Accounting Unit 2 (2-6)

Define cash basis accounting

Cash basis records a transaction only when cash is received or paid out. It is simple

Define accrual basis accounting

Accrual basis records a transaction when it happens — when revenue is earned or an expense is incurred — regardless of when cash moves.

Distinguish between cash basis and accrual basis accounting

Cash: Records when money moves; simpler and shows actual cash flow. Accrual: Records when transactions happen; matches revenue and expenses to the correct period and gives a more accurate profit picture. Both track income and expenses

Identify when revenue is earned and when an expense is incurred under the accrual basis

Revenue is earned when goods are sold or a service is delivered. An expense is incurred when goods or services are used. Record them in the period they relate to

Explain why the accrual basis gives a more accurate measure of profit for a period

It matches revenue earned with expenses incurred in the same reporting period

Explain why profit is not the same as the cash a business has in the bank

Profit is revenue earned minus expenses incurred during a period

State the accounting equation

Assets = Liabilities + Owner’s Equity. The equation must always balance because everything a business owns is funded by borrowing or the owner’s investment.

Define assets

liabilities and owner’s equity

Classify items as assets

liabilities or owner’s equity

Calculate a missing element of the accounting equation

Rearrange the equation: Assets = Liabilities + Owner’s Equity. Owner’s equity = Assets − Liabilities. Liabilities = Assets − Owner’s Equity. Example: Assets = $50

Explain the effect of a transaction on the accounting equation

A transaction changes one or more elements

Distinguishing between current and non-current assets

Current assets are expected to be sold

Distinguishing between current and non-current liabilities

Current liabilities are debts expected to be paid within the next 12 months. Non-current liabilities are debts not expected to be paid within the next 12 months.

Classifying assets and liabilities as current or non-current

Current assets: Cash at bank

Why classifying items as current or non-current is useful to the owner

It separates resources and debts by timing

Purpose of a balance sheet

A financial report that shows a business's financial position at a specific point in time

Preparing a classified balance sheet with correct headings and date

Include the business name

Calculating total assets

total liabilities and owner's equity

Purpose of an income statement

Shows how much income a business has made after deducting the cost of goods sold and other expenses. It shows whether the business made a net profit or net loss over a reporting period.

Preparing an income statement with correct headings and reporting period

Include the business name

Classifying items as revenue or expenses

Revenue: Income earned by the business

Calculating net profit or net loss

First calculate gross profit by subtracting cost of goods sold from revenue. Then subtract total expenses from gross profit to calculate net profit or loss. Gross profit = Revenue − Cost of Goods Sold. Net profit/loss = Gross Profit − Total Expenses. If the result is positive

Distinguishing between a balance sheet and an income statement

A balance sheet shows the business's financial position on a specific date (assets