Fundamentals of Accounting Principles and Financial Statements

Accounting Equation

Assets = Liabilities + Stockholders' Equity

Balance Sheet

A snapshot of a company's financial position at a specific point in time.

Three Main Sections of the Balance Sheet

Assets, Liabilities, and Stockholders' Equity

Current Assets

Assets expected to be converted to cash or used within one year.

Examples of Current Assets

Cash, Accounts Receivable, Supplies, Inventory, Prepaid Expenses

Long-term Assets

Assets not expected to be used or turned into cash within a year.

Current Liabilities

Obligations due within one year, like Accounts Payable and Unearned Revenue.

Stockholders' Equity Composition

Contributed capital (Common Stock + Additional Paid-in Capital) and Retained Earnings

Retained Earnings

Cumulative net income not distributed as dividends.

Purpose of the Income Statement

To report revenues and expenses to calculate net income over a period.

Operating Revenues

Revenues from the core business operations (e.g., sales of products/services).

Operating Expenses

Expenses incurred to generate operating revenue.

Three Categories on the Cash Flow Statement

Operating, Investing, Financing

Examples of Operating Activities

Cash from customers, cash paid to suppliers and employees

Examples of Investing Activities

Purchase/sale of equipment, investments

Examples of Financing Activities

Issuing stock, borrowing money, paying dividends

Accrual Basis Accounting

Revenues/expenses are recognized when earned/incurred, not when cash is received/paid.

Revenue Recognition Principle

Recognize revenue when goods/services are delivered.

Matching Principle

Record expenses in the same period as the related revenues.

Difference Between Expenditure and Expense

An expenditure is any cash outflow; an expense is a cost matched with revenue.

Adjusting Entries

Required at the end of the accounting period before financial statements are issued.

Deferred Revenues

Cash received before revenue is earned; recorded as a liability.

Accrued Revenues

Revenue earned but not yet received or recorded.

Deferred Expenses

Prepaid expenses not yet used; recorded as assets.

Accrued Expenses

Expenses incurred but not yet paid or recorded.

Depreciation

The allocation of the cost of long-term assets over their useful lives.

Account Used to Record Depreciation

Accumulated Depreciation (a contra-asset)

Net Book Value

Asset cost minus accumulated depreciation.

Treasury Stock

Stock repurchased by the company, reducing stockholders' equity.

Contra-account

An account that reduces a related account (e.g., Accumulated Depreciation).

Journal Entry

A formal accounting record of a transaction using debits and credits.

T-accounts

Used to visualize the effects of transactions on accounts.

Trial Balance

To ensure total debits equal total credits.

Closing Process

Transferring temporary account balances to retained earnings.

Temporary Accounts

Revenues, expenses, and dividends — reset to zero after closing.

Post-Closing Trial Balance

To confirm that debits = credits and all temporary accounts are zeroed.

GAAP

Generally Accepted Accounting Principles — rules for financial reporting.

FASB

Financial Accounting Standards Board, which sets GAAP.

Going Concern Assumption

The business will continue operating into the foreseeable future.

Separate Entity Assumption

Business transactions are separate from the owner's personal activities.

Monetary Unit Assumption

Financial results are reported in a consistent currency (e.g., U.S. dollars).

Historical Cost Principle

Assets are recorded at their original cost.

External Transaction

A transaction between the company and an outside party.

Internal Transaction

Events like using prepaid rent or recording depreciation.

Current Ratio Formula

Current Assets / Current Liabilities.

High Current Ratio

Indicates a strong liquidity position — better ability to pay short-term obligations.

Revenue Recognition

Revenue is not recognized at the time of payment when goods/services are not yet delivered (e.g., gift cards).

Accrued Expense

Record an accrued expense and a payable when expenses are incurred but not paid.

Paying Rent in Advance

Increase Prepaid Expense (asset), decrease Cash.

Using Up Prepaid Rent

Decrease Prepaid Expense, increase Rent Expense.

Recording Expenses When Incurred

You record the cost when the benefit is used, not when you pay.

Depreciation Effect on Accounting Equation

Decreases assets via Accumulated Depreciation, increases expenses (reducing equity).

Closing Entry for Revenue

Debit Revenue, Credit Retained Earnings.

Closing Entry for Expenses

Debit Retained Earnings transferred from: Credit Expense accounts.

EPS Ratio

Net Income / Average Outstanding Shares.

EPS Measurement

Profitability per share of stock.

Unearned Revenue

Classified as a liability.

Dual Effect of Every Transaction

It affects at least two accounts and keeps the equation in balance.

Posting to the Ledger

Transfer journal entry information to T-accounts.

Major Types of Accounts

Assets, Liabilities, Stockholders' Equity, Revenues, Expenses.

Net Profit Margin Ratio Formula

Net Income / Net Sales.

Calculating Earnings Per Share (EPS)

Net Income / Average Shares Outstanding.

Depreciation

(Cost − Salvage Value) / Useful Life

Ending Retained Earnings

Beginning Retained Earnings + Net Income − Dividends

Expanded Accounting Equation

Assets = Liabilities + Contributed Capital + Retained Earnings

Total Assets

Liabilities + Stockholders' Equity

Return on Assets (ROA)

Net Income / Average Total Assets

Interest Expense Calculation

Principal × Interest Rate × Time

Net Book Value

Asset Cost − Accumulated Depreciation

Prepaid Rent Entry on Jan 1

Debit Prepaid Rent $12,000; Credit Cash $12,000

Adjusting Entry for Prepaid Rent on Jan 31

Debit Rent Expense $1,000; Credit Prepaid Rent $1,000

Entry for Cash Received for Shoes Not Delivered

Debit Cash $200; Credit Unearned Revenue $200

Entry When Shoes Are Delivered

Debit Unearned Revenue $200; Credit Sales Revenue $200

Utility Expense Entry for March

Debit Utilities Expense $115; Credit Utilities Payable $115

Repairs Expense Entry for March

Debit Repairs Expense $80; Credit Cash $80

Chipotle Food Sales Entry

Debit Cash $1,315; Debit A/R $44; Credit Revenue $1,359

Chipotle Supplies Purchase Entry

Debit Supplies $459; Credit Cash $379; Credit A/P $80

Gift Cards Cash Entry

Debit Cash $35; Credit Unearned Revenue $35

Interest Revenue Entry

Debit Interest Receivable $1; Credit Interest Revenue $1

Accounting Equation Diagram

A T-chart with Assets on the left, Liabilities + Equity on the right.

Cash Flow Statement Diagram

Three vertical columns: Operating, Investing, and Financing activities.

T-account Layout

T-shape with the account name at the top, debits on the left, credits on the right.

Expanded Equation Diagram

Assets = Liabilities + Contributed Capital + Retained Earnings (Net Income − Dividends)

Income Statement Structure Diagram

Revenue − Expenses = Net Income; with categories like Operating and Non-Operating items.

Adjusting Entries Flowchart

Starts with account balances → Adjustment type → Journal entry → Adjusted balance

Financial Statement Flowchart

Transactions → Journal Entries → T-Accounts → Trial Balance → Adjustments → Financial Statements

Trial Balance vs. Adjusted Trial Balance Diagram

Two columns: pre-adjustment balances on the left, post-adjustment on the right.

Statement of Stockholders' Equity Diagram

Rows for Common Stock, Retained Earnings; columns for Beginning, Additions, Subtractions, Ending.

Accrual vs. Cash Accounting Timing Visual

Timeline showing Revenue/Expense recognition and Cash flow occurring at different times.