Chapter 1: Introduction to Accounting

The Accounting Equation

The accounting equation forms the foundation of financial accounting and represents the relationship among a company's assets, liabilities, and stockholders' equity.

• Equation:

• Assets: Resources owned by the company (e.g., cash, inventory, equipment).

• Liabilities: Obligations owed to outsiders (e.g., loans, accounts payable).

• Stockholders' Equity: Owners' claims on the assets after liabilities are settled (e.g., common stock, retained earnings).

Financial Statements

Financial statements summarize a company's financial performance and position. The main statements are:

• Income Statement: Reports revenues and expenses to determine net income.

• Statement of Retained Earnings: Shows changes in retained earnings over a period.

• Balance Sheet: Presents the company's assets, liabilities, and stockholders' equity at a specific point in time.

Key Formulas:

• Net Income:

• Statement of Retained Earnings:

  • Beginning Retained Earnings

  • + Net Income (or - Net Loss)

  • - Dividends

  • = Ending Retained Earnings

Relationship Among Financial Statements

• Net income from the income statement is added to the statement of retained earnings.

• Ending retained earnings is reported on the balance sheet under stockholders' equity.

Accounts on Financial Statements

• Each account appears on a specific statement (e.g., cash on the balance sheet, revenue on the income statement).

• Understanding account classification is essential for preparing financial statements.

Chapter 2: Financial Statements

Transactions Impacting the Balance Sheet

Business transactions affect the balance sheet by changing assets, liabilities, or equity. Each transaction must keep the accounting equation in balance.

Classified Balance Sheet

A classified balance sheet separates assets and liabilities into current and noncurrent categories:

• Current Assets: Expected to be converted to cash or used within one year (e.g., cash, accounts receivable).

• Noncurrent Assets: Long-term resources (e.g., property, plant, equipment).

• Current Liabilities: Obligations due within one year (e.g., accounts payable).

• Noncurrent Liabilities: Long-term obligations (e.g., bonds payable).

Financial Ratios

Ratios help analyze a company's performance:

• Profitability: Earnings per Share (EPS)

• Liquidity:

  • Working Capital:

  • Current Ratio:

• Solvency:

  • Debt to Total Assets:

Chapter 3: Accounting Records

Transaction Analysis

Transaction analysis determines which events are recorded in the accounting system. Only events that affect the accounting equation are considered transactions.

• Identify affected accounts and their classification (asset, liability, equity, revenue, expense).

• Determine the dollar amounts and the impact on the accounting equation.

Debits and Credits

Debits and credits are the foundation of double-entry accounting. Each transaction must have at least one debit and one credit, and total debits must equal total credits.

• DEA/LOR Rule:

  • Debit increases: Dividends, Expenses, Assets

  • Credit increases: Liabilities, Owner's Equity, Revenues

• Accounts normally have a debit or credit balance based on their type.

Steps in Recording Transactions

1. Identify accounts affected, their classification, and dollar amounts.

2. Book the journal entry: Record debits and credits in the journal.

3. Update T-accounts: Post entries to the ledger accounts.

4. Determine final balances: Calculate ending balances after all entries.

Chapter 4: Adjusting Records

Revenue Recognition and Deferred Revenue

Revenue is recognized when it is earned, not necessarily when cash is received. If cash is received before revenue is earned, it is recorded as deferred (unearned) revenue, a liability.

• Revenue is credited only when earned.

• Deferred revenue is reduced and revenue is recognized when the service or product is delivered.

Expense Recognition and Deferred Expenses

Expenses are recognized when incurred, following the matching principle: expenses are matched to the revenues they help generate in the same period.

• If payment is made before use, record as a deferred expense (asset, e.g., supplies, prepaid insurance).

• When used, transfer from asset to expense.

Adjusting Entries: Deferrals and Accruals

Adjusting entries ensure that revenues and expenses are recorded in the correct period.

• Deferrals: Adjust previously recorded assets or liabilities to reflect earned revenue or used expenses.

• Accruals: Record revenues earned or expenses incurred that have not yet been recorded in cash or accounts.

Contra Asset Accounts

A contra asset account offsets a related asset account. The most common example is accumulated depreciation, which reduces the reported value of fixed assets.

• Increased with credits, decreased with debits (opposite of regular asset accounts).

Adjusting Journal Entries (AJE's)

Adjusting entries are made at the end of the period to update account balances before preparing financial statements.

• Examples include recording accrued expenses, accrued revenues, depreciation, and adjusting deferred accounts.

Additional Topics (Covered in Class)

• Preparation of an adjusted trial balance.

• Preparation of financial statements from the adjusted trial balance.

• Closing entries to zero out temporary accounts (revenues, expenses, dividends) and transfer balances to retained earnings.

Temporary accounts: Income statement accounts and dividends declared; closed at period end.