Principles of Financial Accounting: Introduction to Accounting - Branches of Accounting, Financial Managerial Tax Auditing Forensic

Branches of Accounting

What It Is

Financial accounting focuses on preparing financial statements for external stakeholders, such as investors and creditors. Managerial accounting, on the other hand, provides internal decision-makers with financial information to make strategic decisions. Tax accounting involves preparing tax returns and ensuring compliance with tax laws. Auditing ensures the accuracy and reliability of financial statements. Forensic accounting applies accounting skills to investigate and analyze financial crimes.

Key Concepts & Formulas

• Financial Accounting Equation: Assets = Liabilities + Equity. Example: If a company has $100,000 in assets and $50,000 in liabilities, its equity is $50,000.
• Gross Profit: Gross Profit = Sales – COGS (Cost of Goods Sold). Example: If a company sells $100,000 in products and has a COGS of $60,000, its gross profit is $40,000.
• Debit Rule: Debit what comes in (assets, expenses, dividends) and credit what goes out (liabilities, equity, revenues). Example: If a company receives $10,000 in cash, it would debit Cash $10,000 and credit Cash $10,000 (no net effect).
• Credit Rule: Credit what comes in (liabilities, equity, revenues) and debit what goes out (assets, expenses, dividends). Example: If a company pays $5,000 in cash for rent, it would debit Rent Expense $5,000 and credit Cash $5,000.
• Current Ratio: Current Ratio = Current Assets / Current Liabilities. Example: If a company has $100,000 in current assets and $50,000 in current liabilities, its current ratio is 2:1.
• Return on Equity (ROE): ROE = Net Income / Total Equity. Example: If a company has a net income of $20,000 and total equity of $100,000, its ROE is 20%.
• Accrual Accounting: Match revenues and expenses with the period in which they are earned or incurred. Example: If a company earns $5,000 in revenue in December but doesn't receive payment until January, it would accrue the revenue in December.
• Matching Principle: Match costs with the revenues they help to generate. Example: If a company incurs $10,000 in salaries in December, it would match those costs with the revenues earned in December.

Journal Entry Examples

1. Dr. Cash $10,000 Cr. Accounts Receivable $10,000

Explanation: When a company receives cash from a customer, it debits Cash and credits Accounts Receivable.

1. Dr. Rent Expense $5,000 Cr. Cash $5,000

Explanation: When a company pays cash for rent, it debits Rent Expense and credits Cash.

1. Dr. Accrued Salaries $5,000 Cr. Salaries Expense $5,000

Explanation: When a company incurs salaries expense but hasn't paid it yet, it debits Accrued Salaries and credits Salaries Expense.

Common Mistakes

1. Mistake: Confusing debits and credits for expense accounts. Correction: Remember that debits increase assets, expenses, and dividends, while credits increase liabilities, equity, and revenues.
2. Mistake: Not matching revenues and expenses with the period in which they are earned or incurred. Correction: Use accrual accounting to match revenues and expenses with the period in which they are earned or incurred.
3. Mistake: Not considering the matching principle when matching costs with revenues. Correction: Match costs with the revenues they help to generate.

Exam Tips

1. Tip: Remember that a debit increases assets AND expenses – remember ‘ADE’ (Assets, Drawings, Expenses).
2. Tip: Be careful with reversing normal balances – a debit increases assets, while a credit increases liabilities and equity.
3. Tip: Use the financial accounting equation to ensure that assets, liabilities, and equity are balanced.

Quick Practice

1. What is the adjusting entry for accrued salaries of $5,000? Answer: Dr. Accrued Salaries $5,000, Cr. Salaries Expense $5,000. Explanation: When a company incurs salaries expense but hasn't paid it yet, it debits Accrued Salaries and credits Salaries Expense.
2. What is the journal entry for a company that receives $10,000 in cash from a customer? Answer: Dr. Cash $10,000, Cr. Accounts Receivable $10,000. Explanation: When a company receives cash from a customer, it debits Cash and credits Accounts Receivable.
3. What is the current ratio of a company with $100,000 in current assets and $50,000 in current liabilities? Answer: 2:1. Explanation: The current ratio is calculated by dividing current assets by current liabilities.

Last-Minute Cram Sheet

1. Dividends are NOT an expense – they go directly to retained earnings.
2. Assets = Liabilities + Equity.
3. Gross Profit = Sales – COGS.
4. Debit what comes in (assets, expenses, dividends) and credit what goes out (liabilities, equity, revenues).
5. Credit what comes in (liabilities, equity, revenues) and debit what goes out (assets, expenses, dividends).
6. Current Ratio = Current Assets / Current Liabilities.
7. Return on Equity (ROE) = Net Income / Total Equity.
8. Accrual Accounting matches revenues and expenses with the period in which they are earned or incurred.
9. Matching Principle matches costs with the revenues they help to generate.
10. Reversing normal balances can lead to errors – be careful!