The purpose of accounting is to provide the information that is needed for sound economic decision making. The main purpose of financial accounting is to prepare financial reports that provide information about a firm’s performance to external parties such as investors, creditors, and tax authorities. Managerial accounting contrasts with financial accounting in that managerial accounting [...]

Financial accounting relies on several underlying concepts that have a significant impact on the practice of accounting. Assumptions The following are basic financial accounting assumptions: Separate entity assumption – the business is an entity that is separate and distinct from its owners, so that the finances of the firm are not co-mingled with the finances [...]

 business transaction involves an exchange between two accounts. For example, for every asset there exists a claim on that asset, either by those who own the business or those who loan money to the business. Similarly, the sale of a product affects both the amount of cash (or cash receivable) held by the business and [...]

The resources controlled by a business are referred to as its assets. For a new business, those assets originate from two possible sources: Investors who buy ownership in the business Creditors who extend loans to the business Those who contribute assets to a business have legal claims on those assets. Since the total assets of [...]

When a business transaction occurs, a document known as the source document captures the key data of the transaction. The source document describes the basic facts of the transaction such as its date, purpose, and amount. Some examples of source documents: cash receipt cancelled check invoice sent or received credit memo for a customer refund [...]

After a transaction occurs and a source document is generated, the transaction is analyzed and entries are made in the general journal. A journal is a chronological listing of the firm’s transactions, including the amounts, accounts that are affected, and in which direction the accounts are affected. A journal entry takes the following format:   [...]

 While the journal lists transactions in chronological order, its format does not faciliate the tracking of individual account balances. The general ledger is used for this purpose. The general ledger is a collection of T-accounts to which debits and credits are transferred. The action of recording a debit or credit in the general ledger is [...]

  A basic rule of double-entry accounting is that for every credit there must be an equal debit amount. From this concept, one can say that the sum of all debits must equal the sum of all credits in the accounting system. If debits do not equal credits, then an error has been made. The [...]

In the accounting process, there may be economic events that do not immediately trigger the recording of the transaction. These are addressed via adjusting entries, which serve to match expenses to revenues in the accounting period in which they occur. There are two general classes of adjustments: Accruals – revenues or expenses that have accrued [...]

Revenue, expense, and capital withdrawal (dividend) accounts are temporary accounts that are reset at the end of the accounting period so that they will have zero balances at the start of the next period. Closing entries are the journal entries used to transfer the balances of these temporary accounts to permanent accounts. After the closing [...]

Businesses report information in the form of financial statements issued on a periodic basis. GAAP requires the following four financial statements:  Balance Sheet – statement of financial position at a given point in time.   Income Statement – revenues minus expenses for a given time period ending at a specified date. Statement of Owner’s Equity – [...]

Accounting standards are needed so that financial statements will fairly and consistently describe financial performance. Without standards, users of financial statements would need to learn the accounting rules of each company, and comparisons between companies would be difficult. Accounting standards used today are referred to as Generally Accepted Accounting Principles (GAAP). These principles are “generally [...]

Traditional financial reporting systems provide an indication of how a firm has performed in the past, but offer little information about how it might perform in the future. For example, a firm might reduce its level of customer service in order to boost current earnings, but then future earnings might be negatively impacted due to [...]