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Fundamentals of Financial Accounting
Definitions & notes:

Financial accounting plays a vital role in providing accurate and reliable information
about a company's financial activities, enabling stakeholders to make informed
decisions and assess its overall performance
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The primary objectives of
financial accounting include:
a) Record-keeping: Financial accounting involves the systematic and organized
recording of all financial transactions of a business
...
By maintaining a comprehensive record of these transactions,
financial accountants ensure the accuracy and reliability of the financial
information
...
The
financial accountant records the details of this transaction, such as the date of
the sale, the amount sold, the customer's information, and any associated
costs or discounts
...

b) Financial Statement Preparation: Financial accounting is responsible for
preparing financial statements, which are formal reports that provide an
overview of a company's financial position and performance during a specific
period
...

The balance sheet presents the company's assets, liabilities, and
shareholders' equity at a given point in time
...
This statement helps stakeholders assess the company's financial
health and solvency
...
It provides information about the company's profitability and
performance
...
It shows how the company generates and
uses cash, providing insights into its liquidity and ability to meet financial
obligations
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This information is then used to calculate the
shareholders' equity, which reflects the net worth of the company
...
These users rely on
the financial statements and other financial reports to evaluate the company's
financial performance, make investment decisions, assess creditworthiness,
and determine regulatory compliance
...
Similarly, creditors may examine the
financial statements to evaluate the company's ability to repay loans and meet
its financial obligations
...
It represents
the relationship between three key elements of a business's financial position:
assets, liabilities, and equity
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a) Assets: Assets are the economic resources owned or controlled by a
business that have measurable value and provide future benefits
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Assets represent what the
business owns and uses to generate revenue
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These assets enable the company to produce goods,
generate sales revenue, and contribute to its overall value
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They arise from past transactions or events and require the
business to make future payments or provide goods or services
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Continuing with the manufacturing company example, if the company borrows
money from a bank to purchase new equipment, the loan amount represents a
liability
...

c) Equity: Equity represents the residual interest in the assets of a business after
deducting liabilities
...
Equity can be contributed capital, such as
investments made by owners, and retained earnings, which are the
accumulated profits reinvested in the business over time
...
Additionally, any profits
earned by the company that are not distributed as dividends but reinvested in
the business would also increase equity
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Every financial transaction affects at least two elements of the equation,
ensuring that the equation remains in balance
...
The increase in assets is offset by an increase in liabilities, keeping
the equation balanced
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The increase in assets is matched by an increase in equity,
maintaining the equation's balance
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3-Types of Accounts: Financial transactions are classified and recorded in various
accounts to facilitate accurate and organized tracking of resources
...

They include cash, accounts receivable, inventory, property, plant, and
equipment
...

b) Liabilities: Liabilities are obligations or debts owed by the business to
external parties
...
Liabilities reflect the company's financial
obligations and claims against its resources
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It reflects the owners' investment and their share of
accumulated profits or losses
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Revenues: Revenues are the income generated by the business from its
primary operations
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Revenues increase the equity of the business
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Expenses: Expenses are the costs incurred in the process of generating
revenue
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Expenses decrease the equity of the business
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For example, the sale of assets at a price higher than their carrying value
would result in a gain
...
They occur when assets are sold at a price lower than their carrying
value or due to other non-operating events
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According to this
accounting system, every transaction is recorded with equal debits and credits,
maintaining the balance of the accounting equation
...

a) Debits and Credits: In double-entry accounting, each transaction is recorded
with at least two entries - a debit and a credit
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

Debits: Debits are recorded on the left side of an account
...
Debits
are used to record the sources of funds or the uses of assets in a transaction
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They represent
increases in liabilities and equity or decreases in assets and expenses
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b) Maintaining Balance: The double-entry accounting system ensures that the
accounting equation (Assets = Liabilities + Equity) remains in balance after
each transaction
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For example, suppose a company purchases inventory by paying cash
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

Inventory (Asset): The inventory account is credited to record the increase in
the company's inventory as a result of the purchase
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c) Comprehensive Recording: Double-entry accounting provides a
comprehensive approach to recording financial transactions
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For instance, when a company receives payment from a customer for goods
sold, the transaction involves multiple accounts:


Accounts Receivable (Asset): The accounts receivable account is debited to
record the decrease in the amount owed by the customer
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This transaction reflects both the reduction in accounts receivable (the source
of funds) and the increase in cash (the use of funds), providing a
comprehensive record of the transaction
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This system helps in identifying errors or
discrepancies and provides a robust framework for financial reporting
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The three primary financial statements are:
a) Balance Sheet: The balance sheet is a snapshot of a company's financial
position at a specific point in time, typically at the end of an accounting period,
such as a quarter or a fiscal year
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Here's a breakdown of each component:
Assets: These are the economic resources owned or controlled by the
company
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For example, a technology company may list its assets as cash,
accounts receivable from customers, computers and servers, and intellectual
property rights
...
Liabilities also include items like deferred revenue or customer
deposits
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Shareholders' Equity: This shows the residual interest in the company's
assets after deducting its liabilities
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Shareholders' equity consists of
common stock, preferred stock, retained earnings, and additional paid-in
capital
...

b) Income Statement: The income statement, also known as the profit and loss
statement or statement of operations, summarizes a company's revenues,
expenses, gains, and losses over a specific period, such as a month, quarter,
or year
...
Here
are some components:
Revenues: These represent the company's earnings from the sale of goods or
services
...
For instance, a software company may generate revenues from
the sales of its software licenses or subscriptions
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They can include costs of goods sold,
salaries and wages, rent, utilities, advertising expenses, and depreciation
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Gains and Losses: These are non-operating items that affect the company's
profitability
...
Losses may arise
from asset write-offs, impairment charges, or discontinued operations
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The net income or net loss is calculated by subtracting total expenses and
losses from total revenues and gains
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c) Cash Flow Statement: The cash flow statement provides a comprehensive
summary of a company's cash inflows and outflows from its operating,
investing, and financing activities
...
Here's an overview:
Operating Activities: This section shows the cash flows generated from the
primary business operations, such as cash received from customers and cash
paid to suppliers, employees, and other operating expenses
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Investing Activities: This section reflects the cash flows related to the
company's investment activities, such as the purchase or sale of property,
plant, and equipment, acquisition or sale of investments, and loans made to
other entities
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Financing Activities: This section presents the cash flows resulting from the
company's financing activities, such as the issuance or repurchase of shares,
payment of dividends, borrowing or repayment of loans, and proceeds from
issuing or repaying bonds
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The net change in cash during the period is calculated by summing the cash
flows from operating, investing, and financing activities
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Conclusion: In conclusion, understanding the fundamentals of financial accounting
is essential for any business or individual involved in financial decision-making
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