chapter 1

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University of Toronto St. George
Rotman Commerce
Alexander Edwards

1. What is accounting? Terms e.g. debit/credits, the equation, t- accounts, purpose of accounting and types of businesses. (Ch. 1) Accounting is the system of analyzing, sorting, and recording economic data relating to business transactions. It involves preparing statements of the results for individuals or businesses in order to make business decisions. It looks at what is owned, what is owed and the difference which is called personal net-worth or owners equity if it is a business entity. What Accounting requires? There are five things involved in accounting: Gathering financial data about the business or other organizations Preparing and gathering permanent records of purchases made, payments received, payroll details, etc. Rearranging, summarizing, and classifying financial information. Preparing information reports, and summaries for: a) measuring the outlook of the company b) helping to make decisions c) external use to professionals for example: bankers, investors Establishing domination to endorse accuracy and honesty among employees. The Purpose of Accounting 1. To record the day to day financial activities of the business. 2. To summarize and report information in financial statements for analysis and decision making. Types of Businesses 1. Sole Trader or Sole Proprietorship: The individual and the owner are the same so the owner tolerates all the risks and liabilities. He can be sued and this can be taken form his personal assets to repay the amount owed. 2. Partnership: Business owned by more than 1 person. Again they have total liability and share the liability or the gain. 3. Limited Company Or Corporation: The business is separate from the owner the shareholders own the business and have limited liabilities they stand to lose only their investments. Accounting terminologies Assets: Things that are resources owned by a company and which have future economic value that can be measured and can be expressed in dollars. Examples include cash, investments, accounts receivable, inventory, supplies, land, buildings, equipment, and vehicles. Assets are reported on the balance sheet usually at cost or lower. Assets are also part of the accounting equation: Assets = Liabilities + Owner's (Stockholders') Equity. Cash: A current asset account which includes currency, coins, checking accounts, and undeposited checks received from customers. Account Receivable: A current asset resulting from selling goods or services on credit (on account). Office Supplies/ Equipments: Items purchased for use within the business office. Liabilities: These are the obligations of a company or organization. Amounts owed to lenders and suppliers. Liabilities also include amounts received in advance for a future sale or for a future service to be performed. Account Payables: This current liability account will show the amount a company owes for items or services purchased on credit and for which there was not a promissory note. Bank Loan: The amount of loan owing to the bank. The length of time for these loans is usually 1-5 years. Mortgage Payable: The amount of loan from financial institutions often to purchase buildings or land. The lender has the right to obtain control of the property in the event that the borrower fails to repay the debt. Since the liability is normally large in amount, the time to repay is longer then other liabilities. Owner's equity: The book value of a company equal to the recorded amounts of assets minus the recorded amounts of liabilities. It claims against the assets of the company. The Accounting Equation: Accounting looks at what is OWNED OWED = PERSONAL NETWORTH Assets = Liabilities Owners Equity T-Accounts T-Accounts are used to collect record and summarize the events that take place in individual accounts. For each item on the balance sheet we prepare an account, it is created in a T-form like the balance sheet. Left side Right side Debit Credits Asset Balances Liabilities and O/E normal balances Accountants use T-Accounts for their rough work for help in better analysis of the transaction. All assets are recorded and balanced on the left side which is debit, and Liabilities and Owners Equity are recorded and balanced on the right side which is Credit. 2. All the Gap Principles used in Accounting explain each in detail giving examples. (All Chapters) Business Entity Principle The business entity concept provides that the accounting for a business or organization be kept separate from the personal affairs of its owner, or from any other business or organization. This means that the owner of a business should not place any personal assets on the business balance sheet. The balance sheet of the business must reflect the financial position of the business alone. Cost Principle The cost principle states that the accounting for purchases must be at their cost price. This is the figure that appears on the source document for the transaction in almost all cases. The value recorded in the accounts for an asset is not changed until later if the market value of the asset changes. Time-Period Principle The time period concept provides that accounting take place over specific time periods known as fiscal periods. These fiscal periods are of equal length, and are used when measuring the financial progress of a business. Matching Principle The matching principle is an extension of the revenue recognition convention. The matching principle states that each expense item related to revenue earned must be recorded in the same accounting period as the revenue it helped to earn. If this is not done, the financial statements will not measure the results of operations fairly. Accrual Basis of Accounting This is a system where revenue earned is matched against expenses incurred for the accounting period. This produces an accurate picture of the financial affairs. The Accrual Basis uses the matching principle, where revenue is recorded as its earned and is recorded whether cash or A/R is used. When revenue is earned it increases owners equity and a loss would decrease owners equity. Cash Basis of Accounting This method of accounting distinguishes the revenue and expenses on a cash basis only. Expenses is recorded only when cash is use to pay for it, and revenue is recorded only when cash is received for transactions. The cash basis does not compare all revenue earned for that accounting period with all the expenses of the same period. It does not abide by the matching principle and this is why its not used by Accountants in their businesses. The Principle of Objectivity The objectivity principle states that accounting will be recorded on the basis of objective evidence. Objective evidence means that different people looking at the evidence will arrive at the same values for the transaction. The source document shows the amount agreed to by the buyer and the seller, who are usually independent and unrelated to each other. The Principle of Materiality (GAAP) The materiality principle requires accountants to use generally accepted accounting principles except when to do so would be expensive or difficult, and where it makes no real difference if the rules are ignored. If a rule is temporarily ignored, the net income of the company must not be significantly affected, nor should the reader's ability to judge the financial statements be impaired. The Principle of Conservatism The principle of conservatism provides that accounting for a business should be fair and reasonable. Accountants are required in their work to make evaluations and estimates, to deliver opinions, and to select procedures. They should do so in a way that neither overstates nor understates the affairs of the business or the results of operation. 3. Balance Sheets and Income Statements how are these financial sheets structured? Explain in steps how these are created and how each of them works. (Ch. 2 & 3) Balance Sheet A company's balance sheet is comprised of assets, liabilities and equity. Assets represent things of value that a company owns and has in its possession or something that will be received and can be measured objectively. Liabilities are what a company owes to others - creditors, suppliers, tax authorities, employees etc. A company's equity represents retained earnings and funds contributed by its shareholders, who accept the uncertainty that comes with ownership risk in exchange for what they hope will be a good return on their investment. The relationship of th
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