The language can be broken down into 5 parts.
It can be grouped in to financial statements. We use these statements to analyze transactions.
Transactions are things that effect a business that can be measured in money. Two of the three financial statements you have to know are:
L stands for Liabilities. Liabilities are something you owe. Liabilities have names like Account Payable, Note Payable, Wages Payable, Salaries Payable.
C stands for Capital or Owners Equity. Think of it as adding up all your assets subtract all your liabilities. What is left is Capital or owners equity. (A-L=C) It is the claim of the owners on assets. Capital or Owners Equity is simply called capital or if the business is a corporation it is called Capital Stock. There is an account that reduces capital. When the owners take something out of the business they have a withdrawal or drawing. If the business is a corporation taking something out is a Dividend. These are not a sixth part of the language but since they do the opposite of the Capital or contra capital.
R stands for Revenue. Revenue is what we get when we sell goods or render services. It has names like Professional fees, Service Revenue, Sales, Commissions. You notice that there is a + before R. That is because revenue increases capital or owners equity.
Principles Chapter 1 page 1
E stands for Expenses. These are costs incurred to produce income. This is the most numerous category with names like Advertising Expense, Delivery Expense, Miscellaneous Expense, Rent Expense, Salary expense, Utilities Expense, Wages Expense.
You notice that there is a - before the E. That is because Expenses decrease Capital.
You compare R's to E's on the income statement and if R's > than E's you have net income.
If R's < E's you have net loss.
The third financial statement is a Statement of Owners Equity. It tells you how Capital is increased or decreased.
+ Any capital that is added called additional Investment
+ Net Income: ( you can't have both net income and net loss)
- Net Loss :
-Withdrawals, drawing, dividends
Partnership. Two or more owners. Each owner is a partner. Way to bring skills or capital together.
Corporation. A fictional person has limited liability. It is a legal entity separate from owners. Lose only your investment. Coca Cola, Ford Motor Co.
Reliability (or Objectivity) Principle. Accounting information should be free from error and bias. Must be truthful, verifiable, honest.
The Cost Principle. Assets are to be recorded at cost rather than current market value.
The Going Concern Assumption is that the business will continue to operate in the foreseeable future.
The Stable Monetary Unit. Accountants ignore the effect of inflation
The key to understanding accounting is to understand and analyze transactions: You read the words and translate it into accounting.
1. Make an investment in the business. A and C
Cash or Accounts Receivable or Note Receivable
Account Payable or Note Payable
Advertising Expense, Delivery Expense, Rent Expense
Withdrawal or Drawing
Invested $100,000 in a sole proprietorship by opening a bank Account in the company name.
Paid $300 to purchase office supplies.
Purchased $2,000 more of supplies on account.
Paid cash for land costing $65,000. Company plans to build an office building on the land.
Purchased $10,000 of Machinery and Equipment. Signed a note for the purchase.
Performed $500 of services for a customer on account.
Performed $400 of services for a customer who paid us.
Received payment of the $500 for the services we previously performed.
Borrowed $25,000 from a bank.
Loaned $5,000 to a business Associate.
Paid for the $2,000 of supplies. (See no.# 3 above)
Paid $5,000 on the principal of the note.
Paid employee salaries 1,400, Office rent $1,200 and utilities $300.
Withdrew $650 cash for personal use.
Decrease an asset and decrease a liability.
Increase an asset and increase owner's equity.
Increase an asset and increase a liability.
Increase one asset and decrease another asset.
Decrease an asset and decrease owner's equity.
|Assets||= Liabilities||+ Capital|
|May 31, 1997||May 31, 1998|
a. Owner invested $30,000
b. Owner withdrew $ 6,000
c. Owner invested $ 8,000 and withdrew $6,000
Prepare the balancesheet of Long-Gone Delivery service as of September
30, 1994 from the following Accounts:
|Accounts Payable||$750||L.Gone, Capital||?|
|Accounts Receivable||$900||Note Payable||$8000.00|
|Delivery Equipment||15,500||Salary Expense||$2000|
|Delivery Service Revenue||$4,100||Supplies||$600|
|Accounts Payable||$3,300||Property Tax Expense||$1,200|
|Accounts Receivable||9,000||Rent Expense||$21,000|
|K. Toshi, Capital||$27,100||Salaries Payable||$2,000|
|Notes Payable||$30,000||Service Revenue||$131,000|
|Office Furniture||$45,000||Supplies expense||$4,000|
|Office Supplies||$4,800||Utilities Expense||$5,800|
Account payable. A liability backed by the general reputation and Credit standing of the debtor, these are our trade creditors.
Account receivable. An asset, a promise to receive cash from customers to whom the business has sold goods or for whom the business has performed services.
Accounting. The language of business. The system that measures business activities, processes that information into financial statements.
Accounting equation. The most basic tool of accounting: Assets = Liabilities + Capital (Owner's Equity).
Asset. Something of value you own.
Balance sheet. List of an entity's assets, liabilities, and owner's equity as of a specific date. Also called the statement of financial position.
Capital.Another name for the owners equity in a business.
Corporation. A corporation is a legal entity, "an artificialperson",in the eyes of the law.
Entity. An organization or a section of an organization that, for accounting purposes, stands apart from other organizations and individuals as a separate economic unit.
Expense. Costs incurred to produce revenue. Decrease in owner's equity that occurs in the course of delivering goods or services to customers or clients.
Financial statements. Business documents that report financial information about an entity to persons and organizations outside the business. Most commonly the Income statement, Statement of Owners's Equity and Balance Sheet.
Generally accepted accounting principles (GAAP). Accounting guidelines, formulated by the Financial Accounting Standards Board, that govern how businesses report their financial statements to the public.
Income statement. List of an entity's revenues, expenses, and net income or net loss for a specific period. Also called the statement of operations or the statement of earnings.
Liability. Something you owe. An economic obligation (a debt) payable to an individual or an organization outside the business.
Net income. Excess of total revenues over total expenses. Also called net earnings or net profit.
Net loss. Excess of total expenses over total revenues.
Note payable. A liability evidenced by a written promise to make a future payment. Usually happens when you borrow money or buy an expensive asset.
Note receivable. An asset evidenced by another party's written promise that entities you to receive cash in the future. Usually happens when you loan money or sell an expensive asset.
Owner's Equity.The claim of an owner of a business to the assets of the business. Also called capital. Partnership. A business with two or more owners.
Proprietorship. A business with a single owner.
Revenue. Increase in owner's equity that is earned by delivering goods or services to customers or clients .
Transaction. An event that affects the financial position of a particular entity and can be reliably recorded and measured in money.