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Notes - Basic Accounting

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Notes - Basic Accounting

Uploaded by

LAZARO III DILEM
Copyright
© © All Rights Reserved
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Basic Accounting: An Overview

Accounting is the process of recording, summarizing, and analyzing financial transactions to


provide useful information for decision-making. It is often referred to as the "language of
business" because it communicates the financial performance and position of an organization.
Below are some key concepts to understand in basic accounting:

1. Accounting Equation

The foundational equation in accounting is the Accounting Equation:

Assets = Liabilities + Equity

 Assets: What the business owns (e.g., cash, inventory, buildings, equipment).
 Liabilities: What the business owes (e.g., loans, accounts payable, mortgages).
 Equity: The owner's interest in the business (e.g., common stock, retained earnings).

This equation must always be in balance, meaning that the company's assets are financed either
through debt (liabilities) or equity (owner’s stake).

2. The Two Main Types of Accounting

 Financial Accounting: Focuses on the preparation of financial statements for external


users such as investors, creditors, and regulatory agencies. The key financial statements
are:
o Balance Sheet: Shows the company’s financial position at a specific point in time
(Assets = Liabilities + Equity).
o Income Statement: Summarizes revenues, expenses, and profits or losses over a
specific period.
o Cash Flow Statement: Shows the inflows and outflows of cash in operating,
investing, and financing activities.
o Statement of Changes in Equity: Shows how equity changes over time.
 Management (or Managerial) Accounting: Focuses on providing financial data to help
managers make decisions within the organization. It is more detailed and used for
budgeting, cost analysis, and performance evaluation.

3. Double-Entry System

In accounting, every transaction affects at least two accounts, which is known as the double-
entry system. For example:

 When a company receives cash from a customer, it increases the Cash account (asset)
and increases Revenue (income statement account).
 This ensures the accounting equation remains balanced, with each transaction having a
corresponding debit and credit.
4. Debits and Credits

 Debits and Credits are the fundamental concepts for recording transactions.
o Debits (Dr): Increase assets or expenses and decrease liabilities, equity, or
revenue.
o Credits (Cr): Increase liabilities, equity, or revenue and decrease assets or
expenses.

A typical journal entry will show both a debit and a credit to ensure that the accounting equation
remains in balance.

5. Financial Statements

 Balance Sheet: A snapshot of an organization’s financial position at a given time.


o Assets: Divided into current (cash, accounts receivable, etc.) and non-current
(property, equipment, etc.).
o Liabilities: Also classified into current (accounts payable, short-term loans) and
non-current (long-term debt).
o Equity: The residual interest in the assets of the entity after deducting liabilities
(e.g., stockholder equity, retained earnings).
 Income Statement: Summarizes revenues, expenses, and profits (or losses) over a
period.
o Revenue: Earnings from the sale of goods or services.
o Expenses: Costs incurred in earning revenue (e.g., wages, rent, utilities).
o Net Income: The difference between total revenue and total expenses.
 Cash Flow Statement: Tracks cash movements in and out of the business during a
period.
o Operating Activities: Cash flows from core business operations.
o Investing Activities: Cash flows related to investments in assets like property or
securities.
o Financing Activities: Cash flows related to borrowing or repaying debts or
issuing stock.

6. Accrual vs. Cash Basis Accounting

 Cash Basis Accounting: Recognizes revenue and expenses only when cash is actually
received or paid. It's simpler but may not reflect the true financial position of the
company.
 Accrual Basis Accounting: Recognizes revenue when earned and expenses when
incurred, regardless of when cash is received or paid. This method is preferred under
generally accepted accounting principles (GAAP) as it provides a more accurate picture
of financial performance.

7. Accounting Periods
 Fiscal Year (FY): A one-year period used for accounting purposes, which may or may
not align with the calendar year.
 Quarterly: Many businesses prepare financial statements on a quarterly basis (every
three months).

8. Key Accounting Principles

 GAAP (Generally Accepted Accounting Principles): A framework of accounting


standards used in the United States to ensure consistency and transparency in financial
reporting.
 IFRS (International Financial Reporting Standards): Used internationally, providing
a set of guidelines for preparing financial statements.

9. Important Accounting Terms

 Trial Balance: A report that lists the balances of all accounts in the general ledger. It's
used to check the accuracy of the accounting records before preparing financial
statements.
 Journal Entries: The initial recording of financial transactions in the accounting system.
 Ledger: A collection of all accounts used in a company’s accounting system.
 Chart of Accounts: A list of all accounts used by an organization to classify financial
transactions.

Conclusion

Basic accounting provides the framework for tracking, measuring, and reporting a company's
financial activities. Mastery of key concepts like the accounting equation, double-entry system,
financial statements, and accounting principles is essential for understanding the financial health
of any business. Whether for managing day-to-day operations or making strategic decisions,
accounting is a critical tool for both small businesses and large corporations alike.

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