Accounting: The Accounting Cycle and Financial Statements
Core concepts
Accounting questions test the double-entry system, the accounting equation (Assets = Liabilities + Equity), journal entries, posting to ledgers, the trial balance, adjusting entries, and preparation of the income statement and balance sheet. Understand debit and credit rules for each account class and the matching and accrual principles.
Traps to watch
Common traps include confusing capital expenditure with revenue expenditure, misclassifying drawings as an expense, and forgetting that a trial balance can balance despite errors of principle or omission. Depreciation is an allocation of cost, not a cash fund. Also watch the treatment of prepaid and accrued items in adjusting entries, and remember that closing stock affects both the trading account and the balance sheet.
Worked example
A firm pays 12,000 in advance for one year's rent on 1 October, and the year ends 31 December. Prepaid rent for three months remains: 12,000 × 3/12 = 3,000. The adjusting entry debits Prepaid Rent 3,000 and credits Rent Expense 3,000, reducing the expense for the year to 9,000. Rule of thumb: expense recognised equals the expired portion; the unexpired portion is an asset.
Strategy
For every transaction, identify accounts affected and apply debit-credit rules before writing entries. Use the accounting equation to check balances. In statement questions, classify items first (asset, liability, revenue, expense) and then place them.