Ch. 2: Recording Business Transactions

What is the primary objective of financial accounting?

To provide useful info for internal and external decision makers

Conceptual Framework

Developed by FASB: model of principles, constraints, assumptions, etc. regarding financial information

Principles of Accounting

Historial cost: record the amount when it was orginally bought; not adjusted for inflation or what you believe it to be worth

Revenue recognition: record revenue when it is earned

Matching principle: record expenses when it is incurred

Full disclosure: MUST provide users with info that could impact a decision (communication)

Assumptions

Unit of Measure: measurements are monetary ($$)

Separate entity: activities of the business is SEPARATE from its owners

Periodicity: financial life of company recorded in periods (month end, quarter end, year end)

Continuity: assume entity will not be going out of business in the near future

Characteristics of Useful information

Relevant: info provided would impact a decision

Reliable: can be independantly verified (for example by a CPA) to be accurate

Comparable: similar accounting methods applied across diff. companies

Consistent: similar accounting methods applied over time

Constraints

Cost/Benefit: benefitss providing info to users should outweigh the costs of providing it

Materiality: small amounts (if recorded incorrectly) will not impact a financial decision

Industry Practices: acceptable industry practices that deviate from GAAP

Conservatism: amount least likely to overstate assets/rev, or understate liabilities/exp, should be used for evaluation

Beginning steps in the accounting cycle

1. Analyze the transaction (what accts are affeced, increase? decrease?

2. Apply rules of DOUBLE ENTRY (debits = credits)

3. Record entry in the general journal (chronologically listed)

4. Post entry to general ledger

5. Foot each account and prepare trial balance to make sure debits = credits

6. Prepare financial statements (income statement, retained earnings, balance sheet, cash flows)

The Operating Cycle

time it takes for a company to pay cash to suppliers, sell goods or services to custoemrs, and collect cash from customers

Other items that affect net income

Interest: interest (dividends) earned on investment (interest income) or interest incurred on a liability (interest expense)

Other gains: increase in assets OR decrease in liabiltiies from a transaction not included in normal operating activities

Other losses: decrease in assets OR increase in liabilities form a transaction not included in normal operating activities

Income taxes: last expense listed before net income. ONLY for corps

Earnings per share: Benchmarks profitablity and performance of ONLY corps.

Revenue Recognition Principle

Revenue is recorded when earned, doens’t matter if cash is received or not.

services rendered

collection is reasonably assured

fixed price

evidence of arrangement

Rare revenue recognition rules

Percentage of Completion: recognize long term contracts for % completed

Completion of production: metals with immediae marketability of prices

Installment sales method: if sale can’t be reasonably assured, it is recorded afterwards.

Matching Principle

costs incurred to generate revenues must be recorded in that period

Accrual Accounting

revenues and expenses recognized when transacted causes them to occur. Required under GAAP

Cash Basis Accounting

revenue recognized hwen cash recieved, expenses recognized when paid. Does not accurately reflect liabilities or assets