Accounting

Introduction to Accounting

List of topics
Forms of business organization •
Assets, Liabilities, and equity •
The Basic accounting equation •
Financial performance • Revenues and expenses •
Measurement of assets and liabilities
Hidden reserve and watering-down of the equity • The main financial statements •

:What is accounting
.Accounting is the process of recording financial transactions pertaining to a business
The accounting process includes summarizing, analyzing, and reporting these
transactions

Forms of business organization

Sole Proprietorship: In this kind of business, a single person owns and operates the
.business. Where the owner pays the taxes by himself
Partnership: As the name suggests, it is a business where two or more people run it
.together
Corporation: In this business, a group of individuals act together as a single entity.
The owners in this business are called shareholders. There are unfavorable taxation
rules in a corporation for the business owners
Small Business: There are different sizes of business. Small businesses are
companies where small owners (an individual or a small group) operate. For instance,
family restaurants, clothing companies, home-based companies, and publishing
companies
Mid-sized Business: These businesses rake in millions of dollars in revenue. Usually,
it ranges from $50 million to $1 billion. They are established better than a small
.business
Large Business: This kind of business usually operates as a corporation. It has an
employee base of 1000+ people, and its revenue production is more than $1 billion.
Usually, these businesses issue corporate stock to finance their operations. Examples
of these is amazon, Nike and many others large companies

:Limited Liability
A limited liability company (LLC) is a structure that separates companies and their
owners. It prevents individuals from being liable for the company’s financial losses,
.debts, and other liabilities
In other words, investors' and owners' private assets are not at risk if the company
.fails

:Shares
.Shares are portion of ownership (or equity) of a limited company
Shares can be traded in financial markets, greatly enhancing the ease of transferring or
.adding ownership

WHAT ARE THE ORGANIZATIONS AND RULES THAT GOVERN

?ACCOUNTING
GAAP consists of a common set of accounting rules, requirements, and practices
issued by the Financial Accounting Standards Board (FASB) and the Governmental
Accounting Standards Board (GASB). GAAP sets out to standardize the
classifications, assumptions and procedures used in accounting in industries across the
.US
:The three main financial statements

.Balance sheet: It reports the financial position of a company as of a specific point in time

Income statement (or Profit and loss account): financial report that provides a summary of
a company's revenues, expenses, and profits/losses over a given period of time

Cash flow statement: financial statement that summarizes the movement of cash and cash
 :Three fundamental accounting terms

Assets: An asset is anything that has current or future economic value to a business,
assets could provide monetary benefit in the future. Assets are credits

Assets are what a business owns, and liabilities are what a business owes. Both are
,listed on a company's balance sheet

.Liabilities: are debts or obligations a person or company owes to someone else

Owners’ equity: the portion of a company's assets that an owner can claim

:The basic accounting equation

Assets = liabilities + owners’ equity

:The meaning of owner’s equity

Equity = Assets – Liabilities
The value of a firm’s equity is equal to the value of the assets, minus the value of the
.resources that will have to be paid back to creditors in the future

:Some important accounting conventions

Entity concept: The business entity concept states that the business is separate from
.the owner(s) of the business
Money measurement convention: those transactions that can be measured or
.expressed in monetary terms on the financial statement
Historical Cost Accounting Convention: An accounting technique that values an
asset for balance sheet purposes at the price paid for the asset at the time of its
.acquisition
 :Important assumptions about valuation

Prudence (or conservatism): is a policy of anticipating possible future losses but

.not future gains
Going concern: is an accounting term for a company that is financially stable
.enough to meet its obligations and continue its business for the foreseeable future
Stable monetary unit convention: definition of the dollar will remain constant
.across fiscal periods. The inflation rate is assumed to be zero

:Equity consists of two components

.Contributed capital: it's how much money you as a business owner had put in the business

Retained earnings: are the amount of profit a company has left over after paying all
.its direct costs, indirect costs, income taxes and its dividends to shareholders

:The concept of income

Income is the net increase (profit) or net decrease (loss) in owner’s equity over a
.period of time
Income = (E t1 – E t0) – owners' contributions + owners' distributions →
Equity1 = Equity0 + Income + Contributions – Distributions
Net income = (Et1- Et0) +distributions-contributions
Net income = Revenues – Expenses

:Revenues and expenses

.Revenues: This is the money your business brings in during an accounting period
Expenses: the money spent, or costs incurred, by a business in their effort to generate
.revenues
Revenues and expenses are changes in assets and liabilities, with the exclusion of transactions
.between the firm and the equity participants

In the 1st phase you don't

necessarily need to
immediately spend money,
because you can
always pay after (Transaction
of credit). Anyway, you still
have an expense (even though
you
don't have a decrease of cash),
because you have an increase
of liabilities. However, we
also have a revenue: because
we have an increase of assets,
we have new material.
→ Every time you purchase a
material, you both have a
positive and a negative change
in
your assets, of the same value
in both ways. (You have less
money and more materials).
[ Even though the item you
buy loses value, the moment
you paid it it was worth
the money you spent.
Therefore the value of ∆A is
the same.]
Accrual vs Cash Accounting
.Cash accounting records payments and receipts when they are received
Accrual records payments and receipts when services or good are provided or debt is
.incurred
Example: if the company has provided a service to a customer but has not yet received
payment, it's called an accrual accounting

:Revenue recognition
The principle requires that businesses recognize revenue when it's earned (accrual .
.accounting) rather than when payment is received (cash accounting)

:Matching Principle

The matching principle is an accounting concept that dictates that companies

.report expenses at the same time as the revenues they are related to

:Accrued and prepaid items

Pre-paid expenses: are assets arising from the advance payment of services that will
.be consumed in a future accounting period
Accrued expenses are liabilities arising from the consumption of services in the current
.period, but that will be paid in a future accounting period

.Accrued income (or “accrued revenue”) is an asset, while pre-paid income is a liability

?TRANSACTION
A transaction is any event that affects the financial position of the business and can be
measured with faithful representation. For example: Buying a computer for the office for
$2,000 cash
?FINANCIAL STATEMENTS
Financial statements are business documents that are used to communicate information
.needed to make business decisions
:THE INCOME STAMENT
.The income statement reports the net income or net loss of the business for a specific period

:The statement of retained earnings

The statement of retained earnings reports how the company’s retained earnings
.balance changed from the beginning to the end of the period

:The balance sheet

reports on the assets, liabilities, and stockholders’ equity of the business as of a specific
.date
 :The statement of cash flows

.The statement of cash flows reports the change in cash during the period