Basics of Accounting

Question 1

two primary bases of accounting

Answer 1

accrual basis and cash basis.

Question 2

Cash basis

Answer 2

At its basic level, cash basis accounting is the receipt of funds into an entity, and the payment for goods or services—deposits and checks. Revenue is recorded when it is received (deposited), and expenses are recorded when they are paid (check, wire, electronic payment, credit card, etc.).

Question 3

Accrual basis

Answer 3

revenue is recognized (recorded) when it is earned (not necessarily when it is collected), and expenses are recorded when they are incurred (not necessarily when they are paid).

• The accrual basis includes two major areas: accounts receivable (customer sales on account) and accounts payable (vendor purchases on account). The accrual basis conforms to generally accepted accounting principles (otherwise known as “GAAP”), and is the most common basis for all three levels of reporting on financial statements issued (audits, reviews, and compilations).

Question 4

Balance sheet

Answer 4

A balance sheet shows a company’s assets, liabilities, and shareholders’ equity at a point in time.

• Shareholders’ equity is often referred to as stockholders’ equity.
• The terms assets and liabilities are sometimes used in daily conversations. When these terms are used in financial statements, their meaning remains largely similar.
• Assets are anything that brings value to the business in the future,
• Whereas liabilities are something that is a future burden to the business.
• Shareholders’ equity is a complex topic: s money that the owners have invested in the company. Note that the shares you buy of, say, Apple, also fall under shareholders’ equity. This is because every shareholder owns a part of the company.

Assets = Liabilities + Shareholder equity

Question 5

Debit and Credit

Answer 5

In summary, debit and credit are used in accounting to record the increase or decrease in accounts. Debit represents the left side of an account and is used for assets, expenses, and losses, while credit represents the right side and is used for liabilities, equity, and revenues. The double-entry system ensures that debits and credits are balanced in every transaction.

Example:

Transaction: You receive $500 in cash from a customer as payment for services rendered.

Identify the accounts involved:

Cash (Asset account): Represents the cash received.
Revenue (Revenue account): Represents the revenue earned from the service provided.
Determine the debit and credit entries:

Debit Cash: Increase the Cash account on the left side by $500 to reflect the cash received.

Credit Revenue: Increase the Revenue account on the right side by $500 to recognize the revenue earned.

In this visualization, the debit entry ($500) is recorded on the left side (debit side) of the Cash account, while the credit entry ($500) is recorded on the right side (credit side) of the Revenue account.

It’s important to note that every transaction in the double-entry system maintains the accounting equation’s balance: Assets = Liabilities + Equity. The total debits must always equal the total credits, ensuring accuracy in financial reporting.

Question 6

Assets

Answer 6

Current Assets
Non Current Assets

Question 7

total_current_assets =

Answer 7

inventory + accounts_receivable (Remember this is in general)

Question 8

Accounts receivable

Answer 8

Accounts receivable refers to the money that a business is owed by its customers for products sold or services rendered on credit. When a company sells goods or services to a customer on credit, it issues an invoice indicating the amount owed and the payment terms, such as the due date and any applicable discounts.

These outstanding invoices are recorded as accounts receivable on the company’s balance sheet as a current asset, as they are expected to be collected within a relatively short period of time, usually within 30 to 90 days.

A business that has a high amount of outstanding accounts receivable may experience cash flow issues, as it may not have enough cash on hand to cover its own expenses.

Question 9

Inventory

Answer 9

Inventory refers to the goods or materials that a business holds for the purpose of resale or for use in its production process. It can include raw materials, work-in-progress, and finished goods.

Businesses need to manage their inventory levels effectively to avoid stockouts, excess inventory, or spoilage.

Inventory is recorded on a company’s balance sheet as a current asset, and the value of inventory is reported at the lower of cost or market value. This means that if the market value of inventory falls below its cost, the inventory is written down to reflect the lower value. On the other hand, if the market value of inventory rises above its cost, the inventory is not written up to reflect the higher value.

Question 10

total_non_current_assets =

Answer 10

long_term_investments + property_plant_equipment

Question 11

Long term investments

Answer 11

investments that a company plans to hold for an extended period of time, typically longer than one year. These investments are not intended for sale in the short-term and are expected to provide a return on investment in the long-term, through capital appreciation, dividends, or interest.

Long-term investments can take many forms, such as stocks, bonds, mutual funds, real estate, and other securities. These investments are typically made with excess cash that a company has on hand, and they are often held in order to diversify a company’s investment portfolio and generate returns over time.

Long-term investments are recorded on a company’s balance sheet as a long-term asset, and they are reported at their fair market value. The fair market value of these investments can fluctuate over time, and changes in value are recorded in a separate account called “unrealized gains or losses on long-term investments” until the investments are sold or disposed of.

Question 12

• Property, plant, and equipment (PP&E):

Answer 12

tangible assets that a company owns and uses in its operations to generate revenue. These assets include land, buildings, machinery, equipment, vehicles, furniture, and fixtures.

PP&E are typically long-term assets, meaning that they are expected to provide benefits to the company for more than one year. These assets are recorded on a company’s balance sheet at their cost, including any related expenses such as installation, taxes, and legal fees.

It’s worth noting that although the building itself is an asset and is recorded on the balance sheet, the expenses associated with the building are recorded as expenses on the income statement, and not directly on the balance sheet.

The balance sheet only shows the net value of the asset, which is the building’s cost minus accumulated depreciation, and any related liabilities, such as mortgages or loans used to purchase or improve the building.

Question 13

Liabilities

Answer 13

Current
Non current

Question 14

total_current_liab =

Answer 14

short_term_loans + accounts_payable

Question 15

Short-term loans:

Answer 15

Short-term loans are a type of debt financing that businesses use to raise funds for a period of less than one year. These loans are typically used to cover short-term working capital needs, such as inventory purchases, accounts payable, or payroll expenses.

Short-term loans can be obtained from a variety of sources, including banks, credit unions, online lenders, and other financial institutions. The interest rates on short-term loans are typically higher than those for long-term loans, due to the shorter repayment period and the higher risk associated with short-term lending.

Short-term loans are recorded on a company’s balance sheet as a current liability, which means that they are due within one year or less. The balance sheet will show the principal amount of the loan, any accrued interest, and any fees associated with obtaining the loan.

Businesses must carefully manage their short-term loans to ensure that they have sufficient cash flow to meet their repayment obligations when they come due.

Question 16

• Accounts payable

Answer 16

is a liability that arises when a company purchases goods or services on credit from its suppliers. This liability represents the amount of money that a company owes to its suppliers for goods or services that have been received but not yet paid for.

Accounts payable is recorded on a company’s balance sheet as a current liability, meaning that it is due to be paid within one year or less.

Accounts payable is also an important component of the company’s working capital management, as it represents a source of short-term financing that can help to fund the company’s operations.

Question 17

total_non_current_liab = long_term_loans

Answer 17

• Long term loans: Long-term loans are a type of debt financing that businesses use to raise funds for a period of more than one year. These loans are typically used to finance long-term investments in fixed assets, such as property, plant, and equipment, or to fund growth and expansion initiatives.

Long-term loans can be obtained from a variety of sources, including banks, credit unions, private lenders, and other financial institutions.

Question 18

The Five Accounting Cycles

Answer 18

1. Sales and Accounts Receivable :
2. Purchases and Accounts Payable:
3. Human Resources and Payroll:
4. Inventory and Storage/Warehousing:
5. Capital Expenditures

Ledgers and Journals.

Question 19

1. Sales and Accounts Receivable :

Answer 19

• The fundamental concept of any business involves getting business (sales) from customers, billing for those goods or services, and then making sure the accounts receivable are collected.
• Separation of duties, Physical safeguards of assets, Audit trail (i.e., adequate and proper documentation of transactions), Approval process, Independent checks on the system

Question 20

2. Purchases and Accounts Payable:

Answer 20

• In order to manufacture and/or supply goods and services, a business obviously must procure and pay for the goods and services that underlie its sales.
• . Specifically, depending on what is purchased, the purchases and accounts payable cycle can affect balance sheet accounts, including cash, inventory, and prepaid expenses (collectively “current assets”); equipment, land, buildings, and accumulated depreciation (“fixed assets”); accounts payable and accrued expenses (“current liabilities”); as well as other assets and liabilities
• Similarly, in the income statement, just about every account is affected by this cycle, from cost of sales or cost of goods sold (which typically, when deducted from sales, results in a company’s gross profit or gross margin)

Question 21

3. Human Resources and Payroll:

Answer 21

• From an accounting cycle perspective, there are many accounts primarily affected by these functions, specifically, cash and payroll taxes payable on the balance sheet, and salaries/payroll, payroll taxes, benefits, travel and entertainment, and other related expenses on the income statement
• The safeguards for this cycle are necessary for the prevention of nonexistent (also known as “ghost”) employees, falsified hours and overtime, false expense reports, and false medical claims.

Question 22

4. Inventory and Storage/Warehousing:

Answer 22

• The processes for this cycle, from an accounting standpoint, include processing requisitions for purchases, receipt of raw materials and finished goods, storage of raw materials and finished goods, and shipment of goods to customers.
• From an accounting cycle perspective, this function mainly affects inventory on the balance sheet and cost of goods sold in the income statements

Question 23

5. Capital Expenditures

Answer 23

• This accounting cycle is also known as the capital acquisition and repayment cycle, or the financing cycle. It includes the borrowing of funds, the debt of a company, and so on. Several transactions surround this part of the cycle, specifically recording of capital purchases and the related financing (including debt and interest); payment of interest and dividends; and any equity financing
• From an accounting cycle perspective, this function commonly affects cash, fixed assets, long-term and short-term liabilities (such as mortgages and lines of credit), capital and retained earnings on the balance sheet, and interest expense paid on the debt on the income statement.

Question 24

Ledgers and Journals.

Answer 24

This process is important for financial investigators. To trace the balances and activity as reported on an organization’s financial statements, you will need to request the underlying trial balance reports, general ledgers, and all subsidiary or supporting ledgers and journals (sales, receipts, etc.) to enable a drill-down in reverse from the reported results and balances to the underlying supporting detail (individual transactions)