BASIC ACCOUNTING CONCEPT

1.1. Generally Accepted Accounting Principles(GAAP)

The accounting profession has developed standards that are generally accepted and universally practiced. This common set of standards is called generally accepted accounting principles (GAAP). These standards indicate how to report economic events.

The primary accounting standard-setting body in the United States is the Financial Accounting Standards Board (FASB).  Many countries outside of the United States have adopted the accounting standards issued by the International Accounting Standards Board (IASB). These standards are called International Financial Reporting Standards (IFRS).

As markets become more global, it is often desirable to compare the

results of companies from different countries that report using different accounting standards. In order to increase comparability, in recent years the two standard-setting bodies have made efforts to reduce the differences between U.S. GAAP and IFRS. This process is referred to as convergence.

Generally accepted accounting principles, or GAAP, are a set of rules that encompass the details, complexities, and legalities of business and corporate accounting. The Financial Accounting Standards Board (FASB) uses GAAP as the foundation for its comprehensive set of approved accounting methods and practices.

The Importance of GAAP

1.2 The Accounting Concepts

Slideshare:Accounting Concepts and Principles with Examples

12 Basic Accounting Principles

All 10 GAAP Principles – Meaning, Importance And More

Accounting Principles

1.3 The Accounting Equation

The two basic elements of a business are what it owns and what it owes. Assets are the resources a business owns. Liabilities and owner’s equity are the rights or claims against these resources.

For example, Google has total assets of approximately 

$93.8 billion.  Thus, Google has $93.8 billion of claims against its $93.8 billion of assets. Claims of those to whom the company owes money (creditors) are called liabilities. Claims of owners are called owner’s equity. Google has liabilities of $22.1 billion and owners’ equity of $71.7 billion.

We can express the relationship of assets, liabilities, and owner’s equity as an

equation, as shown below:

This relationship is the basic accounting equation.
 Assets must equal the sum of liabilities and owner’s equity.
Liabilities appear before owner’s equity in the basic accounting equation because they are paid first if a business is liquidated.

The accounting equation applies to all economic entities regardless of size, nature of business, or form of business organization. It applies to a small proprietorship such as a corner grocery store as well as to a giant corporation such as PepsiCo. The equation provides the underlying framework for recording and summarizing economic events.

Let’s look in more detail at the categories in the basic accounting equation.

 Assets : are resources a business owns. The business uses its assets in carrying out such activities as production and sales. The common characteristic possessed by all assets is the capacity to provide future services or benefits. In a business, that service potential or future economic benefit eventually results in cash inflows (receipts). 
For example, consider Campus Pizza, a local restaurant. It owns a delivery truck that provides economic benefits from delivering pizzas. Other assets of Campus Pizza are tables, chairs, jukebox, cash register, oven, tableware, and, of course, cash.

Liabilities: are claims against assets- that is, existing debts and obligations. Businesses of all sizes usually borrow money and purchase merchandise on credit. These economic activities result in payables of various sorts:

• Campus Pizza, for instance, purchases cheese, sausage, flour, and beverages on credit from suppliers. These obligations are called accounts payable.

• Campus Pizza also has a note payable to First National Bank for the money borrowed to purchase the delivery truck.

• Campus Pizza may also have salaries and wages payable to employees and sales and real estate taxes payable to the local government.

All of these persons or entities to whom Campus Pizza owes money are its creditors. Creditors may legally force the liquidation of a business that does not pay its debts. In that case, the law requires that creditor claims be paid before ownership claims.
Owner’s Equity: The ownership claim on total assets is owner’s equity. It is equal to total assets minus total liabilities. Here is why: The assets of a business are claimed by either creditors or owners. To find out what belongs to owners, we subtract the creditors’ claims (the liabilities) from assets. The remainder is the owner’s claim on the assets-the owner’s equity. Since the claims of creditors must be paid before ownership claims, owner’s equity is often referred to as residual equity.

Accounting Equation :The basis of accounting.

The Basic Accounting Equation

Analysis of business transactions is a mental process which includes the following four steps: 

1. Ascertaining the accounts involved in the transaction
2. Ascertaining the nature of accounts involved in the transaction
3. Determining the effects in terms of increase and decrease
4. Applying the rules of debit and credit

Analysis of business transactions

Introduction to GAAP and Transaction Analysis

Analyze Business Transactions Using the Accounting Equation and Show the Impact of Business Transactions on Financial Statements

(For Services and Merchandising Company)

A merchandising company engages in the purchase and resale of tangible goods. Service companies primarily sell services rather than tangible goods. Income statements for each type of firm vary in several ways, such as the types of gains and losses experienced, cost of goods sold, and net revenue.

1.4 Double Entry System

The double-entry system of accounting or bookkeeping means that for every business transaction, amounts must be recorded in a minimum of two accounts. The double-entry system also requires that for all transactions, the amounts entered as debits must be equal to the amounts entered as credits.

Double Entry Definition

Double entry Principle

Example: Double entry bookeeping

Double Entry Ledger 'T' Accounts (You Tube)

The Accounts:An account is an individual accounting record of increases and decreases in a specific asset, liability, or owner’s equity item. 

For example, Softbyte Co. 1) would have separate accounts for Cash, Accounts Receivable, Accounts Payable, Service Revenue, Salaries and Wages Expense, and so on. 

(Note that whenever we are referring to a specific account, we capitalize the name.)

In its simplest form, an account consists of three parts:
 (1) a title, (2) a left or debit side, and (3) a right or credit side. Because the format of an account resembles the letter T, we refer to it as a T-account. 

T - account (Slide share)

Debits and Credits: The term debit indicates the left side of an account, and credit indicates the right side. They are commonly abbreviated as Dr. for debit and Cr. for credit. They do not mean increase or decrease, as is commonly thought. We use the terms debit and credit repeatedly in the recording process to  describe where entries are made in accounts.

For example, the act of entering an amount on the left side of an account is called debiting the account. Making an entry on the right side is crediting the account.

When comparing the totals of the two sides, an account shows a debit balance if the total of the debit amounts exceeds the credits. An account shows a credit balance if the credit amounts exceed the debits.  

Understanding Debits and Credits in Accounting (Slide share)

Analyzing Transaction (Slide share)

Summary of Debit/Credit Rules

Illustration below, shows a summary of the debit/credit rules and effects on each type of account. Study this diagram carefully. It will help you understand the fundamentals of the double-entry system.

Debit and Credit Rules (Slide share)

The Recording Process Account (Presentation)

Recommended text/reading:

• Sangster, A., & Wood, F. (2019). Business accounting volume 2 (14th ed.). Pearson.
•  Sangster, A., & Wood, F. (2018). Business accounting volume 1 (14th ed.). Pearson.
•  Weagant, J.J., Kimmel, P.D., & Keiso, D.E. (2018). Accounting principles (12th ed.).  Wiley. (for this ebook you need to join this channel >> accounting <<
• Accounting Module, Matriculation Programme, Kolej MARA Kuala Nerang

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Sanisah Hanim Jiman