Accounting Fundamentals: Equations, Journals, Financial Statements & Controls

Accounting Equation

Assets = Liabilities + Equity

Balance Sheet

Reports assets, liabilities, and equity at a point in time.

Income Statement

Reports revenues - expenses = net income for a period.

Retained Earnings Formula

Beginning RE + Net Income - Dividends = Ending RE

How Statements Tie Together

Net income from the Income Statement goes into Retained Earnings on the Statement of Retained Earnings.
Ending Retained Earnings goes onto the Balance Sheet.
The ending Cash balance on the Statement of Cash Flows must match the Cash balance on the Balance Sheet

General Journal

Where transactions are first recorded.

General Ledger

All accounts with running balances.

Trial Balance

List of all accounts to confirm debits = credits.

Debits Increase

Assets, Expenses, Dividends

Credits Increase

Liabilities, Equity, Revenue

Sales Revenue

Increases equity (credit).

Expense Accounts

Increase with debits; decrease retained earnings.

Net Income Formula

Revenues - Expenses

Cost of Goods Sold (COGS)

Expense for inventory sold.

Gross Profit

Sales - COGS

Prepaid Expense Adjustment

Debit Expense, Credit Prepaid

Accrued Expense Adjustment

Debit Expense, Credit Payable

Accrued Revenue Adjustment

Debit Receivable, Credit Revenue

Unearned Revenue Adjustment

Debit Unearned Revenue, Credit Revenue

Depreciation Adjustment

Debit Depreciation Expense, Credit Accumulated Depreciation

Accumulated Depreciation

Contra-asset; increases with credit.

Close Revenues

Debit Revenue, Credit Retained Earnings

Close Expenses

Debit Retained Earnings, Credit Expenses

Close Dividends

Debit Retained Earnings, Credit Dividends

Post-Closing Trial Balance

Only permanent accounts remain.

Operating Activities

Cash from day-to-day business.

Investing Activities

Buying/selling long-term assets.

Financing Activities

Borrowing, repaying debt, issuing stock, dividends.

Indirect Method Starting Point

Net Income

Current Ratio

Current Assets ÷ Current Liabilities

Debt-to-Equity Ratio

Liabilities ÷ Equity

Gross Profit %

Gross Profit ÷ Sales

Return on Assets (ROA)

Net Income ÷ Average Total Assets

Return on Equity (ROE)

Net Income ÷ Average Equity

Relevant Costs

Costs that change between alternatives.

Relevant Revenues

Revenues that change between alternatives.

Irrelevant Costs

Same under both choices; ignore.

Sunk Costs

Already spent; ignore.

Differential Net Income

Proposed - Current.

Establish Responsibility

One person per task.

Segregation of Duties

Split up authorization, recordkeeping, custody.

Documentation Procedures

Keep evidence of transactions.

Physical Controls

Locks, safes, passwords.

Independent Verification

Supervisor checks work.

Human Resource Controls

Hiring checks, bonding, mandatory vacations.

Reconciliation Procedures

Compare books to external records.

Monsanto Accounting Issue

Did NOT record rebate payable.

WorldCom Fraud

Capitalized expenses as PP&E.

Assets

Resources providing future benefit.

Liabilities

Debts owed.

Equity

Owner claims (Common Stock + RE).

Common Stock

Owner investment.

Dividends

Distribution to shareholders; reduces RE.

Going Concern Assumption

Company will continue operating.

Cost Principle

Record assets at cost paid.

Entity Assumption

Business separate from personal activity.

Monetary Unit Assumption

Record only dollar-measurable activity.