Financial Accounting part -1

1. Accounting consists of three basic activitiesit identifies, records, and

communicates the economic events of an organization to interested users.

2. Identification of economic events: a company selects the economic

events relevant to it business.

3. Recording: It co consists of keeping a systematic, chronological diary

of economic events.

4.

ommunicating: It communicates the collected information to interested

users by means of accounting reports. The most common of these reports are called financial statements

!. "oo##eeping: It usually involves only the recording of economic events. It

is therefore just one part of the accounting process. In total, accounting involves the entire process of identifying$ recording$ and communicating economic events.

%. Internal &sers: Internal users of accounting information are those

individuals inside a company who plan, organize, and run the business. These include mar#eting managers$ production supervisors$ finance directors$ and company officers.

'. ()ternal &sers: !ternal users are individuals and organizations outside a
company who want financial information about the company. The two most common types of e!ternal users are investors and creditors. "ther users are *a)ing authorities Regulatory agencies ustomers +a,or unions

-. Assets: Assets are resources a business owns .The common characteristic

possessed by all assets is the capacity to provide future services or ,enefits.

.. +ia,ilities: +ia,ilities are claims against assetsthat is, e!isting debts

and obligations.
e3uity

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01ner2s (3uity: The ownership claim on total assets is o1ner2s Increases in 01ner2s (3uity: Investments ,y o1ner are the assets the owner puts into the business
Revenues are the gross increase in owner#s e$uity resulting from business activities entered into for the purpose of earning income

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4ecreases in 01ner2s (3uity:

%n owner may withdraw cash or other assets for personal use. &e use a separate classification called dra1ings ()penses are the cost of assets consumed or services used in the process of earning revenue. 13. *ransactions ',usiness transactions( are a business#s economic events recorded by accountants. 14. Internal transactions are economic events that occur entirely within one company such as the use of supplies 1!. ()ternal transactions involve economic events between the company and some outside enterprise such as purchase and sale. 1%. 4ou,le-entry system: % system that records in appropriate accounts the dual effect of each transaction . 1'. %n account is an accounting record of increases and decreases in a specific asset, liability, or owner#s e$uity item. 1-. *he normal ,alance of an account is on the side where an increase in the account is recorded.

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5teps in the Recording 6rocess :

Analy7e each transaction for its effects on the accounts. (nter the transaction information in a journal. *ransfer the journal information to the appropriate accounts in the ledger. 2/. "usiness documents such as a sales slip, a check, a bill, or a cash register tape, provide evidence of the transaction. 21. 8ournal: 8ournal is a record of transactions in chronological order 'the order in which they occur( showing the debit and credit effects on specific accounts. Thus, the 9ournal is referred to as the book of original entry. 22. 8ournali7ing: ntering transaction data in the journal is known as 9ournali7ing.

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% simple entry involves only two accounts, one debit and one credit. %n entry that re$uires three or more accounts is a compound entry.

+edger: The entire group of accounts maintained by a company is the ledger. The ledger keeps in one place all the information about changes in specific account balances. 2%. % general ledger contains all the asset, liability, and owner#s e$uity accounts. 2'. 6osting: Transferring journal entries to the ledger accounts is called posting. This phase of the recording process accumulates the effects of journalized transactions into the individual account 2-. % trial ,alance is a list of accounts and their balances at a given time. The primary purpose of a trial balance is to prove 'check( that the debits e$ual the credits after posting.

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+imitations of a *rial "alance:

a transaction is not journalized, a correct journal entry is not posted, a journal entry is posted twice, incorrect accounts are used in journalizing or posting, or off )setting errors are made in recording the amount of a transaction. 3/. *ime 6eriod Assumption: %ccountants divide the economic life of a business into artificial time periods. This convenient assumption is referred to as the time period assumption. 31. %n accounting time period that is one year in length is a fiscal year

32.

*nder the accrual basis, companies record transactions that change a company#s financial statements in the periods in 1hich the events occur. 33. *nder cash-,asis accounting companies record revenue when they receive cash. They record an e!pense when they pay out cash. 34. The revenue recognition principle dictates that companies recognize revenue in the accounting period in which it is earned. 3!. :atching principle dictates that efforts 'e!penses( be matched with accomplishments '+evenues(.

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Ad9usting entries: ntries made at the end of an accounting

period to ensure that companies follow the revenue recognition and matching principles.

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%djusting entries are classified as either deferrals or accruals

4eferrals
6repaid ()penses. !penses paid in cash and recorded as assets before they are used or consumed. &nearned Revenues. ,ash received and recorded as liabilities before revenue is earned.

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Accruals
Accrued Revenues. +evenues earned but not yet received in cash or recorded.

Accrued ()penses. !penses incurred but not yet paid in cash or recorded. 4/. Ad9usted trial ,alance: % list of accounts and their balances after the company has made all adjustments. 41. "oo# value: The difference between the cost of a depreciable asset and its related accumulated depreciation.

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4epreciation: The allocation of the cost of an asset to e!pense over

its useful life in a rational and systematic manner. Interim 6eriods: -onthly or $uarterly accounting time periods. &seful life: The length of service of a long)lived asset. Accounting information system: % system that collects and processes transaction data, and communicates financial information to decision makers.

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5u,sidiary ledger: % group of accounts with a common Accounts paya,le ;creditors2< su,sidiary ledger: % Accounts receiva,le ;customers2< su,sidiary ledger: % 5pecial 9ournal: % journal that records similar types of 6urchases 9ournal: % special journal that records all purchases of 5ales 9ournal: % special journal that records all sales of ash payments ;dis,ursements< 9ournal: % special journal ash receipts 9ournal: % special journal that records all cash ontrol account: %n account in the general ledger that summarize :anual accounting system: % system in which someone "an# reconciliation: The process of comparing the bank#s balance

characteristic

subsidiary ledger that collects transaction data of individual creditors.

subsidiary ledger that collects transaction data of individual customers.

transactions, such as all credit sales.

merchandise on account.

merchandise on account.

that records all cash paid.

received.

subsidiary ledger.

performs each of the steps in the accounting cycle by hand.

of an account with the company#s balance and e!plaining any differences to make them agree.

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assets by employees.

"onding: "btaining insurance protection against misappropriation of 4eposits in transit: .eposits recorded by the depositor but not

yet been recorded by the bank

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Internal control: %ll of the related methods and activities adopted

within an organization to safeguard its assets and enhance the accuracy and reliability of its accounting records. %/. Accounts receiva,le: %mounts owed by customers on account. %1. Accounts receiva,le turnover ratio: % measure of the li$uidity of accounts receivable/ computed by dividing net credit sales by average net accounts receivable. %2. Allo1ance method: % method of accounting for bad debts that involves estimating uncollectible accounts at the end of each period. %3. Average collection period: The average amount of time that a receivable is outstanding/ calculated by dividing 012 days by the accounts receivables turnover ratio. %4. "ad 4e,ts ()pense: %n e!pense account to record uncollectible receivables.

%!. %%.

ash ;net< reali7a,le value: The net amount a company e!pects

to receive in cash.

4irect 1rite-off method: % method of accounting for bad debts that involves e!pensing accounts at the time they are determined to be uncollectible. 4ishonored note: % note that is not paid in full at maturity. Factor: % finance company or bank that buys receivables from :a#er: The party in a promissory note who is making the promise to =otes receiva,le: ,laims for which formal instruments of credit 6ayee: The party to whom payment of a promissory note is to be 6ercentage-of-receiva,les ,asis :anagement estimates

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pay.

businesses and then collects the payments directly from the customers.

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made.

are issued as proof of the debt.

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what percentage of receivables will result in losses from uncollectible accounts.

'3. '4. '!.

6ercentage-of-sales ,asis :anagement estimates what

percentage of credit sales will be uncollectible.

6romissory note: % written promise to pay a specified amount of money on demand or at a definite time. Receiva,les: %mounts due from individuals and other companies.

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*rade receiva,les: 3otes and accounts receivable that result from

sales transactions.

Accelerated-depreciation method: .epreciation method that produces higher depreciation e!pense in the early years than in the later years. Amorti7ation: The allocation of the cost of an intangible asset to e!pense over its useful life in a systematic and rational manner. Asset turnover ratio: % measure of how efficiently a company
uses its assets to generate sales/ calculated as net sales divided by average total assets.

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apital e)penditures: !penditures that increase the company#s 4eclining-,alance method: .epreciation method that applies a

investment in productive facilities.

constant rate to the declining book value of the asset and produces a decreasing annual depreciation e!pense over the useful life of the asset.

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4epletion: The allocation of the cost of a natural resource to Franchise ;license<: % contractual arrangement under which the

e!pense in a rational and systematic manner over the resource#s useful life.

franchisor grants the franchisee the right to sell certain products, provide specific services, or use certain trademarks or trade names, usually within a designated geographical area.

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>oing-concern assumption 4tates that the company will >ood1ill: The value of all favorable attributes that relate to a

continue in operation for the foreseeable future.

business enterprise.

Intangi,le assets: +ights, privileges, and competitive advantages that result from the ownership of long)lived assets that do not possess physical substance. 6atent: %n e!clusive right that enables the recipient to manufacture, sell, or otherwise control an invention for a period of the grant. Revenue e)penditures: !penditures that are immediately
charged against revenues as an e!pense.

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5alvage value: %n estimate of an asset#s value at the end of its

useful life.

5traight-line method: .epreciation method in which periodic depreciation is the same for each year of the asset#s useful life. *rademar# ;trade name<: % word, phrase, jingle, or symbol that &nits-of-activity method: .epreciation method in which useful
identifies a particular enterprise or product.

life is e!pressed in terms of the total units of production or use e!pected from an asset.

.3. .4.

&seful life: %n estimate of the e!pected productive life, also called

service life, of an asset.

Average-cost method: Inventory costing method that uses the weighted average unit cost to allocate to ending inventory and cost of goods sold the cost of goods available for sale. onservatism oncept that dictates that when in doubt choose
the method that will be least likely to overstate assets and net income.

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onsigned goods: 5oods held for sale by one party although onsistency principle .ictates that a company use the same urrent replacement cost The current cost to replace an

ownership of the goods is retained by another party.

accounting principles and methods from year to year.

inventory item.

First-in$ first-out ;FIF0< method: Inventory costing method that assumes that the costs of the earliest goods purchased are the first to be recognized as cost of goods sold.

1//. F0" ;free on ,oard< destination: 6reight terms indicating that

ownership of the goods remains with the seller until the goods reach the buyer.

1/1. F0" ;free on ,oard< shipping point: 6reight terms indicating that
ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller.

1/2. Inventory turnover: % ratio that measures the number of times on

average the inventory sold during the period/ computed by dividing cost of goods sold by the average inventory during the period.

1/3. 8ust-in-time ;8I*< inventory method: Inventory system in which

companies manufacture or purchase goods just in time for use.

1/4. +ast-in$ first-out ;+IF0< method Inventory costing : method

that assumes the costs of the latest units purchased are the first to be allocated to cost of goods sold.

1/!. +o1er-of-cost-or-mar#et ;+ :< ,asis: % basis whereby inventory

is stated at the lower of either its cost or its market value as determined by current replacement cost.