Fundamentals of Accounting & Fincancial Statements

Accounting

System for recording financial transactions.

Financial Statements

Reports summarizing financial performance and position.

Financial Statements are identified by

the name of the business, the title of the statement, and the date or period of time.

Income Statement → Stockholders' Equity (relationship)

Net income increases retained earnings; dividends decrease it.

Stockholders' Equity → Balance Sheet: (relationship)

Retained earnings and equity changes update stockholders' equity

Balance Sheet Check(relationship)

Ensures Assets = Liabilities + Stockholders' Equity with updated retained earnings.

GAAP

Generally Accepted Accounting Principles for financial reporting.

Accounting Equation

Assets = Liabilities + Equity.

Assets

are resources owned by the business entity. These resources can be physical items, such as cash and supplies, or intangible that have value.

Liabilities

are debts owed to outsiders (creditors).

Liabilities are often identified on the balance sheet by titles that include payable

Equity

is the stockholders’ right to the assets of the business. Stockholders’ equity is represented by the balance of the common stock and retained earnings accounts

Revenue

are increases in assets and stockholders’ equity as a result of selling services or products to customers.

Examples include fees earned, fares earned, commissions revenue, and rent revenue.

Expenses

result from using up assets or consuming services in the process of generating revenues.

Examples, include wages expense, rent expense, utilities expense, supplies expense, and miscellaneous expense.

Net Income

Total revenue minus total expenses.

Balance Sheet

Snapshot of assets, liabilities, and equity.

Balance Sheet Formula

Assets = Liabilities + Equity(common stock, retained earnings)

Income Statement

Summary of revenues and expenses over time.

Income Statement Formula

Revenues - Expenses = Net Income

Statement of Equity

Changes in equity over a period.

Retained Earnings

Cumulative earnings not distributed as dividends.

Debits

Entries on the left side of an account.

Credits

Entries on the right side of an account.

Accrual Basis

Revenue recognized when earned, not received.

Cash Basis

Revenue recognized when cash is received.

Adjusting Journal Entries

Entries made at period end for accuracy.

Historical Cost Principle

Assets recorded at original purchase cost.

Going Concern Assumption

Business will continue operating indefinitely.

Monetary Unit Assumption

Transactions recorded in a stable currency.

Time Period Assumption

Financial statements prepared for specific time periods.

Accounting Cycle

Process of recording and reporting financial transactions.

Accounting Cycle Steps (In Order):

1:Identify Transactions - Record business activities with financial impact.

2:Journalize Transactions - Enter transactions in the general journal.

3:Post to Ledger - Transfer journal entries to the general ledger.

4:Unadjusted Trial Balance - List all accounts to check for errors.

5:Adjusting Entries - Record accruals, deferrals, and corrections.

6:Adjusted Trial Balance - Verify account balances before statements.

7:Financial Statements - Prepare Income Statement, Equity Statement, and Balance Sheet.

8:Closing Entries - Close revenues, expenses, and dividends to retained earnings.

9:Post-Closing Trial Balance - Ensure only permanent accounts carry forward.

Temporary Accounts

Accounts closed at the end of the period.

Permanent Accounts

Accounts that carry balances into the next period.

Journal Entry

Record of a financial transaction in accounts.

Closing Entries

Entries to transfer balances to retained earnings.

Accrued Revenue

Revenue earned but not yet received.

Dividends

Distribution of earnings to shareholders.

Retained Earnings Formula

Beginning Retained Earnings + Net Income Dividends = Ending Retained Earnings

Balance Sheet Accounts include

Assets-cash,accounts receivable,supplies,prepaid insurance,land,office equipment

Liabilities - Accounts Payable,Unearned Rent

Equity - Common Stock,Retained Earnings,Dividends

Income Statement Accounts include

Revenue - Fees Earned

Expenses - Wages expense,Supplies Expense,Rent expense,utilities expense,Miscellaneous Expense

How do Debits & Credits affect different account types?

🔹 DEAD = Debits Increase

Dividends

Expenses

Assets

🔹 CLER = Credits Increase

Liabilities

Equity

Revenue

✅ Debit = Increase Assets & Expenses

✅ Credit = Increase Liabilities, Equity & Revenue

Example: The company receives $1,000 in cash for services. How do you record this?

Cash (Asset) increases → Debit Cash $1,000

Revenue (Sales) increases → Credit Revenue $1,000

The company pays $500 for rent. How do you record this?

Rent Expense (Expense) increases → Debit Rent Expense $500 Cash (Asset) decreases → Credit Cash $500

✅ Company issues $3,000 of common stock

Cash (Asset) increases → Debit Cash $3,000

Equity (Common Stock) increases → Credit Common Stock $3,000

✅ What is Posting from Journal to Ledger?

🔹 The process of transferring journal entries to the ledger by updating individual accounts.

🔹 Ensures all transactions are properly recorded and balances are accurate.

✅ Steps for Posting from Journal to Ledger?

Back:

1. Identify affected accounts

2. Transfer debit/credit amounts to ledger

3. Update account balances

4. Add references for tracking

✅ What is a Trial Balance?

🔹 A list of all account balances to check if Debits = Credits.

🔹 Helps catch errors before preparing financial statements.

✅ What happens if the Trial Balance doesn't balance?

🔹 There is an accounting error (ex: missing, double, or incorrect entries).

🔹 Must review journal and ledger to find the mistake.

✅ What is the Accrual Basis of Accounting?

Required by GAAP

🔹 Records revenue when earned (not when cash is received)

🔹 Records expenses when incurred (not when paid)

What is the Revenue Recognition Principle?

🔹 Revenue is recorded when earned, not when cash is received.

🔹 Example: If a company provides a service in December but gets paid in January, revenue is recorded in December.

✅ What is the Expense Recognition (Matching) Principle?

🔹 Expenses are recorded when incurred, not when paid.

🔹 Example: If a company pays 6 months of rent upfront, it records only one month's rent at a time as an expense.

✅ Are Adjusting Entries the same as Adjusting Journal Entries?

🔹 Yes! Adjusting Journal Entries (AJEs) = Adjusting Entries

🔹 They update accounts before financial statements

🔹 Recorded in the journal and then posted to the ledger

✅ What is the purpose of adjusting entries?

Ensure revenues are recorded when earned (Revenue Recognition Principle)

🔹 Ensure expenses are recorded when incurred (Matching Principle)

🔹 Update accounts before preparing financial statements

✅ When are adjusting entries made?

At the end of an accounting period before financial statements are prepared

🔹 Adjust for unpaid expenses, unearned revenue, or missing accruals

✅ What are the two key rules of adjusting entries?

1. No Cash Account is involved

2. Always include a Revenue or Expense AND an Asset or Liability

What are the two main types of Adjusting Entries?

🔹 Accruals - Unrecorded, no cash flow yet (Accrued Revenues & Accrued Expenses)

🔹 Deferrals - Cash paid/received first (Prepaid Expenses & Unearned Revenue)

What are Accrued Revenues?

Revenue earned but not yet received 📌

Example: A company provides services in December but gets paid in January. ✅ Adjusting Entry:

Debit Accounts Receivable (Asset ↑)

Credit Service Revenue (Revenue ↑)

What are Accrued Expenses?

🔹 Expenses incurred but not yet paid 📌

Example: A company owes salaries for December but pays in January. ✅ Adjusting Entry:

Debit Salaries Expense (Expense ↑)

Credit Salaries Payable (Liability ↑)

What are Prepaid Expenses?

🔹 Expenses paid in advance, recognized over time 📌

Example: A company pays $12,000 for a year of rent upfront in January. ✅ Adjusting Entry (Monthly):

Debit Rent Expense $1,000 (Expense ↑)

Credit Prepaid Rent $1,000 (Asset ↓)

What is Unearned Revenue?

🔹 Cash received before revenue is earned 📌

Example: A customer pays $3,000 for a subscription service in advance. ✅ Adjusting Entry (As Service is Performed):

Debit Unearned Revenue (Liability ↓)

Credit Service Revenue (Revenue ↑)

✅ How can I remember the four types of adjusting entries?

🔹 A-DER = Accrued (Expenses & Revenues) Deferrals (Expenses & Revenue)

🔹 Accruals → Nothing recorded yet (add revenue or expense)

🔹 Deferrals → Cash paid/received first (adjust assets/liabilities)

What is Depreciation?

A process of cost allocation, NOT market valuation🔹 Spreads the cost of a long-term asset over its useful life🔹 Applies to assets like buildings, equipment, and vehicles (NOT land)

✅ Why is Depreciation recorded?

🔹 Follows the Matching Principle → Expenses must be recorded in the period they help generate revenue

🔹 Helps recognize asset usage over time

What is the journal entry for recording depreciation?

✅ Adjusting Entry:

Debit Depreciation Expense (Expense ↑)

Credit Accumulated Depreciation (Contra-Asset ↑) 📌

Example: If depreciation for the year is $5,000: Debit Depreciation Expense $5,000

Credit Accumulated Depreciation $5,000

What is Accumulated Depreciation?

🔹 A contra-asset account that tracks total depreciation over time

🔹 Appears on the balance sheet under assets but reduces the asset's book value

✅ How does Depreciation affect financial statements?

🔹 Income Statement: Increases Depreciation Expense (reduces Net Income)

🔹 Balance Sheet: Increases Accumulated Depreciation (reduces asset's book value)

✅ What are the common methods of Depreciation?

️1. Straight-Line Method - Equal expense each year

2. Declining Balance Method - Higher expense earlier, lower later

3. Units of Production Method - Based on actual usage of the asset

✅ How can I remember the key points of depreciation?

🔹 "Depreciation is NOT a loss in value, it's a cost allocation!"

🔹 Recorded as an expense, tracked in Accumulated Depreciation

🔹 Affects both the Income Statement & Balance Sheet

✅ How is Property, Plant, and Equipment (PPE) presented on the Balance Sheet?

📌 Formula:

🔹 Cost - Accumulated Depreciation = Book Value

🔹 PPE is reported at its book value, NOT market value

🔹 Found under Assets on the Balance Sheet

✅ What is Book Value?

🔹 Book Value = Original Cost - Accumulated Depreciation

🔹 Represents the asset's remaining value on the books

🔹 Not equal to market value

Where is Accumulated Depreciation on the Balance Sheet?

🔹 Listed under Property, Plant, & Equipment (PPE)

🔹 A contra-asset account that reduces the asset's total cost

🔹 Shows the total depreciation taken over time

✅ Example of PPE on a Balance Sheet?

📌 A company purchases equipment for $50,000

📌 Accumulated depreciation is $20,000

🔹 Balance Sheet Presentation:

Equipment (Cost) = $50,000

Less: Accumulated Depreciation = ($20,000)

Book Value = $30,000

✅ What is the purpose of closing entries?

🔹 To reset temporary accounts (revenues, expenses, dividends) to zero

🔹 Transfers net income (or loss) to Retained Earnings

🔹 Prepares accounts for the next accounting period

✅ Which accounts are closed during closing entries?

🔹 Temporary Accounts → Closed at the end of the period

Revenues

Expenses Dividends (or Owner's Withdrawals)

🔹 Permanent Accounts → NOT closed, carry forward

Assets, Liabilities, Equity (including Retained Earnings)

✅ What are the four steps for closing entries?

1. Close Revenues to Income Summary Debit Revenue Credit Income Summary

2. Close Expenses to Income Summary Debit Income Summary Credit All Expense Accounts

3. Close Income Summary to Retained Earnings If net income: Debit Income Summary, Credit Retained Earnings If net loss: Debit Retained Earnings, Credit Income Summary

4. Close Dividends to Retained Earnings Debit Retained Earnings Credit Dividends

(CE) ✅ Example: Closing $50,000 Revenue and $30,000 Expenses

🔹 Step 1: Close Revenue Debit Revenue $50,000 Credit Income Summary $50,000

🔹 Step 2: Close Expenses Debit Income Summary $30,000 Credit Expense Accounts $30,000

🔹 Step 3: Close Income Summary (Net Income = $20,000) Debit Income Summary $20,000 Credit Retained Earnings $20,000

✅ What are Temporary vs. Permanent Accounts?

🔹 Temporary Accounts: Closed at the end of each period Revenues, Expenses, Dividends

🔹 Permanent Accounts: Never closed Assets, Liabilities, Retained Earnings

✅ How can I remember closing entry steps?

🔹 REDI = Revenues, Expenses, (Income Summary), Dividends

🔹 Always close temporary accounts to retained earnings

Expenses are always?

debits

Revenues are always?

credits

What are the five main types of accounts?

1. Assets - Resources owned (Cash, Accounts Receivable, Equipment)

2. Liabilities - Debts owed (Accounts Payable, Notes Payable)

3. Stockholders' Equity - Owners' claims (Common Stock, Retained Earnings)

4. Revenues - Income earned (Service Revenue, Sales Revenue)

5. Expenses - Costs incurred (Salaries Expense, Rent Expense)

What are examples of asset accounts?

Current Assets: Cash, Accounts Receivable, Inventory, Prepaid Expenses

Long - Term Assets: Land, Equipment, Buildings, Investments

: What are examples of liability accounts?

Current Liabilities: Accounts Payable, Salaries Payable, Unearned Revenue

Long-Term Liabilities: Notes Payable, Bonds Payable

What are examples of stockholders' equity accounts?

Common Stock

Retained Earnings

What are examples of revenue accounts?

Service Revenue

Sales Revenue

Interest Revenue

What are examples of expense accounts?

Salaries Expense

Rent Expense

Utilities Expense

Depreciation Expense