FINANCIAL ACCOUNTING
BASIC ACCOUNTING TERMS
Abstract
Income, Expenses, Assets, Liabilities, Preferred stock,
common stock, complete accounting cycle, Reporting
purpose, Adjusted Entries, Types of adjusted entries,
basic financial statement and Balance Sheet.
Iqra Asif
Iqraasif214@gmail.com
“An asset is a resource controlled by the enterprise as a result of past
events and from which future economic benefits are expected to flow to
the enterprise.”
Properties of an Asset
There are three key properties of an asset:
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Ownership: Assets represent ownership that can be eventually turned into
cash and cash equivalents
Economic Value: Assets have economic value and can be exchanged or sold
Resource: Assets are resources that can be used to generate future economic
benefits
1. Current Assets
Current assets are assets that can be easily converted into cash and cash equivalents
(typically within a year). Current assets are also termed liquid assets and examples of
such are:
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Cash
Cash equivalents
Short-term deposits
Accounts receivables
Inventory
Marketable securities
Office supplies
Prepaid expenses
Accrued income
2. Fixed or Non-Current Assets
Non-current assets are assets that cannot be easily and readily converted into cash
and cash equivalents. Non-current assets are also termed fixed assets, long-term
assets, or hard assets. Examples of non-current or fixed assets include:
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Land
Building
Machinery
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Equipment
Patents
Trademarks
Classification of Assets: Physical Existence
If assets are classified based on their physical existence, assets are classified as
either tangible assets or intangible assets.
1. Tangible Assets
Tangible assets are assets with physical existence (we can touch, feel, and see them).
Examples of tangible assets include:
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Land
Building
Machinery
Equipment
Cash
Office supplies
Inventory
Marketable securities
2. Intangible Assets
Intangible assets are assets that lack physical existence. Examples of intangible assets
include:
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Goodwill
Patents
Brand
Copyrights
Trademarks
Trade secrets
Licenses and permits
Corporate intellectual property
Classification of Assets: Usage
If assets are classified based on their usage or purpose, assets are classified as
either operating assets or non-operating assets.
1. Operating Assets
Operating assets are assets that are required in the daily operation of a business. In
other words, operating assets are used to generate revenue from a company’s core
business activities. Examples of operating assets include:
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Cash
Accounts receivable
Inventory
Building
Machinery
Equipment
Patents
Copyrights
Goodwill
2. Non-Operating Assets
Non-operating assets are assets that are not required for daily business operations
but can still generate revenue. Examples of non-operating assets include:
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Short-term investments
Marketable securities
Vacant land
Interest income from a fixed deposit
Liabilities can be broken down into two main categories: current and noncurrent.
Current liabilities are short-term debts that you pay within a year. Types of current
liabilities include employee wages, utilities, supplies, and invoices.
Noncurrent liabilities, or long-term liabilities, are debts that are not due within a
year. List your long-term liabilities separately on your balance sheet. Accrued
expenses, long-term loans, mortgages, and deferred taxes are just a few examples
of noncurrent liabilities.
Some types of liabilities you might have include:
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Accounts payable
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Income taxes payable
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Interest payable
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Accrued expenses
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Unearned revenue
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Mortgage payable
Revenue, or sales, is the income your business receives from business-related
activities. For most businesses, the majority of its revenue is derived from sales.
Types of revenue
What are the types of revenue in business? There are two types of revenue your
business might receive:
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Operating
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Non-operating
Operating revenue is revenue you receive from your business’s main activities, like
sales
Non-operating revenue is money earned from a side activity that is unrelated to
your business’s day-to-day activities, like dividend income or profits from
investments.
You can have both operating and non-operating revenue accounts:
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Sales
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Rent revenue
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Dividend revenue
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Interest revenue
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Contra revenue (sales return and sales discount)
Expenses refer to costs incurred in conducting business.
List of Expense Accounts
1. Cost of Sales
2. Purchases
3. Freight in
4. Bank Service Charge
5. Delivery Expense
6. Depreciation Expense
7. Insurance Expense
8. Interest Expense
9. Repairs and Maintenance
10.Representation Expense
11.Salaries Expense
12.Supplies Expense
13.License Fees and Taxes
14.Training and Development
15.Utilities Expense etc.
Common stock and preferred stock are the two main types of stocks that are sold by
companies and traded among investors on the open market. Each type gives
stockholders a partial ownership in the company represented by the stock.
Common Stock: Common stock is the most common type of stock that is issued by
companies. It entitles shareholders to share in the company’s profits through
dividends and/or capital appreciation. Common stockholders are usually given voting
rights, with the number of votes directly related to the number of shares owned. The
return and principal value of stocks fluctuate with changes in market conditions.
Shares, when sold, may be worth more or less than their original cost. Shareholders
are not assured of receiving dividend payments. Investors should consider their
tolerance for investment risk before investing in common stock.
Preferred Stock: Preferred stock is generally considered less volatile than common
stock but typically has less potential for profit. Preferred stockholders generally do not
have voting rights, as common stockholders do, but they have a greater claim to the
company’s assets. Preferred stock may also be “callable,” which means that the
company can purchase shares back from the shareholders at any time for any reason,
although usually at a favorable price. Preferred stock shareholders receive their
dividends before common stockholders receive theirs, and these payments tend to be
higher. Shareholders of preferred stock receive fixed, regular dividend payments for a
specified period of time, unlike the variable dividend payments sometimes offered to
common stockholders.
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The accounting cycle is a process designed to make financial accounting of
business activities easier for business owners.
There are usually eight steps to follow in an accounting cycle.
The closing of the accounting cycle provides business owners with
comprehensive financial performance reporting that is used to analyze the
business.
The eight steps of the accounting cycle are as follows: identifying transactions,
recording transactions in a journal, posting, the unadjusted trial balance, the
worksheet, adjusting journal entries, financial statements, and closing the books.
The 8 Steps of the Accounting Cycle
The eight steps of the accounting cycle include the following:
Step 1: Identify Transactions
The first step in the accounting cycle is identifying transactions. Companies will
have many transactions throughout the accounting cycle.
Step 2: Record Transactions in a Journal
The second step in the cycle is the creation of journal entries for each
transaction. Double-entry bookkeeping calls for recording two entries with each
transaction in order to manage a thoroughly developed balance sheet along with
an income statement and cash flow statement.
Step 3: Posting
Once a transaction is recorded as a journal entry, it should post to an account in
the general ledger.
Step 4: Unadjusted Trial Balance
At the end of the accounting period, a trial balance is calculated as the fourth
step in the accounting cycle
Step 5: Worksheet
Analyzing a worksheet and identifying adjusting entries make up the fifth step in
the cycle. A worksheet is created and used to ensure that debits and credits are
equal.
Step 6: Adjusting Journal Entries
In the sixth step, a bookkeeper makes adjustments. Adjustments are recorded as
journal entries where necessary.
Step 7: Financial Statements
After the company makes all adjusting entries, it then generates its financial
statements in the seventh step. For most companies, these statements will
include an income statement, balance sheet, and cash flow statement.
Step 8: Closing the Books
Finally, a company ends the accounting cycle in the eighth step by closing its
books at the end of the day on the specified closing date. The closing statements
provide a report for analysis of performance over the period.
Adjusting entries are changes to journal entries you've already recorded.
The five types of adjusting entries
1. Accrued revenues
When you generate revenue in one accounting period, but don’t recognize it until a
later period, you need to make an accrued revenue adjustment.
2. Accrued expenses
Once you’ve wrapped your head around accrued revenue, accrued expense
adjustments are fairly straightforward. They account for expenses you generated in
one period, but paid for later.
3. Deferred revenues
If you’re paid in advance by a client, it’s deferred revenue. Even though you’re paid
now, you need to make sure the revenue is recorded in the month you perform the
service and actually incur the prepaid expenses.
4. Prepaid expenses
Prepaid Expenses work a lot like deferred revenue. Except, in this case, you’re paying
for something up front—then recording the expense for the period it applies to.
5. Depreciation expenses
When you depreciate an asset, you make a single payment for it, but disperse the
expense over multiple accounting periods. This is usually done with large purchases,
like equipment, vehicles, or buildings.
At the end of an accounting period during which an asset is depreciated, the total
accumulated depreciation amount changes on your balance sheet. And each time you
pay depreciation, it shows up as an expense on your income statement.
The financial statement prepared for the end day of the accounting period to show
the financial position of a business concern is called a balance sheet.
The balance sheet includes assets and liabilities & owner’s equity. The total assets are
equal to the total liabilities and owner’s equity.
So, Assets = Liabilities + Owner’s Equity. In brief A= L + OE.
The balance sheet is prepared with the following objects:
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Knowing the financial position of a business.
Knowing the real value of assets.
Knowing the amount and nature of liabilities.
Verification of debt paying capability of a business.
Knowing the trend of changes in assets and liabilities.
Knowing the trend of profit or loss of business.
Knowing the deduction of depreciation from assets.
Knowing the amount of prepaid and unpaid expenses.
Types of Balance Sheet are ;
1. Unclassified balance sheet.
2. Classified Balance Sheet.