Units 1 and 2: Foundations of Accounting and Accounting for a Trading Business
What you must understand
Units 1 and 2 build the language of accounting. You need to know the accounting equation (Assets = Liabilities + Owner's Equity) and how every transaction affects it, the purpose of source documents, the distinction between cash and credit transactions, and the double-entry recording cycle from journal to ledger to trial balance. Understand the qualitative characteristics (relevance, faithful representation, comparability, verifiability, timeliness, understandability), the accounting assumptions (going concern, accrual basis, period, entity, monetary), and the reporting elements: assets, liabilities, equity, income and expenses. In Unit 2 the focus shifts to a trading business: inventory, sales and cost of sales, the perpetual inventory system, stock cards, and preparation of an income statement and balance sheet.
Traps that appear in questions
- Confusing a cash payment with an expense: buying inventory is an asset swap, not an expense until sold.
- Mixing owner's personal transactions with business transactions (entity assumption).
- Forgetting that cost of sales is recorded at the moment of sale under perpetual inventory, not at purchase.
- Misreading whether a transaction is on credit (creates a receivable or payable) or for cash.
- Reporting a drawings account as an expense rather than a reduction of equity.
- Forgetting that a trial balance can balance yet still contain errors (e.g. a transaction omitted entirely).
Worked example
A business buys inventory for $2,000 cash and later sells half of it for $1,600 cash. Purchase: inventory increases $2,000, bank decreases $2,000. Sale: bank increases $1,600; inventory decreases $1,000 and cost of sales increases $1,000; sales increase $1,600. Net effect on equity: profit of $600, not $1,600.
Rule of thumb
Ask three questions of every transaction: which two accounts change, do they increase or decrease, and does equity rise or fall?