Financial Accounting | Accounting Principles and the Accounting Equation

Financial Accounting

Accounting Principles and the Accounting Equation

Overview

This topic introduces the foundational principles of accounting, the concept of double-entry bookkeeping, and the accounting equation that underpins all financial recordkeeping. These fundamentals are essential for understanding how financial information is classified, recorded, and reported.

Key Concepts and Terms

Generally Accepted Accounting Principles (GAAP): A set of rules and standards used in financial reporting.
Entity Concept: The business is a separate legal entity from the owner.
Monetary Unit Assumption: Financial records are maintained in a stable currency.
Going Concern Assumption: The business is expected to continue operating indefinitely.
Accounting Equation: Assets = Liabilities + Owner’s Equity
Double-Entry System: Every transaction affects at least two accounts and keeps the equation balanced.
Debits and Credits: Debit (left side) increases assets and expenses; Credit (right side) increases liabilities, equity, and revenue.

Step-by-Step Example

Problem: A company receives $10,000 cash from the owner as an initial investment. How does this affect the accounting equation?

Step 1: Identify the accounts affected:

Increase in Cash (Asset) by $10,000
Increase in Owner's Equity by $10,000

Step 2: Update the accounting equation:

Assets = Liabilities + Owner’s Equity
10,000 = 0 + 10,000

Answer: The equation remains in balance.

Quick Tip

Every accounting transaction must keep the accounting equation in balance. If it doesn’t, something is recorded incorrectly!