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Accounting Principles SummaryChapters 1 – 26, excluding 7, 8 and 18.
1. Accounting in Action
What Is Accounting
Accounting consists of 3 activities:
1. Identifies the economic events relevant to its business
2. Recording those events in a systematic, chronological diary of events
3. Communication of collected information to interested users. Vital is the accountants ability to analyze
and interpret the reported information.
Users of accounting data are:
Internal users: managers who plan, organize and run the business
External users: individuals and organizations outside a company who want Financial information
about the company, e.g.: investors, creditors, taxing authorities, regulatory agencies etc.
The Building Blocks of Accounting
Sarbanes-Oxley act (SOX) intents to reduce unethical corporate behavior by making top management
responsible for the accuracy of financial information and by increasing the independence requirements for
outside auditors.
Generally Accepted Accounting Principles (GAAP) generally accepted and universally practiced accounting
standards.
FASB and SEC are respectively the US accounting standard setting body and financial market supervisor
IASB is the international standard-setting body with its own standard called IFRS.
GAAP uses 2 measurement principles. Principle selection results in trade-offs in relevance and faithful
representation.
1. Historical cost principle: companies record assets at their cost. This principle is mostly used.
2. Fair value principle: companies record assets at their fair value.
Two main accounting assumptions:
1. Monetary unit assumption: accounting records only transaction data that can be expressed in money
terms
2. Economic entity assumption: the activities of the entity are to be kept separate from the activities of
the owner and the activities of other economic entities.
Business types:
1. Proprietorship: the business has one owner and the owner is personal liable for all debts of the
business. A proprietorship requires a small amount of capital to start.
2. Partnership: the business has two or more owners. Partners are personal liable for all business debts.
The partnership agreement contains all agreements between partners.
3. Corporation: the business is a separate legal entity, unlike the partner- and proprietorship. Owners
(stockholders) have a limited liability regarding debts.
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Nathan Janssen
,The Basic Accounting Equation
Basic: Assets = Liabilities + Owner’s Equity
Expanded: Assets = Liabilities + Owner’s Capital – Owner’s Drawings + Revenues - Expenses
Assets are resources a business owns. Assets have the capacity to provide future services or benefits.
Liabilities are claims against assets – that is, existing debts and obligations. Types of liabilities:
Accounts payable
Notes payable
Salaries and wages payable
Owner’s Equity is the ownership’s claim on total assets. Asset claims from creditors go before asset claims by
the owner(s). That’s why Residual Equity is a synonym for Owner’s Equity. Owner’s equity consists of:
Owner’s Capital: investments by owner(s).
Owner’s Drawings: assets withdrawn by the owner.
Revenues: gross increase in owner’s equity resulting from business activities entered into for the
purpose of income.
Expenses: decreases in Owner’s Equity resulting from operating expenses.
Using the Accounting equation
Transactions are a business’s economic events recorded by accountants. Transactions must have a dual effect
on the accounting equation. Types of transactions:
Internal: transactions that occur entirely within the company.
External: transactions involving the company and some outside entity.
Examples on pages 15-20 of the book.
Financial Statements
There are four financial statements:
1. Income statement presents revenues and expenses and resulting net income or net loss. For a period
of time.
2. Owner’s Equity statement summarizes the changes in owner’s equity. For a period of time.
3. Balance sheet reports the assets, liabilities and owner’s equity. At a specific date.
4. Cash flow statement summarizes information about the cash inflows (receipts) and outflows
(payments). For a specific period of time.
Examples on page 21 of the book.
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Nathan Janssen
, 2. The Recording Process
The Account
An account is an individual accounting record of increases and decreases in a specific asset, liability or owner’s
equity item. Accounts are presented in the form of a T-account.
Debit (Dr.) indicates the left side of an account. Title of account
Credit (Cr.) indicates the right side account.
Left or Debit side Right or credit side
Debiting means increasing the left side of the account.
Crediting means increasing the right side of the account.
If debiting an account increases the account, than the account is a debit account.
If crediting an account increases the account, than the account is a credit account.
The following tables show the effect of debiting and crediting of the various accounts of the accounting
equation.
Assets Liabibities Owner's Equity
Assets = Liabilities + Own. Cap. - Own. Draw. + Revenues - Expenses
Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr.
+ - - + - + + - - + + -
Steps in the Recording Process
Every business uses three basic steps in the recording process.
1. Analyze each transaction for its effects on the accounts.
2. Enter the transaction information in the journal.
3. Transfer the journal information to the appropriate accounts in the ledger.
The journal is referred to as the book of original entry. Companies initially record transactions in chronological
order here. Uses of the journal:
1. Discloses in one place the complete effects of a transaction.
2. Provides a chronological record of transactions.
3. Helps to prevent and locate errors, because debit en credit amounts can be compared easily.
Examples on page 53 and 54.
The ledger is the entire group of accounts maintained by a company. The ledger provides the balance in each
of the accounts as well as keeps track of changes in these balances. The ledger consists of the:
Individual asset accounts, e.g.: equipment, land, supplies and cash.
Individual liability accounts, e.g.: interest payable, salaries and wages payable, accounts payable, notes
payable.
Individual owner’s equity accounts, e.g.: Salaries and wages expense, service revenue, owner’s
drawings, owner’s capital
Examples on pages 56 – 64 of the book.
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Nathan Janssen
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