Accounting Cycle and Financial Accounting Principles

Introduction

• Instructor: James
• Topic: Basic accounting, aimed at helping people pass exams or manage their businesses
• Format: Five-hour tutorial broken down into segments with timestamps
• Resources: Cheat sheets available on the website

Key Concepts in Accounting

Accounting Cycle

1. Identifying Transactions: Recognizing financial transactions within a period.
2. Journal Entries: Recording transactions in journals with debits and credits, maintaining the balance between them.
3. General Ledger: A comprehensive record of all journal entries, categorized by accounts.
4. Trial Balance: Summarizes the closing balances of all ledger accounts to ensure debits equals credits.
5. Adjusting Entries: Adjust to account for accrued and deferred items to align with the accrual method.
6. Financial Statements: Includes the balance sheet, income statement, and cash flow statement.
7. Closing Entries: Reset temporary accounts to zero and close out the period.
8. Post-Closing Trial Balance: Ensures all entries are accounted for correctly and debits equal credits.

Double Entry Accounting

• Basic Idea: The business's assets equal the sum of its liabilities and equity.
• T-Accounts: Visual representation of accounts with debits on the left and credits on the right.
• Debits and Credits: Every transaction affects at least two accounts and ensures the accounting equation balances.
• Types of Accounts: Assets, liabilities, equity, revenue, expenses, and dividends
• Debit/Credit Rules:
  • Assets = Liabilities + Equity
  • Debits increase assets and expenses; credits decrease them.
  • Credits increase liabilities, equity, and revenue; debits decrease them.

Financial Reporting Standards

• IFRS and GAAP: Forms of standards and principles to ensure true and fair financial view.
• Accrual Method: Revenue recognized when earned and expenses when incurred, not necessarily when cash changes hands.
• Balance Sheet, Income Statement, and Cash Flow Statement: Key financial statements reflecting financial health
• Financial Ratios: For analyzing business performance

Practical Examples

Rough Times Tabloid Example

1. March Promotion: $40,000 in new annual subscriptions, paid in cash.
2. Journal Entry: Debit cash, credit subscription revenue.
3. General Ledger Post: Post entries to specific T-accounts for cash and subscription revenue.
4. T-Accounts: Drawing T for visualization, debits left, credits right
5. Unadjusted Trial Balance: Summarizes all account balances before adjustments
6. Adjusting Entries: To align with the accrual method (example: deferred revenue).

Equity

• Equity Components: Capital contributions, retained earnings, dividends
• Calculating Equity:
  • Retained Earnings: Opening balance + current year profit - dividends
  • Expanded Accounting Equation: Shows link between balance sheet, income statement via equity

Transactions and Entries

1. Owner's Investment: Debit cash, credit owner's equity for $100.
2. Loan: Debit cash, credit loans payable for $200.
3. Asset Purchase: Debit equipment, credit cash for $30.
4. Inventory on Account: Debit supplies, credit accounts payable for $50.
5. Revenue Recognition: Debit cash, credit revenue for $150
6. Expense Recognition: Debiting relevant expense accounts as incurred

Financial Statements

Balance Sheet

• Assets, Liabilities, Equity: Assets broken into current/non-current
  • Current Assets: Cash, accounts receivable, supplies, etc.
  • Non-Current Assets: Investments, Plant Property, and Equipment (PPE)
  • Liabilities: Current liabilities like payable accounts and non-current like long-term loans
  • Equity: Owner's equity and retained earnings

Income Statement

• Revenues and Expenses: Categorized into direct (cost of goods sold) and indirect (operational costs)
• Types of Profit: Gross profit, operating profit, net profit
• Operating Profit/Earnings Before Interest and Tax (EBIT): Net income from core business operations
• Gross Profit Margin: Efficiency of production and sales calculated as (Sales - COGS) / Sales

Cash Flow Statement

• Direct Method: Shows actual cash flows tied directly to operations
  • Operating Activities: Includes cash receipts from customers and cash payments
  • Investing Activities: Cash flows related to buying/selling assets
  • Financing Activities: Cash flows from borrowing or repaying loans or equity.
  • Calculation: Start with net profit, adjust for non-cash transactions, and changes in working capital (Receivables, Payables, Inventories)

Summary

• Key tools and resources provided, including cheat sheets and memberships for further learning.
• Reiterated the importance of financial statements and their correct preparation for insights into business health.
• Closed with best practices for using financial metrics to analyze business performance.