Understanding Accounting Principles Quiz

Understanding Accounting: An Informative Guide

Background

Accounting is a practice focused on recording, summarizing, analyzing, and communicating economic information. Financial accounting deals with the preparation, presentation, and interpretation of financial statements, such as balance sheets and income statements. The items classified under current assets vary, depending on the entity and the standards used. Cash is considered an asset in accounting terms, typically consisting of liquid, easily convertible assets.

Subtopics

Financial Accounting

Financial accounting focuses on producing external financial reports that comply with generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS). These reports are intended for users who lack specific knowledge about the internal controls of an entity.

Current Assets

Items under current assets are those that are expected to be realized within one year. Some examples include cash, marketable and investment securities, prepaid expenses, and accounts receivable. The classification of assets as current is based on the entity's estimated liquidation period.

Cash

In accounting terms, cash refers to money that is readily available for immediate use by an entity. It includes physical currency and bank balances, which can include checking accounts, savings accounts, and certificates of deposit (CDs). However, cash does not include items such as investments or other types of assets that are not immediately available.

Accounts under Assets

Assets represent resources that have economic value and can be used in the production or delivery of goods and services. Examples of accounts under assets include property, plant, equipment, intangible assets, and investments. The balance sheet provides a summary of these assets at a point in time.

Liabilities

Liabilities represent obligations to transfer money or other assets to other entities in the future. They result from past events and subsequent transactions that require settlements in the future. Some common examples of liabilities include accounts payable, notes payable, and loans payable.

Equity

Equity represents ownership interest in an entity and reflects the residual interest in its assets after deducting its liabilities. It includes both stockholders' equity (stockholders' capital) and retained earnings. Stockholders' equity is calculated by subtracting total liabilities from total assets. Retained earnings reflect the accumulated profits of the company over time.

Basic Assumptions of Accounting

Accounting has several fundamental assumptions to ensure accuracy and relevance of financial statements. These assumptions include going concern, consistency, revenue recognition, and matching.

Consistency

The consistency assumption requires that financial statements be prepared using the same accounting principles from one period to the next, unless there is a valid reason to change. This ensures that financial statements are comparable over time.

Revenue Recognition

The revenue recognition assumption requires that revenue be recorded when it is earned, and that it is matched with the costs incurred in earning it. This ensures that revenue is reported in the period in which it is earned, and costs are matched against the revenue they generate.

Matching

The matching assumption requires that expenses be matched with the revenue they help generate. This ensures that expenses are reported in the periods they benefit, rather than in the periods they are incurred.

Computation of Total Assets and Liabilities

The balance sheet is a financial statement that provides a snapshot of an entity's financial position at a specific point in time. It lists the entity's assets, liabilities, and equity. Assets are listed in order of their liquidity, while liabilities and equity are listed in order of their due dates. The total assets must always equal the sum of total liabilities and equity.