future economic benefits.
- Examples: Cash, Accounts Receivable, Inventory, Prepaid Expenses, Property, Plant & Equipment, Intangible Assets.
Liabilities: Obligations that a company owes to others.
- Examples: Accounts Payable, Notes Payable, Accrued Liabilities, Unearned Revenue, Long-term Debt.
Equity: The amount of ownership interest in a company.
- Examples: Common Stock, Retained Earnings, Additional Paid-In Capital, Dividends.

Accounting Cycle

Refers to the steps involved in recording and reporting financial information.
It involves various activities from collecting and organizing financial data to creating financial statements.