General Pricipal of Accounting

CHAPTER 4: GENERAL PRINCIPLES OF ACCOUNTING

An important part of accounting is identifying or specifying the entity for which the financial statements are being prepared. The accounting entity maybe different than the legal entity. The entity being studied may be a subsidiary of a larger corporation.

Financial Accounting: provides general-purpose financial statements or reports to aid decision makers, both internal and external to the organization, such as the following

1. balance sheet

2. statement of revenues and expenses

3. statement of cash flows

4. statement of changes in fund balances

Managerial Accounting: primarily concerned with preparing financial information for a specific purpose, usually internal users

Liabilities: represent the claim of one entity on another’s assets

Revenues: correspond to the increases in fund balance from the sale of goods or delivery of services (when the accrual principle of accounting is used, this is recorded when the revenue is earned which is not necessarily the same as when it is collected)

Expenses: costs incurred by a business to provide goods or services that reduce fund balance (under the accrual principle of accounting, this is recorded when the assets are used to provide the good or service, not necessarily when they are paid for)

Net income: the difference between revenue and expense

The value of assets must always equal the combined value of liabilities and net assets (or fund balance); Assets = Liabilities + Net Assets.

Whenever a financial transaction occurs, such as borrowing money or purchasing supplies, it is important to keep the accounting equation in balance.

The values on the balance sheet represent the acquisition cost of the asset and may not represent the assets current value if it were sold or replaced. Why use the acquisition or historical cost rather than current market value or replacement value? The current market value may be hard to...