Ch.1 acct notes -FC- (W1)

Assets = what you own

Liabilities = what you owed

Revenue = what you earned

Expenses = what is spent to generate / earn revenue

Net Worth = Assets + Liabilities

Assets = Liabilities + Net Worth

LO 1-1 The Purpose of Accounting

• Definition of Accounting: A system to identify, measure, and communicate all financial activities of individuals or businesses.

• Personal Accounting: Tracks individual wealth and worth. It's important for managing expenses to save comfortably for retirement.

• Transactions: Financial activities that involve a trade or exchange to receive for value. It's essential to maintain records of transactions affecting net worth (earnings, investments, spending).

• Perception of Accounting: Often associated with numbers and calculations, but it also requires logical thinking. (just a fact)

• Assets vs. Liabilities:

  • Assets: Everything you own.

  • Liabilities: Everything you owe.

Page 2: Assets and Liabilities

• Net Worth Comparison:

  • Scenario 1: Assets = $104,000, Liabilities = $72,000, Net Worth = $32,000

  • Scenario 2: Assets = $133,000, Liabilities = $107,000, Net Worth = $26,000

• Implication: Higher assets do not automatically mean higher net worth if liabilities are also high.

LO 1-2 The Balance Sheet

• Personal Balance Sheet Definition: a document used to record assets, liabilities, and net worth on a specific date. (Role: what we own vs what we owe)

• Assets: What you own that benefits you now and in the future. (cash, home, car, furniture, electronics and investments, etc.)

• Liabilities: Obligations, sometimes referred to as debt. An example of liability is unpaid accounts. (credit card bills towards utilities, cell phones and etc.)

• Net Worth: is what is left if you cash out and pay everything you owe. It tracks what you’re worth in both personal life and any businesses.

• Net Worth Calculation: Net Worth = Assets - Liabilities. (N = A + L)

LO 1-3 The Income Statement

• Income Statement: is a record used to show and summarize revenue (increase to net worth) and expenses (decrease to net worth).

  • Role: Records revenues and expenses

• Income Statement Purpose: is to determine the change in net worth over a specific period of time. The date of income statement is written as “For the Period Ended…”

• Revenue: is known as income, earned through providing goods or services.

  • In personal life, usually earned by working or receiving salary or wages as well as earnings of investments or saving accounts.

• Expenses: the costs incurred in generate revenue, decrease in net worth.

  • It can include operational costs, rent, insurance, food, etc.

• Surplus & Deficit:

  • When Revenue is greater than expenses, surplus is added to net worth.

  • When Expenses are greater than revenue, the deficit is subtracted from net worth.

• Income Statement Format: Example provided illustrates a $36,000 revenue with $29,500 expenses leading to a net surplus of $6,500.

  • This shows 36,000 - 29,500 = 6,500 which is a net surplus (deficit). Because Revenue is greater than expense.

  • In contrast, if the income statement reflected $25,000 in revenue and $30,000 in expenses, the resulting calculation would be 25,000 - 30,000 = -5,000, indicating a net deficit of $5,000 that would reduce net worth.

Page 6: Accounting Periods and Monitoring

• Accounting Period Definition: Time frame for preparing financial statements (monthly, quarterly, etc.). - (one year, six months, three months or one month)

• Purpose of Accounting Period: Analyze changes in net worth consistently and manage financial behavior effectively.

• Advantages of Monthly Periods: Tracks regular expenses (rent, cell phone etc.), maintaining realistic expectations, controlling errors effectively.

  • Another benefit would be able to estimate surplus or deficit that you generate each month.

LO 1-5 The Accounting Equation

• Accounting Equation: Assets = Liabilities + Net Worth.

• Double Entry: The logic is based on the accounting equation. his shows every financial transaction impacts at least two accounts, maintaining the balance of the equation.

• Account: Allows us to track detailed information about the values of individual items. (cash & unpaid accounts)

• T-Account: A tool to record transactions and keep accounting equation balanced.

• Imbalance Example: Receiving cash or making payments requires balanced entries in the accounts.

• Analytical Approach: Transactions must maintain balance through appropriate double entries.

• Journal Entries: Document the initial transaction details before posting to the T-Account, ensuring accurate tracking of all financial activities.

• Ledger: A collection of all T-Accounts that provides a comprehensive overview of all transactions over a specific period.

• Revenue increases on the right side and decreases on the left side of the T-account (Same as Net Worth)

• Expenses increases on the left side and decreases on the right side of the T-account

• When Revenue exceed expenses, the overall impact on net worth is an increase.

• When Expense exceed revenue, the overall impact on net worth is a decrease.

• Opening Balance: The money left over from the last period carried over to the beginning of the current period. This is the first entry you put into a T-account.

• Closing Balance: Amount remaining in an account at the end of the period.

LO 1-6 Accrual-Based Accounting

• Definition: Accrual-Based Accounting means revenue and expenses are recorded in the period in which they occur, regardless of when cash payment is received or paid.

• Accrual: Accrual’s are accumulation of amounts owed but not yet paid, and of amounts due but not yet received.

  • The notion of accrual is recognizing how much you are worth at a point in time.

• Concept Explanation: Differentiates between cash flow and net worth implications of expenses.

Page 15-16: Cash Flow vs. Accruals

• Cash Flow: relates to cash flowing into and out of the bank account

• Accruals: relate to net wroth, not necessarily connect to cash flow.

• Cash-based accounting: Revenue and expenses reported only when cash is received or paid (tend to use this method for personal finances accounting. It’s more straightforward)

• Accrual-based accounting: Revenue and expenses are reported in the period in which they are earned or incurred.

Account for Debt:

• When you borrow money, you increase your assets and debts (Net worth not affected)

  • When you pay your debts (principal), you decrease your assets and debts (net worth not affected)

  • There is no change to net worth when borrowing money and repaying the principal.

  • Paying the interest portion of a loan payment for money you borrowed decreases net worth

LO 1-8 Buying Assets

• Purchasing Assets: Buying an asset does not impact net worth since it’s an exchange of assets (cash for car).

LO 1-9 Capital Increases to Net Worth

• Capital: Amounts increase your net worth but are not earned, therefore not considered revenue. (Gifts, Lottery winnings)

  • Important because it separates the revenue received from regular activities to knowing the sources of net worth that helps you month to month finances

• Capital Examples: Non-earned increases to wealth, recorded separately to manage finances effectively.