Financial Accounting - Measuring Business Activities

Functions of Financial Accounting

  • Measure business activities and record transactions.
  • Communicate measurements to external parties for decision-making by preparing financial statements.

Steps in Measuring External Transactions

  • Step 1: Use source documents to identify accounts affected.
  • Step 2: Analyze the transaction's impact on the accounting equation.
  • Step 3: Assess whether the transaction results in a debit or credit.
  • Step 4: Record the transaction in a journal using debits and credits.
  • Step 5: Post the transaction to the general ledger.
  • Step 6: Prepare a trial balance.

Capturing Transactions in Accounts

  • Account: A record of all transactions related to a particular item over time.
    • Asset accounts: Cash, Supplies, Equipment.
    • Liability accounts: Accounts Payable, Salaries Payable, etc.
    • Stockholders’ equity accounts: Common Stock, Retained Earnings.
  • Chart of accounts: A list of all account names used to record transactions.

Accounting Equation

  • Assets = Liabilities + Stockholders’ Equity
  • Each transaction has a dual effect on the accounting equation.
  • If total assets increase, then liabilities or stockholders’ equity increases by the same amount.
  • If total assets decrease, then liabilities or stockholders’ equity decreases by the same amount.

Analyzing Transactions

For each transaction, ask:

  1. What is one account affected? Does it increase or decrease?
  2. What is a second account affected? Does it increase or decrease?
  3. Do assets equal liabilities plus stockholders’ equity?

Expanded Accounting Equation

  • Assets = Liabilities + Stockholders’ Equity
    • Stockholders’ Equity = Common Stock + Retained Earnings
    • Retained Earnings = Revenues - Expenses - Dividends

Debit and Credit Effects

  • Assets increase with debits, while Liabilities and Stockholders’ Equity increase with credits.
  • Revenues increase with credits, while Expenses and Dividends increase with debits.

Journal Entry Format

DateDebitCredit\text{Date} \quad \text{Debit} \quad \text{Credit}
Account NameAmount\text{Account Name} \quad \text{Amount}
Account NameAmount\text{Account Name} \quad \text{Amount}
(Description of transaction)\text{(Description of transaction)}

General Ledger and Posting

  • Posting: Transferring debit and credit information from the journal to general ledger accounts.
  • General ledger: A collection of each account with its transactions and balance.

T-Account

  • A T-account includes the account title at the top, one side for recording debits, and one side for recording credits.

Trial Balance

  • A list of all accounts and their balances at a particular date.
  • Shows that total debits equal total credits.
  • Used for internal purposes.