Accounting Principles I – Principles of Accounting - Quick Guides

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Study GuideAccounting Principles I–Principles of Accounting1. Introduction to AccountingAccounting is often called thelanguage of business—and for good reason. Just like a languagehelps people communicate, accounting helps businessesexplain their financial story clearly andaccurately.At its core, accounting is a system used torecord, summarize, and analyzea business’s financialtransactions. Every time a company earns money, spends cash, borrows funds, or pays expenses,accounting keeps track of it. This information is essential because good decisions depend on clearand reliable financial data.1.1Why Accounting MattersBusinesses don’t operate in isolation. Many people depend on accounting information to understandhow a company is doing.•Internal usersinclude managers and employees. They use accounting data to plan, controloperations, and make day-to-day decisions.•External usersinclude banks, investors, government agencies, financial analysts, and laborunions. They rely on accounting reports to evaluate a company’s financial health andperformance.Without accounting, it would be very difficult for any of these groups to make informed decisions.1.2Questions Accounting Helps AnswerAccounting information helps users answer importantquestions such as:•Is the company making a profit?•Does the business have enough cash to pay employees?•How much debt does the company owe?•Is the company earning more or less than planned in its budget?

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Study Guide•How much money do customers still owe the company?•Has the company regularly paid cash dividends?•How much income does each department or division generate?•Should the company invest money to grow or expand?Each of these questions plays a role in deciding the future direction of a business.1.3The Role of AccountantsAccountants are responsible for turning financial data intoclear and useful information. Theyprepare reports that are easy to understand and designed to help users make sound decisions.The most important and commonly used reports prepared by accountants are calledfinancialstatements. These statements summarize a company’s financial activities and provide a snapshot ofits overall financial condition.In short, accounting helps businesses communicate their financial results—and that communication iskey to success.2. Understanding Financial StatementsFinancial statements are formal reports that show how a business is performing and what its financialposition looks like. The examples shown here belong to asole proprietorship, which is a businessowned by one person. Financial statements forcorporations are similar, but they include a fewadditional details.There arefour basic financial statements, and each one has a specific purpose:1.Income Statement2.Statement of Owner’s Equity3.Balance Sheet4.Statement of Cash FlowsTogether, these statements give a complete picture of a business’s financial health.

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Study Guide2.1 The Three-Line Heading (Used in All Financial Statements)Every financial statement begins with athree-line heading. This heading tells the reader exactlywhat the report is about.The heading always includes:•Name of the company•Name of the financial statement•Time period or specific date coveredThis format helps users quickly understand what information they are looking at.2.2 Income StatementTheincome statementis usually preparedfirst. It is sometimes called thestatement of earningsorstatement of operations.This statement shows:•Revenues earned during a period•Expenses incurred during the same period•The resultingnet income or net lossIftotalrevenues are greater than total expenses, the business hasnet income.Iftotal expenses are greater than total revenues, the business has anet loss.The income statement covers aspecific period of time, such as a month, quarter, or year.

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Study Guide2.3Statement of Owner’s EquityThestatement of owner’s equityis preparedafter the income statement.This statement explains how the owner’s equity changed during the period. It shows:•Beginning owner’s equity•Owner investments•Net income or net loss (from the income statement)•Owner withdrawals•Ending owner’s equityOnly thetotal net income or lossappears on this statement because the detailed revenues andexpenses are already shown on the income statement.Amounts shown inparenthesesrepresent values that aresubtracted, such as withdrawals.

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Study Guide2.4Balance SheetThebalance sheetshows what a businessowns and owes at a specific point in time. Unlike theother statements, it doesnotcover a period of time—it shows balances on a single date.The balance sheet lists:•Assets(what the business owns)•Liabilities(what the business owes)•Owner’s equityIt proves that theaccounting equationis in balance:Assets = Liabilities + Owner’s EquityThe ending owner’s equity amount from the statement of owner’s equity is used directly on thebalance sheet.

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Study Guide2.5Statement of Cash FlowsThestatement of cash flowstracks howcash moves in and out of the businessduring a specificaccounting period.

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Study GuideAll cash activities are grouped into three categories:1.Operating activities–cash from daily business operations2.Investing activities–cash related to buying or selling long-term assets3.Financing activities–cash from owner investments, withdrawals, or borrowingThis statement calculates thenet increase or decrease in cashand explains the difference betweenbeginning and ending cash balances.Only items that affectactual cashappear in the main body of the statement. However, significantnon-cash activitiesmust still be disclosed separately.2.6Direct vs. Indirect MethodCurrent accounting standards allow operating cash flows to be reported using either:•Thedirect method, or•Theindirectmethod

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Study GuideThedirect methodlists actual cash received and cash paid by category. This method is used in theexample provided because it is easier for students to understand and clearly shows how cash movesthrough the business.3. The Accounting EquationTo understand financial statements, you first need to know what kinds of items appear in them andhow those items are grouped. One of the most important ideas in accounting is theaccountingequation. It shows the basic relationship between the mainparts of a business.A business is built on three key elements:•Assets•Liabilities•Owner’s Equity(orStockholders’ Equityin a corporation)These parts are connected through the accounting equation, which explains how a company’sresources are financed.3.1Assets: What the Company OwnsAnassetis anything valuable that a company owns. Assets can be:•Tangible assets(physical items you can touch)•Intangible assets(valuable rights or ideas that you can’t physically touch)3.1.1Tangible Assets (Physical Assets)Tangible assets are usually grouped into three major categories:1.Current assets2.Property, plant, and equipment3.Long-term investments

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Study GuideA.Current Assets (Short-Term Assets)Current assetsare cash or items the company expects to turn into cash, sell, or use up withinoneyear.On thebalance sheet, current assets are listed frommost liquid to least liquid.Liquid assetsare assets that are easy to convert into cash. They are also commonly acceptedwhen paying debts.Here are the common types of current assets:1. CashThis includes:•Cash on hand (likepetty cash)•Bank balances (checking, savings, or money-market accounts)•CashequivalentsCash equivalentsare super short-term investments that are almost as good as cash. Examplesinclude:•Certificates of deposit (CDs)•U.S. treasury billsTo count as cash equivalents, they must have a maturity of90 days or less at the time of purchase.2. Marketable SecuritiesThese areshort-term investmentssuch as:•Stocks•Bonds (debt)•Certificates of deposit•Other securities

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