Basic Accounting Concepts

Balance Sheet

The Balance Sheet A quantitative summary of a company’s

financial condition at a specific point in time.

A snapshot of the financial health of an entity.

Basic financial statement that measures the position of a company’s assets, liabilities and owners equity ,as on a given date.

It is a status report.

Assets Economic resources controlled by an entity

and whose cost at the time of acquisition can be objectively measured.

Key points: (i) an asset must be acquired in a

transaction(ii)an asset must be an economic resource(iii)the resource must be controlled by the entity(iv)Its cost at the time of acquisition must be objectively measured.

Economic resource A resource is an economic resource if it

provides future benefits to the entity. Resources provide future benefits under

any of the 3 conditions(i) they are cash or can be converted into cash

(ii)they are goods that are expected to be sold and cash received for them.

(iii) they are items expected to be used in future activities that will generate cash inflows to the entity.

Current Assets Cash and other assets that are expected to

be realized in cash or sold or consumed during the normal operating cycle of the business or within one year, whichever is longer, are called as current assets.

Cash Marketable securities Accounts receivable Inventories Prepaid expense

Cash-consists of fund that are readily available for disbursement. (cash in bank & cash in hand)

Marketable securities-investments that are readily marketable and expected to be converted into cash within a year.( made for earning some return)

Accounts Receivable Amounts owed to the entity by its

customers. Amounts owed to the entity by parties

other than customers would appear under the head “Notes receivable or other receivables” rather than accounts receivable.

If the amount owed to the company are evidenced by written promises to pay, they are listed as notes receivable.

Inventories Inventories are aggregate of those items that

are either (i) held for sale in the ordinary course of business (ii) in process of production for such sale (iii) are soon to be consumed in the production of goods or services that will be available for sale.

Truck offered by truck dealer-inventory Truck used by the same dealer to make service

calls-not an inventory.

Prepaid expenses It represents certain assets, usually of

intangible in nature, whose usefulness will expire in near future.

Non current Assets Assets that are tangible and relatively long

lived. The entity has acquired these assets in order to use them to produce goods and services that will generate future cash flows. (also termed as fixed assets)

Ex:property, plant & equipment It is recorded at its original cost(amount

paid to acquire these items) Depreciation-portion of original cost that is

written off, allocated as cost of doing a business

Other Assets Another type of non current asset-Investments. Intangible assets include

goodwill,patents,copyrights,trademarks and similar valuable but non physical things controlled by business.

They are distinguished from prepaid expenses

Liabilities Obligations of the entity to outside parties who

have furnished resources. Because an entity will use its assets to payoff

its claims, those claims are against entity’s assets. (all assets)

If a liability is a claim against a specific asset, its title indicates that fact, as in a mortgage loan or secured long term debt.

Current Liabilities Liabilities that are expected to be satisfied or

extinguished during the normal operating cycle or within one year, which ever is longer.

Accounts payable Taxes payable Accrued expenses Deferred revenues

Accounts payable

Represents claims of suppliers arising from their supply of goods or services to the entity for which they have not been paid. (usually these claims are unsecured)

Amounts owed to financial institutions are called notes payable or short term loans.

Accrued expenses Amounts that have been earned by outside

parties but have not been paid by the entity.

Ex:interest earned by the lender but not paid by the entity (interest payable)

Wages and salaries owed to the employees for the work they have performed,but for which they have not been paid(wages payable)

Deferred revenues Also called as unearned revenue Liability that arise because the entity has

received advance payment for a service it has agreed to render in future.

Non current Liabilities

Long term debt

Owners’ equity The amount the owners have invested in

business. In a company, the ownership interest is

evidenced by shares and owners’ equity is labeled as shareholders’ equity.

Shareholders’ equity is divided into: Paid in capital & retained earnings. Net Worth-a synonym for the term owners’

equity.

Paid in capital-amount the investors have invested directly in business

Retained earnings-part of the total earnings that have been retained for use in-reinvested in-the business.

Retained earnings is the difference between the total earnings of the entity from its inception to date and the total amount of dividends paid out to its shareholders over its entire life.

If the difference is negative, the item is labeled as deficit.

Amount of retained earnings on a given date is the cumulative amount that has been retained in the business.

Unincorporated business

Proprietorship-capital account of one person

partnership-capital account of each partner.

Drawings.

Basic Accounting Concepts Money measurement-accounting records

only those facts that can be expressed in monetary terms.

Entity-accounts are kept for entities as distinguished from the persons associated with those entities.

Going concern-Accounting assumes that an entity will continue to exist indefinitely and that it is not about to be liquidated.

Cost-Assets are ordinarily entered in the accounts at the amount paid to acquire them.

Dual Aspect-Every transaction affects at least two items and preserve the fundamental equation:

assets-=liabilities+ owners’equity