Chapter 3: Key Accounting Concepts Flashcards
Master important accounting principles like double-entry accounting, prepaid expenses, and unearned revenue. Grasp the essential rules for managing financial systems effectively.
- What is double-entry accounting?
Double-entry accounting is a system where every transaction affects at least two accounts, ensuring the accounting equation (Assets = Liabilities + Equity) stays balanced. For example, if a business buys equipment for $1,000, it increases assets (equipment) and decreases cash (another asset) or increases liabilities (a loan).
- What is accrual basis accounting?
Accrual basis accounting records revenues and expenses when they are earned or incurred, not when cash is exchanged. For example, if a company delivers a service in January but gets paid in February, the revenue is recorded in January.
- What is cash basis accounting?
Cash basis accounting records revenues and expenses only when cash is received or paid. For example, if a business delivers a service in January but gets paid in February, the revenue is recorded in February under cash basis accounting.
- What is the difference between accrual and cash basis accounting?
The main difference is timing:
* Accrual basis focuses on when income or expenses are earned or incurred.
* Cash basis focuses on when money is received or paid.
For example, a company using accrual accounting would record a sale immediately, while one using cash basis accounting would wait until the customer pays.
- What are operating and non-operating expenses?
- Operating expenses are costs related to the core activities of a business, like salaries or rent.
- Non-operating expenses are costs unrelated to core activities, like interest on loans.
For instance, a bakery’s operating expense might be flour costs, while interest on a business loan is a non-operating expense.
- What is bookkeeping?
Bookkeeping is the process of recording financial transactions systematically. It includes tracking sales, purchases, payments, and receipts. For example, recording daily sales in a cash register log is part of bookkeeping.
- What is materiality in accounting?
Materiality refers to the significance of an item or transaction in financial reporting. If omitting or misstating it could influence decisions, it’s considered material. For example, a $5 mistake in a large corporation might not matter, but a $50,000 mistake would be material.
- What is GAAP?
GAAP (Generally Accepted Accounting Principles) is a set of accounting standards and guidelines followed in the U.S. to ensure consistency and transparency in financial reporting. For example, GAAP ensures that revenue is recognized when earned, not when received.
- Why is double-entry accounting important?
Double-entry accounting prevents errors by ensuring that every transaction is balanced. For example, if cash decreases, another account like equipment or expenses must increase, keeping the books accurate.
- Why is understanding key accounting concepts important?
These concepts provide a foundation for making informed financial decisions, maintaining accurate records, and complying with regulations. For instance, understanding GAAP helps businesses prepare reliable financial statements for investors and lenders.
