FINANCIAL ACCOUNTING Week Two: February 22/29,

2024
 Recap
 GAAP Principal, FASB, IAS
 Revenue and Expense – Income Statement
 Effects of Transactions on Assets Liabilities and Equity
 Demo Questions
 The Charts of Accounts
 Rules of Debit and Credit

It is the RECORDING of Business Events and Transactions on Daily Basis in Chronological

Order (General Entries).

It is CLASSIFYING transactions/ events into related groups or respective accounting titles

(Assets, Liabilities & Owners Equity).

Is ANALYZING transactions effects on business (Rules of Debit & Credit).

SUMMARIZING the classified information into Financial Reports known as Financial

Statements:
 Balance Sheet
 Income Statement
 Cash Flow Statement

GAAP, FASB, IAS

All the financial reports are prepared under the Generally Accepted Accounting Principles
(GAAP). They are not prepared especially for owners, creditors, or any other particular user
group but are intended to be equally useful for all user groups.
The Financial Accounting Standards Board (FASB) is primarily responsible for developing the
rules that form the foundation of financial reporting.
The International Accounting Standards Board (IASB) is a global accounting rule-setter.

Generally Accepted Accounting Principles (GAAP)

Generally Accepted Accounting Principles are the ground rules for financial reporting. These
principles provide the general framework, determining ‘what’ information be included in the
financial statements and ‘how’ the information should be recorded for presentation.
Accounting is the language of business and it is used to communicate financial information about
a business entity to users such as shareholders and managers. For the information to make sense,
it is based on 12 fundamental concepts. These concepts form the basis for all of the Generally
Accepted Accounting Principles (GAAP). By using these concepts the readers of financial
statements and other accounting information do not need to make assumptions to understand the
numbers.
Basic rules provided under GAAP

Business entity concept

It is a basic concept in accounting. This concept requires the affairs of the business should be
kept separate from other non-business activities of the owners. In other words, an accounting
entity is an organization that stands apart from any other business and individuals as a separate
economic unit.

Going concern concept

It is a fundamental concept enforced through the Companies Act. According to this concept,
accountants assume that once a business is set up it will carry out its objectives and commitments
for an indefinite period or till eternity. In other words, when you start a business, you assume the
business will continue to operate for a long period of time.

Stable Monetary (dollar) Unit concept

Accounting information is expressed in monetary terms. Transactions expressed in monetary are
recorded and it is assumed that this unit is a Stable unit of measurement, accountants ignore the
effect of inflation while recording transactions.
In America, accountants record transactions in dollars ($).
In Britain, accountants record transactions in pounds Sterling (£).
In Japan, accountants record transactions in yen (¥).

Historical Cost concept or Cost concept

According to this concept assets and expenses are recorded at the actual amount paid/ spent in
acquiring them i.e. acquisition cost. In many cases, the actual cost of goods and services is
ascertainable from the invoices, receipts, and contracts.

Time period concept

This concept ensures that accounting information is reported at regular intervals. Managers,
investors, and creditors have to make decisions daily and need periodic statements on the
progress of the business.
Therefore, results of the business operations in the form of a Balance Sheet, Income Statement,
and Cash Flow are reported on a monthly, quarterly, half-yearly, and annual basis this is known
as the Accounting Period.

Adequate Disclosure principle

Financial statements should provide all the financial material information and facts for the proper
interpretation of accounts shown on the financial statements.
A company’s financial statement should contain adequate/ sufficient information for outsiders
and other professionals to make knowledgeable decisions about the company. A company should
report relevant, reliable, and comparable information. For instance, while recording stock or
inventory reporting a change in the method of inventory valuation is disclosure.

Materiality concept
This concept states that a company records those transactions that are significant or relevant for
operating the business. There should be no omission or misstatement of information. For
example, a box of paper pins will be recorded when purchased not whenever the pins are used.

Objectivity
Accounting
records and statements are based on available data that is highly reliable, accurate, and useful. As
such information contained in the financial statements is flawless and error-free. Accounting
measurements are based on cost rather than current market value because they are factual and
subject to independent verification. Assets are valued at acquisition cost price. Market values are
not used because they fluctuate.

Consistency concept
The concept states that once a firm has adopted a method for the valuation of inventory or
depreciation of fixed assets (except land) in year 1 it should continue using the same method in
the preceding years. If a firm keeps on changing its method of computing inventory or
depreciation every year the amount of profit earned will result in a misleading figure.

Conservative or Prudence concept

An accountant has to use his judgment to decide which amount to be considered for recording
transactions. An accountant must ensure that investors and other users get accurate facts and
figures about the business activity of a firm. An accountant should ensure that assets, equity, and
revenue are not over-valued or overstated. On the other hand liabilities and expenses are not
undervalued or understated. Prudence is required to ensure:
(i) Profits are not overstated.
(ii) Losses are recorded or recognized as soon as they are incurred.

Realization concept
This concept states that revenue should not be recorded or recognized in the books of account
before it has been earned or realized. The sale of goods takes place when goods are sold on cash
or credit (accounts receivable). A promise by a customer to purchase goods at a future date is not
a SALE hence no revenue has been earned.
According to this concept revenue and other income should be recognized or recorded in the
financial period it has arisen or accrued even if cash has not been received.
Similarly, expenses should be recognized or recorded in the financial period it has been incurred
not based on payments made in that period. Expenses incurred but not paid are recorded as
accruals (liabilities). Expenses that have been paid but pertain to a later financial period are
recorded as prepayments (assets).

Matching principle
This principle requires identifying all expenses incurred during an accounting period and
matching these expenses against the revenue earned during the same time period. Matching the
expenses involved in generating that revenue.

EXPENSES
Expenses are the costs of manufacturing goods or rendering services for generating or earning
revenue. When to record expenses – the realization and matching principle.
EXPENSES: (NATURE: DEBIT)
Salaries and wages, rent, insurance, advertisement, interest, fees, commission, traveling,
transportation, freight, delivery.
REVENUE:
Revenue is the price of goods sold or services during a given accounting period. When to record
revenue – the realization principle.
REVENUE: (NATURE: CREDIT)
Sales revenue, commission, interest, fee, etc.

Demonstration Questions – for assignment One

Self-test questions 1 to 7 explaining accounting reasons for valid answers.
Exercise 2.2, 2.6, 2.7.
Problem 3.4

THE CHART OF ACCOUNTS

Owner
Assets Liabilities Expenses Equity
Revenue

Current Assets Short Term Liabilities Salaries Sales

Wages capital Interest

Cash account
payable

Account Rents Commesion

Receivable Note
Payable
Others Others
Inventory
Accrued
Expenses
Office supplies
Unearned
Revenue
Prepaid Rent

Fixed Assets Or Long Term Liabilities

long Term

Office
Equipment

Lands & Building

Plants

Other assets

ACCOUNT
 The Account is a technical term used to record the increase or decrease in an items - Assets,
Liabilities, Owner's Equity, Expenses and Revenues.

Rules of Debit & Credit

 An amount recorded on the left-hand side of the Balance sheet is called a debit or debit entry.
 An amount entered on the right-hand side of the Balance sheet is called a credit or credit
entry.

 The act of recording a debit in an account is called debiting the account.

 The act of recording a credit in an account is called crediting the account.

 All assets are recorded as debits, an increase in assets is a debit entry while a decrease in
assets is a credit entry.
 All liabilities are recorded as credits, increase in liabilities is a credit entry while a decrease
in liabilities is a debit entry.
 Owners' equity is recorded as a credit, an increase in owners' investment is a credit entry
while a decrease in owners' capital is a debit entry.

Recording the Effects of business transactions Problem 2.3

GOLDSTAR COMMUNICATIONS
Owner's
Assets = Liabilities +
Equity
Office Notes Accounts Capital
Cash + Land + Building + Equipment = Payable Payable + Stock
Balances $37,000 $95,000 $125,000 $51,250 $80,000 $28,250 $200,000

(a) 35,000 35,000

Balances $72,000 $95,000 $125,000 $51,250 $80,000 $28,250 $235,000

( b ) -22,500 $35,000 $55,000 67,500

Balances $49,500 $130,000 $180,000 $51,250 $147,500 $28,250 $235,000

(c) 9,500 9,500

Balances $49,500 $130,000 $180,000 $60,750 $147,500 $37,750 $235,000

(d) 20,000 20,000

Balances $69,500 $130,000 $180,000 $60,750 $167,500 $37,750 $235,000

( e ) -28,250 -28,250

Balances $41,250 $130,000 $180,000 $60,750 $167,500 $9,500 $235,000

 Assets $412,000 = $177,000 + $235,000

Interpreting the Effects of business transactions Problem 2.2

AJAX MOVING COMPANY
Owner's
Assets = Liabilities +
Equity

Accounts Accounts
Cash + Receivable + Land + Building + Equipment = Payable + Capital

Balances $26,000 $39,000 $45,000 $110,000 $36,000 $42,000 $214,000

(a) -3,200 3,200

Balances $22,800 $39,000 $45,000 $110,000 $39,200 $42,000 $214,000

(b) 900 -900

Balances $23,700 $38,100 $45,000 $110,000 $39,200 $42,000 $214,000

(c) -3,500 13,500 10,000

Balances $20,200 $38,100 $45,000 $110,000 $52,700 $52,000 $214,000

( d ) -14,500 -14,500

Balances $5,700 $38,100 $45,000 $110,000 $52,700 $37,500 $214,000

(e) 15,000 15,000

Balances $20,700 $38,100 $45,000 $110,000 $52,700 $37,500 $229,000

(f) 7,500 7,500

Balances $20,700 $38,100 $45,000 $110,000 $60,200 $45,000 $229,000

Income Statement Exercise 2.12

Hernandez Inc. had the following transactions during the month of March 2023. Prepare an
Income statement based on this information. Include only related accounts.
Hernandez Inc.
Income Statement
For the year ended March 2023

Revenue Earned $ 9,500

Less: Expenses 5,465
Gross Profit 4,035
Less: Dividends 4,000
Net Profit $ 35

General Entries Problem 3.4

1. Analyze the effects of each transaction
Income Statement Balance Sheet
Transaction Revenue - Expenses = Net Assets = Liabilities + Equity
Income
June 1 NE NE NE I NE I

2. Prepare the General Entries for Wendy Winger as per format.

WW AERIAL PHOTOGRAPHY SERVICES

GENERAL JOURNAL
JUNE 01 to 30, 2023
Date Account Titles and Explanation DEBIT CREDIT
2017 Rs. Rs.
JUNE 01 Cash 60,000
Capital Stock 60,000
(Issued 60,000 shares @ Rs 1.00 )
JUNE 02 Aircraft 220,000
Cash 40,000
Notes Payable 180,000
(Purchased Aircraft partially for cash &
signed a note for the balance)
JUNE 04 Rent Expense 2,500
Cash 2,500
(Paid rent for the office & hangar space
To the Civil Aviation Authority)
JUNE 15 Accounts receivable 8,320
Aerial Photography Revenue 8,320
(Revenue earned billed the customer)
JUNE 15 Salaries Expense 5,880
Cash 5,880
(Paid salaries to the employees)
JUNE 18 Maintenance Expense 1,890
Cash 1,890
(Paid for the repairs & maintenance of the
airplane)

JUNE 25 Cash 4,910

Accounts receivable 4,910
(Collected from the customer)
JUNE 30 Accounts receivable 16,450
Aerial Photography Revenue 16,450
(Revenue earned billed the customer)
JUNE 30 Salaries Expense 6,000
Cash 6,000
(Paid salaries to the employees)
JUNE 30 Fuel Expense 2,510
Accounts payable 2,510
 (Fuel Expense for the month has to be paid)
JUNE 30 Dividends 2,000
Dividends payable 2,000
(Dividend declared but not yet paid)