Overview
This lecture covers the fundamentals of basic accounting, including the accounting cycle, key concepts like assets, liabilities, equity, debits/credits, adjusting entries, and the creation of financial statements such as the income statement, balance sheet, and cash flow statement.
The Accounting Cycle & Financial Accounting
- Financial accounting identifies, records, summarizes, and reports financial transactions in statements.
- The accounting cycle involves identifying transactions, preparing journal entries, posting to the ledger, preparing a trial balance, making adjustments, creating statements, and closing accounts.
- The accounting equation: Assets = Liabilities + Equity must always balance.
Double Entry Accounting & Debits/Credits
- Double entry accounting means every transaction affects at least two accounts, maintaining balance.
- Debits increase assets, expenses, and dividends; credits increase liabilities, equity, and revenue (use the acronym DEALER).
- T-accounts visually represent account balances, showing debits on the left and credits on the right.
Key Accounts Explained
- Assets: Resources providing future economic benefit (e.g., cash, inventory, equipment).
- Liabilities: Obligations to transfer assets or services in the future (e.g., accounts payable, loans, unearned revenue).
- Equity: Owner’s claim after liabilities are settled, including capital and retained earnings.
Methods of Accounting
- Cash accounting records transactions when cash changes hands.
- Accrual accounting records revenue when earned and expenses when incurred, regardless of cash flow.
Adjusting Entries
- Adjusting entries ensure accrual accounting compliance at period-end.
- Types include prepaid expenses, deferred (unearned) revenue, accrued expenses, and accrued revenue.
- Depreciation allocates the cost of tangible assets over their useful lives.
Financial Statements
- Income Statement: Reports revenues, expenses, and profit/loss over a period.
- Balance Sheet: Snapshot of assets, liabilities, and equity at a point in time.
- Cash Flow Statement: Summarizes cash inflows and outflows from operations, investing, and financing activities.
- Direct vs. Indirect cash flow methods differ mainly in reporting operating activities.
Closing Entries
- Closing entries reset temporary accounts (revenues, expenses, dividends) to zero and transfer balances to retained earnings in equity.
Key Terms & Definitions
- Asset — Resource controlled by an entity providing future economic benefit.
- Liability — Present obligation to transfer assets or services due to past events.
- Equity — Owner’s claim on the net assets of a business.
- Journal Entry — Record of a financial transaction, showing debits and credits.
- T-account — Visual tool to display increases and decreases for each account.
- Trial Balance — Report listing all account balances to check if debits equal credits.
- Prepaid Expense — Future expense paid in advance, recorded as an asset first.
- Deferred Revenue — Cash received before earning revenue, recorded as a liability.
- Accrued Expense — Expense incurred but not yet paid or recorded.
- Accrued Revenue — Revenue earned but not yet invoiced or received.
- Depreciation — Allocation of the cost of tangible assets over their useful life.
Action Items / Next Steps
- Review the DEALER acronym for debits and credits.
- Practice journal entries and creating T-accounts.
- Prepare simple versions of the three main financial statements.
- Study examples of adjusting and closing entries.
- Complete assigned readings or homework as directed by your instructor.