General Topics: The Accounting Framework and the Accounting Cycle
Financial accounting is a rules-based system for recording, summarizing, and reporting economic events to external users. Start with the accounting equation: Assets = Liabilities + Equity. Every transaction preserves it, which is why double-entry bookkeeping always touches at least two accounts and total debits equal total credits.
The accounting cycle runs: analyze transactions, journalize, post to the ledger, prepare an unadjusted trial balance, make adjusting entries, prepare an adjusted trial balance, prepare financial statements, and make closing entries. Adjusting entries fall into two families: deferrals (prepaid expenses and unearned revenues, where cash moved before the expense or revenue was recognized) and accruals (accrued revenues and accrued expenses, where recognition precedes cash). Closing entries zero out temporary accounts (revenues, expenses, dividends, and Income Summary) into retained earnings; permanent accounts carry forward.
Traps to watch: (1) Confusing the cash basis with the accrual basis-accrual accounting recognizes revenue when earned and expenses when incurred, regardless of cash. (2) Forgetting that a trial balance can balance while still containing errors (e.g., a transaction recorded in the wrong account, or omitted entirely). (3) Mixing up the current versus long-term classification of an item. (4) Assuming debits are always "bad"-debits increase assets and expenses but decrease liabilities, equity, and revenues.
Rule of thumb (DEALER): Dividends and Expenses and Assets increase with debits; Liabilities, Equity, and Revenues increase with credits. Worked example: A company pays $1,200 in advance for six months of rent on the first day of the month. The entry is Debit Prepaid Rent $1,200 / Credit Cash $1,200. At month-end, one month is used: Debit Rent Expense $200 / Credit Prepaid Rent $200. The remaining $1,000 is a current asset.