SECTION 1 Principles of Accounting

SECTION 1 Principles of Accounting
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  1 PRINCIPLES OFACCOUNTINGII LECTURENOTES STUDYSECTION 1 1.Element of Financial Statements2.Understanding the Accounting Cycle3.Accounting for merchandising Business4.Accounting for Inventories, InternalControl, and Cash INTERNAL USE ONLYLECTURED BY: PHAMNHAT DONGHOCHIMINH CITY, JULY2014  2 STUDYSECSION 01+2Element of Financial StatementsUnderstanding the Accounting Cycle 1.1INTRODUCTION Accounting is often referred to as the “language of business” It is a process whose goals arethe recording, summarizing, classifying of financial information. The input to thisprocessesare the transactions that are company engages in; the output is the financial statements.The financial statements of a sole proprietorship or partnership consist of the balancesheet, theincome statement, the capital statement and the statementsof cash flows.The recording aspect of the accounting process is based on a fundamental equation, whichstates: Assets–Liabilities = Capital (Owners’ Equity) Or A-L = C Assets are probablefuture benefits obtained by a company as a result of past transactions.Thus anything owned by a company (cash, machines, buildings, land, merchandise,paperclips,….) and anything owned to it (accounts receivable) is an asset.Liabilities are debts that the company owes to others. Thus, accounts payable, wagespayable, expensepayable and notes payable are all examples of liabilities.Capital is the amount left over from the asset “pie” to be kept (or “eaten”) by the ownersafter the liabilities have been paid. Example 1: If assets are $1,000 and liabilities are $700, capital is $300Some people express the accounting equation in a slightly different form, as follows:Assets = Liabilities + capital (Owners’ Equity)A= L +CIn a corporation the owners are thestockholders. Therefore, the equation is expressed inthe formAssets-Liabilities = Stockholders’ EquityOrAssets = Liabilities + Stockholders’ Equity 1.2THE NATURE OF ACCOUNTS In accounting, we keep track of assets, liabilities and capital by recording them in a specialrecord called an account (that’s why this subject is called accounting).These accounts resemblethe letter “T” and therefore are referred to as T-accounts.  3 The left side of the T is called the debit side; the right side is called thecredit side.The word debit is simply a synonym for “left”; the word credit is a synonym for “right”There are three types of accounts, and they are all kept in a special book called the generalledger. The three types of accounts: asset accounts, liability accounts, and capital accounts.The rules of debits and credits are quite simply:Assets accounts are debited for increases and credited for decreases; liability and capitalaccounts work in the opposite manner. These rules are illustrated by the following T-accountsNotice that the word debit is abbreviated DR, and the word credit is abbreviated CRAll companies have expenses, revenue, and drawings (withdrawals by the owner of assets forpersonal use). Let‘s remember an important rule regarding these items: Revenue increasescapital; expenses and drawings decrease capital. Thus it would make perfect sense to recordthese events in the capital account. However, we do not want to “crowd” the capital account,so they have their ownseparate T-accounts, as followsThese accounts are by nature of the capital type, and are considered to be branches of themain capital account. Accordingly, under the rules of debits and credits mentioned earlier,expenses and drawings (which decrease capital) are debits, while revenue (which increasescapital) is a credit.Here is a fundamental rule of bookkeeping to which there are no exceptions: every transactionwill have a debit and an equal credit. That is why this system is called the double-entrybookkeeping system. This does not mean that there will be one debit and one credit, butrather, the total dollar value of the debits will always equal the total dollar value of the credits.Thus a transaction may have one debit and several credits or vice versa, provided the dollarvalues are equal. This is called a compound entry. 1.3TRANSACTION ANALYSIS Let’s look at several transactions and see how they are entered in the T-accounts. We willfirst analyze the transaction in terms of the accounting equation, because this will make iteasier for us to determine what t-accounts to use, and how to record the debits and credits. Example 2 The owner invested $30,000 of this personal fundin the companyAnalysis:A = L+ C+ NC + ( NC mean no change)Entry:  4 CashCapitalUnder the rules of debits and credits, the asset cash is debited because it increased, whilecapital is credited for the same reason. Notice that this transaction is consistent with theimportant rule mentioned earlier: it has a debit of equal dollar value to the credit. Example 3 The company purchases a machine for $5,000, paying $3,000 down and agreeing to pay$2,000 laterAnalysisA =L +C+5,000 =+2,000 +NC-3,000EntryMachineCashAccounts payableNote that this is compound entry. Example 4: The company performs service of $2,000 for cashAnalysisA =L +C+2,000 =NC ++2,000 (remember: revenue increases capital)EntryCashService revenue Example 5 The company performs service of $4,000 on credit (on account)A =L +C+4,000 =NC ++4,000EntryAccounts receivableService Revenue

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Jul 27, 2017
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