Accounting Principles and Practices PDF

# What is Accounting? - Also known as book-keeping. - It's the language of business: records every business transaction. ## Examples of Financial Transactions - Fast food restaurant buys buns for $300 - FFR pays $100 for electricity - FFR buys a computer for $1000 ## Accounting Entries - Each...

# What is Accounting? - Also known as book-keeping. - It's the language of business: records every business transaction. ## Examples of Financial Transactions - Fast food restaurant buys buns for $300 - FFR pays $100 for electricity - FFR buys a computer for $1000 ## Accounting Entries - Each transaction is recorded in the accounting language. - Every transaction will have two consequences: Debit & Credit - No exceptions. All transactions have these two. ### Example: Purchase of Buns **Non-Accounting Entry (single entry):** - Cost of buns $300 **Accounting Entry (double entry):** - **Debit** - Buns Inventory (Asset) $300 - **Credit** - Cash paid (Asset) $300 - Debit always = Credit ## Key Rules in Accounting - Start thinking about each transaction in terms of the two consequences or results (Debit/Credit) - Each transaction results in either an increase (+) or decrease (-) in: - Assets - Liabilities - Income - Expense - Equity ### Rules of Debit & Credit: **Example: Payment of Electricity:** **Non-Accounting Entry (single entry):** - Cost of electricity $100 **Accounting (double entry):** - **Debit** - Electricity (Expense) $100 - **Credit** - Cash (Asset) $100 **Example: Purchase of computer:** **Non-Accounting Entry (single entry):** - Cost of computer $1000 **Accounting (double entry):** - **Debit** - Computer (Asset) $1000 - **Credit** - Cash (Asset) $1000 ### Note: What are Debit and Credit: - **Debit:** Money/items coming into an account - Example: Adding money to cash account. - Buying/Assets coming to me. - Expenses/Losses (things that take away value) - Increase assets like cash/equipment. - Goes up for things I own, assets and expenses. - **Credit:** Money coming out of an account - Example: Paying with cash, money going out of account. - Increase in income (sales revenue) - Goes up for things I owe, shares and incomes earned. ## Rules | Type | Increase | Decrease | |---|---|---| | Asset | Debit | Credit | | Liability | Credit | Debit | | Equity | Credit | Debit | | Income | Credit | Debit | | Expense | Debit | Credit | ### Explanation: - **Asset:** Computer: Increase in debit: 1 computer and purchased another so now we have 2 computers. Decrease in debit: $3000 - $1000 (computer change) = $2000 with money. - **Liability:** - Credit ↑: increasing what I owe (e.g. borrowing money) - Debit ↓: reducing what I owe (e.g. paying off loan) - **Equity:** Represents what the company owes its shareholders. - Example: Owner invests $1000 - Credit ↑: owners add money to business & increase their share (you owe them) - Debit ↓: when owners take money out (reducing their share) - **Income:** Money the business earns, making a sale from products. - Credit ↑: earning money (sales/revenue coming in) - Debit ↓: losing income (like refunds) - **Expense:** Like rent, utilities or supplies. - Debit ↑: increases expenses because money is out - Credit ↓: get refunded for something you paid for. # What are Assets? - Something I own & expect to use/benefit from in the future. - "A present economic resource controlled by an entity as a result of past events" - "A right that has potential to produce economic benefits." - International Finance Reporting Standards: IFRS ## Examples of Assets: | Current Assets | Non-current Assets | Intangible Assets | |---|---|---| | CASH | Inventory | Accounts Receivable (money customers owe after getting a service done) | | Non-cash | Building/Office/Land/Property | Prepaid Payments (payments made in advance for services) | | Intangible | Computer hardware/software | Investments | | | Furniture | Goodwill (buying out another company) | | | Equipment/Machinery | Trade marks/patents/copyrights | | | Vehicles | ## Types of Assets: | Current | | Non-Current | | Tangible (Physical Things) | Intangible (Not Physical) | | -------- | -------- | -------- | -------- | -------- | -------- | | Short-term | | Long-term | | Tangible | Intangible | | Cash/Cash equivalents (can be converted into cash quickly if needed) | Expealed to form to cash within 12 months | Fixed | All assets over than current assets | Can be created/acquired | Can be created: no book value | | | Expelled to be sold/consumed within nonnal operating cycle | Capital | Expected to be utilized or converted to cash over more than 12 months | | Can be definite/indefinite | | | Found in balance sheets | | | | | | | | | | # What is a Liability? - Something the company owes, i.e. debts/obligations that need to be paid in the future. - IFRS: "present obligation of the entity to transfer an economic resource as a result of past events" ## Examples of Liabilities: | Current | Non-Current | | -------- | -------- | | Accounts Payable (due to be paid by company (opposite or receivables) | Long-term Debt/Loans | | Accrued Liabilities (expenses incurred but not received the bill yet, i.e. electricity expenses) | | | Accrued Salaries and Wages (same as ↑, employees worked but not paid yet) | | | Taxes Payable | | | Deferred Revenue (money received from customers but service not provided yet) | | | Bank Overdraft (any money overdrawn from bank) | | | Short-term Debt | | ## Types of Liabilities: | Current | | Non-Current | | Contingent | | -------- | -------- | -------- | -------- | -------- | | Short-term | | Long-term | | Liabilities dependent on an uncertain future | | | | Fixed | | Examples: lawsuits, product warranties, bank guarantees | # What is Equity? - The value that belongs to the owner after all liabilities have been paid, i.e. the owner’s share of the company assets. - IFRS: "Residual interest in the assets of the entity after deducting all its liabilities" ## Equity: - Represents ownership - **Assets - Liabilities = Equity** / **Assets = Liabilities + Equity** - Ordinary Shares - Preference shares - Accumulated Retained Earnings: yearly profits/losses # Income and Expenses - Income: Money the company earns from sales, services or investments, it increases assets + equity, & decreases liability. - Example: Selling food for cash: ↑ cash assets - Accounting entry: - Debit: Cash received (Asset) $600 - Credit: Sale of burgers (Income) $600 - Examples: sale of goods, service income, dividend income, rental income, gain on sale assets. - Expenses: The cost the company pays to run its business, in exchange for something. - ↓ assets/cash, ↑ liability, ↑ equity - Debit entry when: - Decrease in Assets: Cash/Prepaid Expenses, etc. - Increase in Liabilities: Accrued Expenses, etc. - Credit entry when: - Increase in Equity (e.g., paying for a building) - Example: Paying rent for a building. - Accounting entry: - Debit: Rent (expense) $600 - Credit: Cash (Asset) $600 - Examples: salaries/wages, training, meals, rent, cleaning, office supplies, electricity, gas, water, repairs/maintenance, taxes, interest, depreciation, insurance, lease, travel. ## IFRS: - Income: Increases in assets/decrease in liabilities that result in increases in equity, other than those relating to contributions from holders of equity claims - Expenses: Decreases in assets/increase in liabilities that result in decreases in equity, other than those relating to distributions to holders of equity claims. ## Accounting Principles - Applied when preparing financial statements or accounting entries. 1. Accrual Principle 2. Matching 3. Consistency 4. Cost (or historical cost) 5. Going Concern 6. Materiality 7. Revenue recognition ### Accrual Principle: - Record transactions in the period when they actually occur. - Not when related cash is paid or received (Opposite of cash basis of accounting). - Example: If you pay an electric bill of January in February, record no expense in January. - You can estimate if you don't have exact bills. ### Matching Principle: - Match revenue and expenses so that they are recorded in the same period - Example: Record cost of sales expense in the same period as when the sales revenue is recorded. - Company bought 10 phones to sell in January but sold them in February, record cost of sales in February. The phones in January will be recorded as assets/Inventory ### Cost Principle: - Record assets at their purchase price and do not adjust for inflation or market value fluctuations - Example: Company buys a car and records its original cost of purchase and depreciate over its car life, without considering market value changes - **Note:** Depreciation: Gradual decrease of tangible asset over time as a result of wear and tear. - Does not apply to all types of assets (e.g. short-term investments). - Does not allow recording assets which were not acquired in a transaction. - Example: Internally generated goodwill or trademark. ### Going Concern Principle: - Assumption that business will remain in operations for the foreseeable future. - Write down of assets not required, since all previously recovered assets are still valid. - Example: Plant and machinery can be carried off Net book value (cost - depreciation). - However, if business will shut down, the assets will devalue, so the value of assets need to be written down. ### Materiality Principle: - If the amount is not large enough to influence the decision of investors, a misclassification or omission is not material. - Example: Asset with useful life of 10 years that cost $25 (e.g. calculator) can be recorded fully as an expense immediately (no need to match useful life of the asset with the time it was bought/allocation if its cost). - Vary by size of the organization. ### Revenue Recognition Principle: - Record revenue as/when goods or services are delivered, regardless of when cash is received (Accrual and matching) - Example: - When product is sold for credit, revenue is recorded when product is delivered, not when cash is received. - When revenue is related to project work, revenue is recorded based on % of completion, not when payments are received. ### Consistency Principle: - Need to consistently apply accounting principles, policies and methods unless a better one is available. - To unify financial statements to be able to read and compare them. - Example: Straight line method to calculate depreciation vs. reducing balance method, capitalization policy ## Flow of Accounting Entries 1. **Journal Entries:** Record all business transactions (double entry) in chronological order 2. **General Ledger:** Summarize all transactions with balances by account type in respective General Ledger Accounts 3. **Trial Balance:** List of accounts with balances 4. **Financial Statement:** - Balance Sheet - Income Statement - Cash flow Statement - Changes in Equity - Comprehensive Income.