Accounting Lessons

Product Cost versus Period Cost

2012-05-21T08:00:00.001-07:00

Product Cost

Product cost consists of cost which have been used in making or acquiring the product. Product costs are included in determining the cost of a product. In a manufacturing business, their period cost consist of direct materials, direct labor and factory overhead. Product cost becomes part of the cost of inventory which is why it is also called inventoriable cost.

Period Cost

Period cost are cost which are not considered as product cost. These costs are charged against revenue for its full amount and are treated as expense without regards to production and sales. This is not part of the cost of inventory.

Management Accounting

2012-05-21T07:31:00.001-07:00

Management Accounting or managerial accounting is the application of accounting information to assist the managers of the entity in making reasonable decisions on achieving the objectives of the entity.

It also refers to reports designed to help the internal users of the entity.

Unlike financial accounting, it does not have principles to follow in preparing reports. The managers are the ones who make rules which they probably think will be the most useful in achieving its objectives.

Nature of Business Operations

2012-05-20T02:24:00.000-07:00

Many business are classified in one of these four types which are service, merchandising, manufacturing or financial services. But there are also some business that are a combination of two or more.

Service.A service company provides services to their clients for a fee.

Merchandising. A merchandising company buys goods which are available for sale, they add value to it, then sells them to customers with the added value.

Manufacturing. A manufacturing company buys the materials, converts them into products then sell these products to customers.

Financial services. Financial services companies deal in services related to money.

Debit and Credit

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Debit is the left side of the account. It is abbreviated as Dr from the Latin word debere.

Credit is the right side of the account. It is abbreviated as Cr from the Latin word credere.

Assets are increased in debit and decreased in credit.

Liabilities are increased in credit and decreased in debit.

Equity accounts are owner's capital, withdrawals, income and expense.

Owner's capital is increased in credit and decreased in debit.

Withdrawal is increased in debit and decreased in credit.

Income is increased in credit and decreased in debit.

Expense is increased in debit and decreased in credit.

Accounting Equation

2012-05-19T06:30:00.001-07:00

Accounting Equation is the most basic tool in accounting. It is the foundation of the double-entry system. It states that assets should always be equal to liabilities and equity.

You can also derive from the formula to get the liabilities and equity.

Account

2012-05-19T05:23:00.001-07:00

Account is the basic summary device of accounting. It shows the record of the decrease, increase and the balance of each of the element of the financial statements.

One example of account is the "T account" which is shaped like a letter T.

The debit (abbreviated as Dr) is always on the left side while the credit (abbreviated as Cr) is always on the right side.

Equity

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Owner's Equity can also be called net worth, net assets, capital or simply equity. It refers to the owner's interest in the entity. It is also define as the residual interest in the assets after deducting all of its liabilities.

The words used in reporting equity in the balance sheet depends on the form of business. Owner's equity is used on the balance sheet if the company is a sole proprietorship. Partners' equity is used in a partnership. And stockholders' equity or shareholders' equity in a corporation.

Liabilities

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Liabilities are defined as present obligation of entity because of past events. Its settlement is expected to result in an outflow of resources.

Liabilities are classified into two which are current and noncurrent liabilities. Current and noncurrent liabilities are reported separately in the statement of financial position.

Current Liabilities
These are liabilities which are settled within a year or the entity's normal operating cycle, whichever is longer.

Examples of current liabilities: Accounts payable, notes payable, unearned revenues, current portion of long-term debt

Noncurrent Liabilities
These are liabilities which are settled more than one year or beyond the normal operating cycle of the entity.

Examples of noncurrent liabilities: Bonds payable, mortgages payable, long-term notes payable

Assets

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What are assets?

Assets are resources owned or controlled by the entity. They represent probable future economic benefits which can be measured reliably. Assets arise as a result of past transaction or event.

Assets can be classified into two which are current and noncurrent assets.Current and noncurrent assets are reported separately in the statement of financial position.

Current Assets
Current assets are assets that are reasonably expected to be converted in cash, sold or consumed within one year or normal operating cycle, whichever is longer.

Examples of current assets: Cash and cash equivalents; accounts receivable; inventories; prepaid expenses

Noncurrent Assets
Noncuurent assets are all other assets not classified as current assets.

Examples of noncurrent assets: investments; property, plant and equipment; intangible assets

Normal operating cycle is defined as the average time it needs to go spending cash to receiving cash.

Basic Principles in Accounting

2012-05-16T08:36:00.000-07:00

These are the basic principles of accounting:

Consistency Principle. The entity should use the same accounting method and functions from period to period. This principle is also known as "principle of regularity".

Objectivity Principle. Accounting records should be based on a reliable data so that the financial reports will project the real financial position of the entity. This principle is also known as "principle of sincerity".

Full Disclosure/Materiality. All information that would affect the user's understanding should be disclosed in the records.

Cost Principle. This principle states that assets should be recorded at their original cost rather than their fair market value.

Business Entity Principle. The business is a separate entity from its owners. Personal accounts of the owners should be separate from the accounts of the business entity.

Time Period Principle. Financial statements are prepared in a particular period of time. This allows users to obtain timely information useful in their decision making. This principle is also known as "principle of periodicity".

Stable Monetary Unit. Transactions should be recorded in a single currency and exchange rate. Inflation is ignored in the accounting records.

Business Goals and Activities

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Major goals of all business are profitability and liquidity.

Profitability
Profitability is the potential of a business to be successful. It is the ability of a business to earn a financial income or gain.

Liquidity
Liquidity is the availability of cash to settle financial commitments when the are due.

For a business to achieve these goals, they should engage on business activities. The three types of business activities are financing, operating and investing.

Financing Activities
Financing activities involves obtaining resources to start the business and keep it going. These activities include obtaining and repaying loans, and also having investments and withdrawals by the owner.

Operating Activities
Operating activities involves the use of resources to design, produce, distribute and market goods and services. These activities include buying and selling of inventory, rendering services to customers and production.

Investing Activities
Investing activities involve spending capital to acquire other resources to help achieve the entity's objectives. These activities include buying land, building, equipment and other resources needed in operating the business and also selling them when they are no longer needed.

What is Accounting?

2012-05-16T06:48:00.000-07:00

American Accounting Association defines accounting as "the process of identifying, measuring and communicating".

Accounting Standards Council defines accounting as "a service activity".

Accounting vs. Bookkeeping

Accounting is considered by some as synonymous with bookkeeping but those two are totally different. Bookkeeping is concerned with systematic recording of transactions. While, accounting is the bigger picture. Accounting is concerned with preparing and interpreting financial reports. Accounting provides information for the management that will be useful for decision making.

Forms of Business

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Sole proprietorship, partnership and corporation are the three forms of business. Accounting process is different on each of the form of business.

Sole Proprietorship

This form of business may also be called "single proprietorship" or simply "proprietorship". This form of business is usually a small type of business. It is owned by a single person who usually runs the business. The owner of the business control and owns all the assets and receives all the profits but also absorbs all the losses and responsible for all the liabilities that the business may incur.

Partnership

This business is owned by two or more persons who bind themselves to contribute money, property or industry to a common fund. Profit is divided among the partners and each of the partner is liable for the liabilities of the partnership (only if it is pure general partnership).

Corporation

This is a big type of business which is why it is difficult to create, organize and manage. This business is owned by "stockholders". It is created under the law and is a separate legal entity. Stockholders are not liable for the liabilities of the corporation. Stockholders are only liable up to the amount of his/her investment. Personal belongings of the stockholders can not be used to settle the corporation's debts.