Financial Accounting
FINANCIAL ACCOUTING (NOTES) – Module 2
2.1 ECONOMIC EVENTS AND ACCOUNTING EVENTS .....................................................................2
2.2 THE DUALITY PRINCIPLE AND THE DOUBLE-ENTRY METHOD ..................................................2
2.3 ACCOUNTS AND ACCOUNTING BOOKS ...................................................................................2
JOURNAL ...........................................................................................................................................2
GENERAL LEDGER ................................................................................................................................3
INVENTORY BOOK AND ANNUAL ACCOUNTS .............................................................................................3
2.4 HOW ACCOUNTS WORK .........................................................................................................3
2.5 THE ACCOUNTING PROCESS OF RECORDING ..........................................................................3
ASSETS .............................................................................................................................................3
LIABILITIES AND EQUITY ........................................................................................................................4
EXPENSES ..........................................................................................................................................4
REVENUES .........................................................................................................................................4
ACCOUNTING PROCESS OF RECORDING .....................................................................................................4
2.6 RECOGNITION OF ACCOUNTING EVENTS, VALUATION CRITERIA AND DERECOGNITION OF
ITEMS IN ACCOUTING .....................................................................................................................4
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Financial Accounting
2.1 Economic events and accounting events
Those economic events that affect a company´s financial position are business transactions.
To measure them there are three steps to follow:
1. Recognition: when the transaction took place. When a business transaction should be
recorded; the recognition point.
2. Valuation: the monetary value assigned to business transactions.
a. Transactions should be valued at fair value when they occur.
b. Generally, an asset´s value remains at its initial fair value or cost until it is sold,
expires, or is consumed.
3. Classification: assigning all transactions to appropriate categories or accounts.
Recognition, valuation, and classification are an indisputable part of accounting decision-
making.
2.2 The duality principle and the double-entry method
The double entry systems is crucial in the accounting process. It follows the principle of
duality, which says that every effort/ sacrifice has a reward/benefit. Each transaction must be
recorded with at least on credit and one debit. Total amounts of debits must equal total
amount of credits.
2.3 Accounts and accounting books
Accounts are used to store accounting data from similar transactions.
• There are separate accounts for each asset, liability and
element of stockholder´s equity.
• A T-account has three parts: the title identifying the asset,
liability or stockholder´s equity accounts; a left side called the
debit; and a right side called the credit.
There are several types of accounting books:
• Journal (Mandatory and Principal)
• General Ledger (Voluntary and Principal)
• Inventory Book and Annual Accounts (Mandatory and Principal)
• Minutes book (Mandatory and Auxiliary)
• Others (Voluntary and Auxiliary)
Journal
Is material support for the chronological recording of accounting events.
It is an aggregate book which presents raw accounting data. It contains all day-to-day records
of the company´s transactions in chronological order. Each record is called a journal entry.
Journal entries are recorded in the company´s local
currency and include information such as the date, related
account name (or code), description, and debit/ credit
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Financial Accounting
amounts. It is mandatory to record all of the company´s accounting transactions in the
journal.
General Ledger
Material support for recording account movements.
Each transaction generates two effects in the firm´s equity (double-
entry): an origin and a destination of resources that must be recorded
simultaneously. This system allows changes in a particular account to
be easily tracked.
Inventory Book and Annual Accounts
It includes an initial balance sheet, quarterly trial balances, inventories at closing and annual
accounts at closing.
2.4 How accounts work
An account is formed in the T-shape. Each transaction has a twofold (double) impact on the
firm´s equity: an origin and a destination, which is the concept of double-entry bookkeeping.
Transactions can either increase the debit or the credit side.
Debit: is what the business owns.
Credit: what the business owes.
Transactions can either increase the debit or the credit side.
If the total of debit entries exceeds the total of credit entries: debit balance, and vice versa. If
both are the same: zero balance.
At the end of the accounting period, all accounts need to be closed. This process involves
creating financial statements for the next period.
• Income statement accounts are temporary accounts, their balances are not carried
forward to the next period.
• Balance sheet accounts are permanent accounts, their balances are carried forward.
2.5 The accounting process of recording
Assets
• Accounts begging with a debit entry.
• They can receive entries on the debit and credit sides.
• Restriction: debit ≥ credit.
• Final balance: debit or zero balance.
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Financial Accounting
Liabilities and Equity
• Accounts begin with a credit entry.
• They can receive entries on the debit and credit size.
• Restriction: credit ≥ debit.
• Final balance: credit or zero balance.
Expenses
• They decrease equity.
• They increase with debit registries.
• Unilateral working: these accounts have entries on the credit side (cannot be
credited).
Revenues
• They increase equity.
• They increase with credit registries.
• Unilateral working: these accounts cannot have entries on the debit side (cannot be
debited).
Accounting process of recording
When recording a transaction in the Journal and the General Ledger, the following questions
need to be answered:
1. What accounting elements are involved in this transaction?
2. To which categories do these elements belong (assets, liabilities, equity)?
3. What is the effect of this transaction? Does it increase or decrease any accounts?
4. Do these elements start with a debit or credit?
5. What is the value of this elements? What is the amount?
2.6 Recognition of accounting events, valuation criteria and derecognition of items in
accouting
Accounting is maintained on an accrual basis: revenues and expenses are recorded in the
periods in which they are incurred, and not necessarily when the actual cash flows occur.
At the end of each accounting period, it is important to ensure that all realized transactions
have been accounted for.