Reading 2022-02-13

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Notes from reading

Notion of debit/credit:

  • DEBITS represent the flow of economic benefit to a destination
  • CREDITS represent the flow of economic benefit from a source

Notion of Assets/Liabilities:

  • Assets: future economic benefit
  • Liabilities: future economic sacrifice

I also found that this interpretation of the basic equation of Accounting is easier to understand.

Assets = Liabilities + Equity

Assets = Liabilities + (Owner's Equity - Dividends + Retained Earnings)

Assets = Liabilities + Owner's Equity - Dividends + (Revenue - Expenses)

or can be rewritten as:

Assets + Dividends + Expenses = Liabilities + Owner's Equity + Revenue

which leads to

  • the accounts on the left side of equation INCREASE when DEBITED
  • the accounts on the right side of equation INCREASE when CREDITED

or a trick to memorize when to Debit/Credit trick-to-memorize

There are 2 definitions of Equity

  1. Equity is the residual value of an entity's Assets after deducting all of its Liabilities
    or the basic equation: Equity = Assets - Liabilities
  2. Equity represents the net funds invested into a business by its owners or Equity = Capital Contributions + Retained Earnings equity

Some jargons and their equivalents for each type of entity's ownership: terminology

  • Temporary accounts: Revenue, Expenses, Dividends
    • closing balance at the end of accounting period is reset to 0
  • Permanent accounts: Assets, Liabilities, Equity
    • closing balance at the end of accounting period is carried forward into next term

Accrual basis of accounting

  • Revenue recognition: Revenue is recognized as it's earned, not when Cash is received
  • Matching principles: Expenses are recorded as they incurred, not when Cash is paid out

Cash flow statements

  • prepared by Direct Method
    • suitable for small firm
    • easier to read for investors
    • costly and time-consuming for accountants in large companies to do direct-method
  • prepared by Indirect Method
    • preferred by large companies
    • far less intuitive to understand for investors indirect-method
  • These 2 methods is differentiated by their layout of Cash Flow from Operating Activities. Or, the Cash Flow from Investing and Financing Activities are identical in both methods

Working Capital = Current Assets - Current Liabilities

Accrued Expense: is a past expense that hasn't been recorded or paid for yet

  • example: you receive your utility bill (water, gas) every 3 months, but you have to record accrued expense for your monthly consumption

Accrued Revenue: is revenue that has been earned in the past but not invoiced yet, aka unbilled revenue

Prepaid Expense: is a future expense which has been paid for in advance

  • example: on Dec 2021, you have to pay $100 for insurance in period starting from Jan 2022 prepaid-expense

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