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
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,
Rearranging, summarizing, and classifying
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:
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.
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
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
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
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 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
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.
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
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
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
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
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)
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