Accounting 1 Course Notes

1. Introduction to Accounting

● Definition: Accounting is the process of recording, summarizing, and reporting financial

transactions to provide information that is useful in making business decisions.
● Users of Accounting Information:
○ Internal Users: Managers, employees (for decision-making and performance
evaluation).
○ External Users: Investors, creditors, regulators (to assess the company’s
financial health).
● Types of Accounting:
○ Financial Accounting: Focuses on preparing financial statements for external
users.
○ Managerial Accounting: Provides information for internal users to assist in
decision-making.

2. The Accounting Equation

● Accounting Equation:
Assets=Liabilities+Equity\text{Assets} = \text{Liabilities} + \
text{Equity}Assets=Liabilities+Equity
○ Assets: Resources owned by the business (e.g., cash, inventory, equipment).
○ Liabilities: Obligations the business owes to outsiders (e.g., loans, accounts
payable).
○ Equity: Owner’s claim on the assets after liabilities are settled (e.g., common
stock, retained earnings).

3. Financial Statements

● Balance Sheet: Shows a company's financial position at a specific point in time,

summarizing assets, liabilities, and equity.
● Income Statement (Profit and Loss Statement): Reports a company’s financial
performance over a period of time, showing revenues, expenses, and net income (or
loss).
○ Net Income:
Net Income=Revenues−Expenses\text{Net Income} = \
text{Revenues} - \text{Expenses}Net Income=Revenues−Expenses
● Statement of Retained Earnings: Shows changes in retained earnings over a period of
time, including net income and dividends.
● Statement of Cash Flows: Reports cash inflows and outflows categorized into
operating, investing, and financing activities.

4. The Double-Entry Accounting System

● Double-Entry Accounting: Every transaction affects at least two accounts, ensuring

that the accounting equation stays balanced.
○ Debits and Credits:
■ Debits (Dr.): Recorded on the left side; increase assets, expenses, and
dividends.
 ■ Credits (Cr.): Recorded on the right side; increase liabilities, equity, and
revenue.
● Normal Balances:
○ Assets: Debit.
○ Liabilities: Credit.
○ Equity: Credit.
○ Revenue: Credit.
○ Expenses: Debit.

5. Recording Transactions

● Steps in the Accounting Cycle:

○ Analyze Transactions: Identify which accounts are affected and how.
○ Journalize Transactions: Record transactions in the general journal.
○ Post to Ledger: Transfer journal entries to the general ledger accounts.
○ Prepare a Trial Balance: A list of all accounts and their balances to ensure
debits equal credits.
○ Adjusting Entries: Update accounts at the end of the period for accrued and
deferred items.
○ Prepare Financial Statements: Based on the adjusted trial balance.
○ Closing Entries: Close temporary accounts (revenues, expenses, and
dividends) to retained earnings.
○ Post-closing Trial Balance: Ensure all temporary accounts have been closed
and the accounting equation remains balanced.
● Types of Accounts:
○ Permanent Accounts: Assets, liabilities, and equity (not closed at the end of the
period).
○ Temporary Accounts: Revenue, expense, and dividend accounts (closed at the
end of the period).

6. Adjusting Entries

● Purpose: Ensure that revenues and expenses are recorded in the correct period
(matching principle).
● Types of Adjusting Entries:
○ Accruals: Revenue or expenses that have been earned or incurred but not yet
recorded.
■ Accrued Revenues: Revenue earned but not yet received (e.g., interest
receivable).
■ Accrued Expenses: Expenses incurred but not yet paid (e.g., wages
payable).
○ Deferrals: Cash has been received or paid, but revenue or expense is
recognized later.
■ Prepaid Expenses: Payments made for expenses that will benefit future
periods (e.g., prepaid insurance).
■ Unearned Revenue: Cash received before revenue is earned (e.g.,
customer deposits).

7. The Trial Balance

● Purpose: A list of all accounts and their balances at a given point in time to check that
total debits equal total credits.
● Adjusted Trial Balance: Includes adjusting entries to ensure accuracy before preparing
financial statements.

8. Closing Process

● Closing Entries: Transfer balances of temporary accounts (revenue, expenses, and

dividends) to retained earnings.
○ Steps:
1. Close revenues to Income Summary.
2. Close expenses to Income Summary.
3. Close Income Summary to Retained Earnings.
4. Close Dividends to Retained Earnings.
● Post-closing Trial Balance: Ensures all temporary accounts have been closed and
checks that debits still equal credits.

9. Internal Controls

● Definition: Processes designed to safeguard assets, ensure accurate financial

reporting, and promote operational efficiency.
● Key Components:
○ Segregation of Duties: Dividing responsibilities among employees to reduce the
risk of error or fraud.
○ Authorization: Approving transactions before they are recorded.
○ Documentation: Maintaining evidence of transactions.
○ Reconciliation: Comparing records with actual assets (e.g., bank
reconciliations).

10. Cash and Bank Reconciliation

● Cash Controls: Safeguarding cash through internal controls like physical security,
authorized access, and regular reconciliations.
● Bank Reconciliation: A process of comparing the company’s cash records with the
bank statement to identify discrepancies (e.g., outstanding checks, deposits in transit,
bank fees).

11. Accounting for Receivables

● Types of Receivables:
○ Accounts Receivable: Amounts owed to the company by customers from sales
on credit.
○ Notes Receivable: Written promises from customers to pay a specific amount at
a future date.
● Bad Debts: Accounts receivable that are unlikely to be collected.
○ Allowance Method: Estimating uncollectible accounts and recording an
allowance to reduce accounts receivable.
○ Direct Write-off Method: Writing off specific uncollectible accounts when they
are deemed uncollectible.

12. Inventory Accounting

● Types of Inventory: Raw materials, work-in-progress, finished goods.
● Inventory Valuation Methods:
○ First-In, First-Out (FIFO): Assumes the oldest inventory items are sold first.
○ Last-In, First-Out (LIFO): Assumes the most recent inventory items are sold
first.
○ Weighted Average: Calculates a weighted average cost of inventory.
● Inventory Management: Ensuring the right balance of stock to meet demand without
overstocking or understocking.

13. Depreciation and Fixed Assets

● Fixed Assets: Long-term assets used in business operations (e.g., buildings,

machinery, equipment).
● Depreciation: The systematic allocation of the cost of a fixed asset over its useful life.
○ Straight-Line Depreciation:
Cost−Salvage ValueUseful Life\frac{\text{Cost} - \text{Salvage
Value}}{\text{Useful Life}}Useful LifeCost−Salvage Value
○ Declining Balance Method: Accelerated depreciation method, applying a
constant depreciation rate.
○ Units of Production: Depreciation based on usage or production levels.

14. Liabilities and Equity

● Current Liabilities: Debts or obligations due within one year (e.g., accounts payable,
short-term loans).
● Long-term Liabilities: Debts due beyond one year (e.g., long-term loans, bonds
payable).
● Equity: The residual interest in the assets of the company after deducting liabilities.
○ Common Stock: Represents ownership in a company.
○ Retained Earnings: Cumulative net income that has not been distributed as
dividends.

15. Ethics in Accounting

● Importance of Ethics: Maintaining trust in financial reporting and ensuring compliance

with laws and regulations.
● Key Concepts:
○ Integrity, objectivity, professional competence, confidentiality, and professional
behavior.