Accounting vocab 1-3

Separate entity assumption

The business is treated as distinct from its owners; personal and business transactions are kept apart.

Historical cost principle

Assets are recorded at their original cost when acquired, not current market value.

Revenue recognition (realization) principle

Revenue is recorded when it is earned (service performed or goods delivered), regardless of when cash is received.

Time period assumption

The life of a business is divided into artificial periods (months, quarters, years) for regular reporting.

Conservatism

When uncertain, choose the option less likely to overstate assets or income.

Materiality

Only items large enough to affect decisions must follow GAAP strictly; trivial amounts (e.g., a $15 stapler) can be expensed.

Going concern assumption

The business is assumed to continue operating into the foreseeable future.

Cost-benefit

The benefit of providing accounting information must exceed the cost of providing it.

Unit of measure assumption

Transactions are recorded in a stable monetary unit (dollars), ignoring changes in purchasing power.

Sole proprietorship

Business form with one owner; not legally separate from the owner.

Partnership

Business form with two or more owners; not legally separate from the owners.

Corporation

Business form that is a separate legal entity owned by stockholders, who have limited liability.

Assets

Economic resources owned by the business (cash, accounts receivable, supplies, equipment, land).

Liabilities

Obligations owed to others (accounts payable, notes payable, salaries payable, unearned revenue).

Owners' (stockholders') equity

The owners' residual claim on assets after liabilities are paid (assets - liabilities).

Revenues

Inflows from providing goods or services (e.g., service revenue).

Expenses

Costs incurred to earn revenue (rent, wages, utilities, supplies used).

Operating activities

Day-to-day activities of earning revenue (collecting from customers, paying wages and rent).

Investing activities

Buying and selling long-term assets (equipment, land, buildings).

Financing activities

Obtaining money from owners and creditors (issuing stock, borrowing, repaying loans, paying dividends).

Accounting equation

Assets = Liabilities + Owners' Equity

Income statement

Reports revenues minus expenses (net income or net loss) for a period of time.

Statement of retained earnings

Reports beginning retained earnings + net income - dividends = ending retained earnings, for a period of time.

Balance sheet

Lists assets, liabilities, and owners' equity at a specific date.

Net income (profit)

Revenues minus expenses for the period.

Fiscal year

Any 12-month reporting period; may be the calendar year or a natural business year ending when activity is low.

Interim period

A reporting period shorter than a year, such as a month or quarter.

Operating cycle

Time to go from spending cash on inventory/services, to making sales, to collecting cash from customers.

Liquidity

How quickly an asset can be converted to cash, or ability to pay obligations; balance sheet assets are listed in order of liquidity.

Current asset

Cash or an asset expected to be converted to cash or used up within one year or the operating cycle.

Transaction

An event with a measurable economic effect on the business that is recorded in the accounts (purchase, sale, payment, investment).

Double-entry accounting

Every transaction affects at least two accounts, and the accounting equation always stays in balance.

Accounting cycle

The series of steps repeated each period, from analyzing and recording transactions through preparing statements and closing the books.

Asset vs. expense

A cost benefiting future periods is an asset (prepaid insurance, equipment); a cost used up now is an expense (this month's rent).

Accounts receivable

Amounts customers owe you for services already provided (asset).

Accounts payable

Amounts you owe suppliers for purchases on account (liability).

Notes payable

Amounts owed under a formal written promise to pay (liability).

Unearned revenue

Cash received before the service is performed; a liability because you owe the service.

Prepaid expense

A cost paid in advance, recorded as an asset until used.

Account

A record used to collect the increases and decreases for one item (e.g., cash, rent expense).

T-account

Simplified account with three parts: title (account name), left side (debits), right side (credits).

Debit

An entry on the left side of an account.

Credit

An entry on the right side of an account.

Normal balance

The side that increases an account.

Chart of accounts

The list of all accounts a company uses, usually numbered by type.

General ledger

The complete collection of all of a company's accounts.

Dividends

Distributions of a corporation's earnings to stockholders; reduce retained earnings and are NOT an expense.

Components of corporate owners' equity

Common stock (paid-in capital from stockholders) and retained earnings (cumulative net income less cumulative dividends).

Debit-normal accounts (DEALER)

Dividends, Expenses, Assets: debit increases, credit decreases.

Credit-normal accounts

Liabilities, Equity (common stock, retained earnings), Revenue: credit increases, debit decreases.

Debit-normal T-account balance

Total debits - total credits.

Credit-normal T-account balance

Total credits - total debits.

Entry: cash paid to creditors on account

Debit Accounts Payable, Credit Cash.

Entry: issue stock for cash

Debit Cash, Credit Common Stock.

Entry: receive cash before service is performed

Debit Cash, Credit Unearned Service Revenue.

Entry: perform service on account

Debit Accounts Receivable, Credit Service Revenue.

Entry: collect cash on account

Debit Cash, Credit Accounts Receivable.

Entry: buy one-year insurance policy for cash

Debit Prepaid Insurance, Credit Cash.

Entry: pay dividends

Debit Dividends, Credit Cash.

Retained earnings formula

Beginning RE + Net income - Dividends = Ending RE