Chapter 2 Condensed (Day 1)
I. Overview of Accounting Concepts
II. Accounting for Business Transactions
III. Keeping Track of Account Balances
A. Journal Entries – General Journal
B. T-Accounts – General Ledger
IV. Prepare a Classified Balance Sheet
V. Current Ratio
I. Overview of Accounting Concepts
A. Objective of Financial Reporting - Primary objective of external financial reporting is to provide useful
economic information about a business to help external parties make sound financial decisions Help
people make decisions
B. Traits of Useful Accounting Information
1. Relevance – Would influence a decision, provides useful current information
2. Reliability – Can be depended upon, neutral representation of the financial information
3. Comparability – Results from companies following the same accounting rules in preparing their
financial info. Allows stakeholders to compare the financial position and performance of two
companies in the same industry.
4.Consistency – The company uses the same accounting principles and rules from year to year. Allows
stakeholders to compare the financial position and performance of the same company over time.
C. Assumptions and Principles of Financial Statements
1. Unit-of-measure assumption – States that each business entity accounts for and reports its financial
results primarily in terms of the national monetary unit ($, €, etc.).
2. Separate entity assumption -Assumes economic events can be identified with a particular unit of
accountability. Requires economic activities of an entity be kept separate from those of owner and
separate from all other economic entities.
3. Time period assumption - Allows the business to be divided into artificial time periods (choose
whenever is a good breaking point).
4. Continuity assumption / Going concern assumption - Assumes business will be in existence long
enough to carry out goals. The business will be a continued ―going concern.‖ They have to assume they
can pay off their short-term and long-term debts/liabilities. Someone else will have to come in if they
are in danger of bankruptcy.
5. Historical Cost principle - Requires assets to be recorded at original cost as it is verifiable. It used to
be that it was only based on this conservative principle.
6. Full Disclosure principle - Requires that all circumstances and events that would make a difference
to users of financial statements be presented. Therefore, notes are often disclosed, to include things
like market price.
1 D. Two Constraints in Accounting
1. Materiality - Small amounts that are not likely to influence a user’s decision can be accounted for in
the most cost-beneficial manner. Is it worth it to take the effort to audit all the details of the smallest
portions of inventory?
2. Conservatism - Allows the accountant to choose the accounting method that will be the least likely to
overstate assets and income—doesn’t imply that you should intentionally understate assets or income!
If the fair market value rises, you do nothing and record only the historical cost! If the fair market
value falls, you lower the price in the books as an expense.
E. Elements of the Balance Sheet
1. Assets – economic resources with probable future benefits owned by the entity as a result of past
transactions. future economic benefits
i. To be reported, assets must have a measurable, verifiable value, usually based on the
purchase price (historical cost), using a receipt or ―bill of lading‖
ii. Assets are measured initially under the historical cost principle (i.e., its fair market value
on the exchange date).
iii. Assets are listed in order of liquidity – how soon an asset is expected by management to
be turned into cash or used, classified balance sheet is broken up by:
a. Current assets: will be used or turned into cash within one year
b. Long Term assets: assets to be used or turned into cash beyond the coming year.
2. Liabilities – probable debts or obligations of the entity that result from past transactions, which will
be paid with assets or services.
i. Creditors – entities that a company owes money
ii. Liabilities are usually listed on the balance sheet in order of maturity – how soon an
obligation is to