ACT 201: Financial Accounting

Chapter 1: Accounting in Action

Accounting
Accounting is the process of recording financial transaction regarding a Business,

Accounting consist of Three activities

Identification:
Identification means identifying economic events.
Recording:
Recording means record, classify and summarize the data into our accounting record.
Communication:
Communication means preparing the accounting reports and analyzing and interpreting
these reports for users.

Users of Accounting data

There are two users of Accounting data.
Internal User:
Internal users are different departments of a company like Finance, Marketing and
Human Resource etc.
External User: External users are
Creditors:
Creditors are those who give out loan to the company
Investors:
Investors are those who invest in the company

Measurement Principle
Historical Cost Principle
Historical Cost Principle states that the value of an asset is recorded at its original cost
price when acquired by the company.
Fair Value Principle
Fair Value Principle states that current market value should be used for recognizing
certain types of assets and liabilities.

Assumption
Monetary Unit Assumption
Monetary Unit Assumption states to include in accounting records only transaction data
that can be expressed by in terms of money.
Economics Entity Assumption
Economic Entity Assumption states that activities of Entity should be kept separate and
distinct from activities of owners and all other entities.

Forms of Business Ownership

There are three types of Business Ownership
Proprietorship:
- Owned by one person
- Owner is often manager/operator
- Owner receive profit, suffer any losses and personally liable for company’s debt
Partnership:
- Owned by two or more person
- Generally have unlimited personal liability
- Partnership is usually bound by partnership agreement
Corporation
- Usually ownership is divided into shares of stock
- Separate legal entity organized under corporate law
- Usually has limited liability
Basic Accounting Equation
Basic Accounting Equation provides the underlying framework for recording and
summarizing economic events.
Basic Accounting Equation expresses as

Asset = Liability + Owner’s Equity

Asset:
Asset is the resource that a business owns. It usually provides future services and
benefits.Cash, Supplies & Accounts Receivable are some of the examples of assets.
Liability:
Liability is a claim against assets. Creditos are the party to whom money is owed.
Accounts Payable, Notes Payable are some of the examples of Liability.
Owner’s Equity:
It is the Ownership claim on total assets. It is also referred to as Residual Equity.

Expanded Basic Accounting Equation expresses as

Asset = Liability + Owner’s Capital - Owner’s Drawings + Revenue - Expense

Owner’s Capital:
It is the assets that the owner puts into the company.
Revenue:
Revenue is basically income.
Owner’s Drawing:
A withdrawal of cash or any other type of asset by owner for personal use.
Expense:
It is the cost that was incurred to earn revenue
Four Financial Statements
Four Financial Statement that we will learn are
Income Statement, Owner’s Equity Statement, Balance Sheet and Cash Flow
Statement.
Income Statement:
Income Statement reports revenue and expenses for a specific period of time. This
specific period of time can be a month, six months or a year etc. If the revenue is
greater than the expense then we will have net income. If the expense is greater than
the revenue then we will have net loss.
Owner’s Equity Statement:
Owner’s equity statement reports changes of owners equity in the company for a
specific period of time. This period of time is the same as that covered in the income
statement.
Balance Sheet:
Balance Sheet records Assets, Liabilities and Owner’s equity. It is a snapshot of a
company's financial position at a specific moment in time. In balance sheet total assets
must be equal to total liabilities and owner’s equity.
Cash Flow Statement:
Cash Flow Statement reports cash receipt and cash payment for a specific period of
time. Cash flow statement usually records three activities- Operating activities, Investing
activities and financing activities.